Equity Education

Equity glossary

8 January 2024
The Carta Team

From shares to options and pre-emption to preferences, understanding equity can sometimes feel like learning to speak a new language. And to make matters more complicated, startups, law firms, private equity firms and venture capital firms often add their own definitions into the mix.

Our mission at Carta is to make the language of equity accessible to employees, founders and investors alike. Whether you’re new to equity or an expert on the topic, you’ll find useful definitions for the essential equity terms in this glossary.

409A valuation

An independent assessment of the fair market value (FMV) of a company’s ordinary shares, named after section 409A of the IRS Internal Revenue Code (IRC).

Actual market value (AMV)

A company’s share price, determined by valuing share options in light of certain restrictions found in shares issued to minority shareholders like employees. Restrictions include vetoes on transfers, risk of forfeiture and pre-emption provisions, among others. The AMV may be significantly lower than the unrestricted market value (UMV).

Anti-dilution

A clause built into the terms of shares, warrants and convertible loan notes that shields investors from dilution. Even when new shares are created and issued, the investors’ stake in the company remains the same. The most common anti-dilution provisions apply when shares are sold to new investors at a price lower than that paid by earlier investors.

Angel investor

A high-net-worth individual or fund that provides financial backing – primarily to early-stage startups or entrepreneurs – in exchange for equity ownership in a company.

Articles of association (AoA)

A set of documents laying out rules for running a company, agreed upon by its shareholders, directors and company secretary. May include information on how shares are issued, what rights are granted to shareholders and how the option pool is authorised. Also known as articles of incorporation in some jurisdictions.

Board of directors (BoD)

A group of individuals elected by a company’s shareholders to oversee its development and influence important decisions such as hiring or terminating the CEO. May include investors, mentors and C-suite executives.

Board resolution

The formal approval of an agreement or decision made by a company’s board of directors. Used to adopt an EMI share plan and authorise company management to issue options.

Bootstrapped

A term used to describe a company financed by its own revenue or the founder’s personal capital instead of investors, crowdfunding or bank loans.

Bridge loan

A short-term fundraise providing a startup with immediate capital to cover expenses until the next major round of funding. Also known as a swing loan; typically no longer than 12 months.

Burn rate

A measurement of how fast a company with a negative cash flow is spending its capital.

Capital gains tax (CGT)

A tax on the profit (gain) made by disposing of an asset that has increased in value. Only applies to gains above the tax-free allowance. Each jurisdiction carries different tax rates and exclusions.

Cap table

A capitalization table, or cap table, is a list of all the securities a company has issued, who owns them (stakeholders) and under what terms. Common shares, preferred shares, options, warrants and convertible loan notes are all types of security that may feature on the cap table. Stakeholders listed may include founders, investors, advisors and employees.

Cashless exercise

A transaction that allows an employee to exercise share options without having to pay cash upfront to cover the exercise price. Also known as a same-day sale, a cashless exercise must be pre-organised with a broker.

Cash flow

The net balance of cash moving in and out of a business at a specific point in time. Positive cash flow means a company has more money moving into it than out, while negative cash flow indicates the reverse.

Cliff

A point in time after which employee equity on a vesting schedule begins to vest. Also known as a “vesting cliff”, it is typically fixed at one year after the grant date. 

Common share

A security that represents company ownership and allows the grantholder certain rights, such as electing the board of directors and voting on corporate policies. Also known as an ordinary share.

Companies House

A government body that stores information on all the limited companies registered in the UK. Reports filed to Companies House include statutory accounts and confirmation statements.

Company Share Option Plan  (CSOP)

A government-approved share scheme in the UK, in which options are available for exercise three years after the grant date and capital gains tax applies at the point of sale. Income tax and National Insurance contributions do not apply.

Convertible loan note (CLN)

A short-term debt that is converted into equity shares at a later date. Typically allows the investor to receive a discounted share price based on the company’s future valuation. The debt may sometimes be repaid or cancelled instead of being converted.

Dilution

A decrease in existing shareholders' ownership percentage of a company, as a result of the company issuing new equity.

