BZT Dictionary®

A-Z Hem
2nd round
Second round financing

The financing of a young company is usually divided into a number of rounds. The first round (first round financing) is the one which is associated with the greatest risk since the company has perhaps not yet managed to launch its products and start its sales. In the second round (second round financing) the company has come a bit of the way along the road and the risk is therefore lower. A third round is called "third round financing", and so on.

Early investors usually ask for some type of compensation (downside protection) in case the valuation in the following rounds do not meet the value expectations from the previous round. The value of the company may have declined. The compensation may consist of free shares so that the price of the "old" shares corresponds to the price that is set for the new issuance.


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Stock exchange
Securities exchange

A "securities exchange" is a company which has obtained permission from an authorized governmental authority to operate so-called regulated markets for trading in securities, for example in shares. A synonym often used is Stock exchange.

The extensive rules which securities exchanges must comply with are intended to protect investors, for example by seeing to it that trading and the setting of prices is efficient as well as, to the extent possible, preventing insider trading.

Examples of major stock markets are:

  • New York Stock Exchange,
  • NASDAQ,
  • London Stock Exchange,
  • Deutsche Börse
  • Tokyo Stock Exchange, and
  • Shanghai Stock Exchange.


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Secrecy
Secrecy agreement

The agreement governs how the parties must deal with the confidential information which they share with one another for example during a business negotiation or in the process of a transaction. See also "NDA".


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Seed
Seed capital

A form of financing for a very early stage financing. Seed capital makes it possible for an idea to begin to be developed into a product or for a research project to be made into a company. Enterprise incubators, or business angels, can help with seed capital in a first round of financing.

"Risk credits/capital" is a type of seed capital.

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Seed
Sellers' knowledge

In the warranty section of a share purchase agreement (SPA), the sellers are required to provide warranties regarding essential circumstances in the company and its operations. The warranties are generally made on the date when the seller and buyer sign the SPA (signing).

If the closing of the transaction (the point in time when the shares change owners and the proceeds are paid) takes place at a later date than the signing date, it is often a hot topic to agree whether the warranties are made on the date of signing only or at signing and also at closing. Notably, in case there is an extended period between signing and closing, it is reasonable to require the seller to renew its warranties at closing.

It should be noted, however, that sellers never should agree to provide forward-looking warranties, i.e., not give warranties relating to events that may happen in the future. Further, sellers’ warranties should be made by each seller individually and severally, and not jointly and severally. Examples of typical and fundamental warranties are sellers’ full ownership of the shares in the company and that the shares are not subject to any encumbrances, the accuracy of financial information, tax payments, material agreements, salaries and remuneration, and the company’s compliance with relevant laws, regulations and policies.

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Some warranties state positive facts such as that the company owns real estate, production facilities, material rights such as trademarks patents – all listed in an appendix to the agreement. Other warranties may state negative facts, e.g., the company is not involved in any legal disputes or that no ongoing customer contracts exceeding 5% of sales are terminated or has expired. An important matter when negotiating the warranty clauses is whether the warranties should only relate to the current situation of the business or should it also refer to past circumstances.

In some instances, the seller knows that a specific warranty is true and fact-based – for example, that none of the company’s ten largest suppliers have terminated their supplier agreement. However, in other cases, the seller may not be entirely sure if the warranty can be fact-based or not, e.g., “no key supplier intends to terminate its contract with the company.” The warranty, in such a case, becomes a matter of risk allocation. If the seller provides the warranty, the seller will be responsible for the cost the buyer receives if a critical supplier will terminate the agreement. If the seller does not give the warranty, any damages