Down round

Funding raised at a lower company valuation than the previous financing round.

Due diligence

The process of examining a company’s operations and finances, carried out by a potential investor or buyer. Includes financial records, product, team, contracts and supply chains.

EMI annual return

A compulsory annual filing submitted to HMRC that lists out all the relevant changes to a company’s EMI scheme within the tax year. Currently due annually on 6 July.

EMI notification

A compulsory filing submitted to HMRC within 92 days of issuing new grants under an EMI scheme. Provides information about new grantholders, the number of options issued, vesting schedules and exercise prices. To be discontinued from April 2024.

Employee share ownership plan (ESOP)

A government-approved share scheme for awarding share options to employees. Entitles the company and employees participating in the scheme various tax benefits.

Enterprise Investment Scheme (EIS)

A UK investment scheme which helps companies to fundraise by incentivising investors with tax relief.

Enterprise Management Incentive (EMI)

The UK’s most popular employee share scheme. It provides a tax-efficient means of rewarding, incentivising and retaining qualifying employees. Among other benefits, participants pay no tax upon exercising their options, and only 10% capital gains tax on selling their shares.

Equity

Any type of security that represents ownership in a company, such as common shares, growth shares, share options and warrants.

Equity management

 The process of managing company ownership. Includes tracking and reporting changes in ownership, maintaining and submitting compliant documentation to local authorities, communicating with stakeholders and consulting the board of directors.

Exercise

The process of converting an option agreement’s underlying security, such as an employee purchasing company shares at the predetermined strike price.

Exercise price (or strike price)

The fixed price (per share) paid by an employee grantholder to exercise their share options, as defined in the option agreement. Calculated using the actual market value (AMV) of the company’s shares, and typically heavily discounted from the investor share price.

Exercise window

The window of time a former employee has to exercise their options after leaving a company. Exercise windows are set by the company and can range from 30 days to 10 years.

Exit

An event – such as an IPO, merger or acquisition – that marks the sale or change in control of a company, in which shareholders exit by liquidating their equity.

Fair market value (FMV)

The estimated value of an asset if it were sold on the open market today. The fair market value of a private company’s common shares is determined by its 409A valuation for US tax purposes.

Fully diluted equity

The total number of shares that each stakeholder would hold if all of the company’s legal obligations towards its stakeholders were fulfilled. Assumes the conversion of convertible loan notes into equity and the exercise of all options.

Grant

An agreement providing equity – or rights to obtain equity in the future – to the grantholder. Options and warrants are examples of grants.

Growth share

A type of security that enables the shareholder to benefit from future growth in a company's value. The "growth" depends on a specific valuation hurdle; a sale above the hurdle triggers the growth shares to become valuable.

HMRC

Her Majesty’s Revenue and Customs, commonly abbreviated to HMRC. The UK government department responsible for collecting taxes from individuals and businesses. ERS and EMI annual returns are filed with HMRC.

HMRC valuation

An umbrella term for a company valuation approved by HMRC, for the purpose of issuing option grants under an EMI, CSOP or SIP scheme in the UK. It determines the lowest share price at which a company can issue options to its employees.

Internal Revenue Service (IRS)

The US federal government’s revenue service, responsible for collecting US federal taxes and implementing the Internal Revenue Code (IRC).

Initial Public Offering (IPO)

The first time a company offers its shares on a stock exchange, to be bought and sold in the public market. This is an enormous step for most companies and represents the culmination of the startup journey.

Know your customer (KYC)

A security practice carried out by companies to verify the identity of clients in compliance with financial and legal regulations to avoid online fraud. KYC is a central part of the due diligence that anti-money laundering (AML) programs require.

Leaver (bad) 

An employee who leaves a company under specific circumstances, such as gross misconduct, which means they are no longer entitled to any of their vested options. Companies may set their own conditions for bad leavers.

Leaver (good) 

An employee who leaves a company under normal circumstances and has the right to purchase any vested shares within a fixed window. Exercise windows are typically set at 90 days from the employee’s departure.

Liquidation preference

An investment contract clause which determines which shareholders are paid first and how much they receive when a company reaches a liquidity event.

Liquidity

The extent to which a security can be sold or purchased in the market at a price that reflects its current value.

Liquidity event

A process in which a company’s equity is converted into cash, allowing shareholders to realise the value of their investment by selling their shares. There are several different types of liquidity events, including an IPO, secondary transaction, merger or acquisition.

Market cap

The open market valuation of a publicly traded company. Indicates the market’s perception of the company’s prospects as it reflects what investors are willing to pay for its stock.

Mergers and acquisitions (M&A)

A merger is the combination of two or more separate companies to form a new, larger organisation. An acquisition is when one company buys a stake of more than 50% in another company to take majority ownership and control over it.

Notice of exercise

Written notice of a grantholder’s desire to buy or sell the underlying security of their option contract. Also known as an exercise notice, this document specifies the number of options being converted.

Notice of option grant

A document given to each optionholder outlining the details specific to their issuance (e.g. the number of options granted, vesting schedule, exercise rules and strike price).

Option agreement

A legal contract that details the conditions that the optionholder must meet in order to purchase shares, and explains the terms associated with the purchase.

Option pool

A board-approved allocation of shares set aside by a company for employee equity awards. Also known as an incentive pool, it typically ranges between 10% and 20% of total company ownership.

Participation preference

A contract clause giving a grantholder certain rights, including dividends and liquidation preferences. Typically introduced during an investment round.

Pre-clearance

A term used to signify a company valuation approved by HMRC. While it’s not essential to secure HMRC pre-clearance before issuing option grants, doing so benefits a company and its employees.

Pre-emption rights

The right of first refusal offered to existing shareholders when new shares are issued. Often this is a contractual obligation related to anti-dilution preferences, designed to protect each stakeholder’s current ownership percentage in the company.

Preferred share

A share classification that gives shareholders a priority claim over earnings whenever dividends or assets are distributed. Also known as a preference share.

Refresher grant

An additional equity award, typically offered to high-performing or long-standing employees.

Restricted stock unit (RSU)

A type of equity award granted to employees upon meeting certain conditions. RSUs do not need to be exercised; instead, shares are issued automatically once the conditions are met.

Reverse vesting

An inverse vesting process, where shares are granted upfront but may be repurchased by the company if the shareholder leaves during the vesting period. Typically applied to founder equity awards.

Right of first refusal (ROFR)

A contractual right giving a company’s existing investor the option to take part in a transaction before the company enters that transaction with a third party.

Round modelling

The process of calculating the potential impact of new funding on a company’s cap table, including the dilution of existing shares. Also see scenario modelling.

Run rate

A measurement of the financial performance of a company based on current financial information. Can be used to predict future performance.

Safe harbor

A concept under the US Internal Revenue Code providing that 409A valuations performed by an independent provider are presumed to be reasonable.

Save As You Earn (SAYE)

A UK government-approved share scheme allowing employees to buy shares in a company by setting aside a portion of salary each month. Among other benefits, participants pay no tax upon exercising their shares, and only 10% capital gains tax on selling them.

Scenario modelling

The process of examining and evaluating possible future scenarios for a company, such as new funding rounds. Used to understand how a scenario may impact company ownership or shareholder payouts. Also see round modeling.

Secondary transaction

The sale of existing shares in a private company. Secondaries can take many forms, from a 1:1 share transfer between two stakeholders to multiple buyers, multiple sellers and even unknown buyers sourced from a secondary marketplace.

Security

A financial instrument that represents company ownership. May take many forms including ordinary shares, preferred shares, share options and convertible loan notes.

Seed Enterprise Investment Scheme (SEIS)

A government-approved scheme which offers tax relief and benefits to investors in return for investment in small or early-stage startups in the UK.

Shares and assets valuations (SAV)

A specialist team within HMRC that manages requests for share scheme valuations, and ensures share options are issued to employees at a fair price.

Share Appreciation Right (SAR)

A type of compensation granted to employees that does not rely on an exit event for a pay out. It is linked to the company's share price during a predetermined period. When the share price rises, employees receive the sum of the increase in shares or cash.

Share class

A classification that indicates the level of shareholder ownership in a company in relation to voting rights and liquidation preferences.

Share Incentive Plan (SIP)

A tax-advantaged share plan that offers companies the ability to award equity to employees. Shares awarded under a SIP are held in a trust and must be held for at least five years to qualify for tax-relief benefits.

Shareholders' agreement

A document outlining shareholder rights and obligations, the relationship between shareholders, the financing and management of the company, and share-related policies. Designed to minimise disputes and protect shareholders in the event of a crisis.

Shareholder register

A list of active owners of a company's shares and the number of shares they own. Different jurisdictions require different levels of detail to feature on the register. Also known as a register of members in the UK.

Share option

A type of equity award which gives the optionholder the right to buy a certain number of company shares in the future for a predetermined price – known as the exercise or strike price. Share options are not the same as shares. 

Share option plan rules

The blueprint for an employee share scheme. Sets out company policies including optionholders’ rights, the treatment of leavers and option lapsing. These rules apply to all employees on the scheme, and must be approved and adopted by the board of directors.

Share price

The price paid per single share of a company, as determined by the particular conditions of the transaction. Share price varies depending on factors including share class, investment round and shareholder type.

Share split

The process of dividing a share into two or more parts. The total value of the original share is unchanged, but split across multiple parts.

Simple Agreement for Future Equity (SAFE)

An agreement between an investor and a company, giving the investor the right to future equity in the company without determining a specific price per share at the point of investment.

Significant event

An event which affects a company’s value, and therefore its share price. Significant events call for a new company valuation to be performed. Known as a “material event” in the US.

Trigger event

An event that signals the conversion of an option, convertible loan note, warrant or other convertible grant into equity. A trigger event is typically an IPO, significant funding round or change of control in the company.

Term sheet

A nonbinding agreement summarising the key deal terms of a funding round. Serves as a basis for detailed, legally binding documents.

Unapproved share option

A type of grant that doesn’t need pre-clearance from local tax authorities and isn’t limited to employees of the company. Unapproved options don’t provide any specific tax advantages.

Unrestricted market value (UMV)

A company’s share price, determined by valuing shares to be granted under the EMI scheme as if they have no restrictions, and presuming all shares can be sold equally easily. The UMV is often higher than the actual market value (AMV).

Unvested option

An equity award that has been allocated to a particular grantholder, but is not yet available to convert into a common share. Until the terms of the vesting schedule are met, the grantholder only has the right to exercise the share option in the future.

VAL231

The form submitted to HMRC in order to get an EMI valuation. Must include a proposed unrestricted market value (UMV) and actual market value (AMV).

Valuation

The estimated monetary value of a company, based on existing capital, previous raises, perceived market fit and growth potential. Valuations can be performed pre-money (i.e. before a funding round) or post-money.

Valuation cap

The upper limit of a company’s valuation at which an investor can convert their convertible loan note or SAFE into equity. Often set to protect early investments.

Vesting

The process of earning an asset or equity award like share options. The grant is awarded over time according to a vesting schedule. When options are fully vested, the grantholder is entitled to exercise the full grant.

Vesting schedule

A schedule which determines when a grantholder is entitled to their equity award. Typically begins with a cliff, after which shares vest at regular intervals for the duration of the schedule. A four-year vesting schedule with a one-year cliff is one of the most common arrangements.

Virtual share

An equity award that entitles the shareholder to a cash payment in case of an exit event. The cash payment corresponds to the market value of company shares at that point, minus the hurdle price where applicable. Also known as a phantom share.

Virtual share option plan (VSOP)

A share scheme for awarding virtual share options to employees under the German legal system.

Voting rights

The right of a shareholder to vote on certain company matters beyond the scope of the board of directors.

Warrant

A type of equity award which gives the warrantholder the right to buy a certain number of shares at a fixed price in the future.

Waterfall analysis

The process of calculating possible future payouts for each shareholder in the case of an exit event.


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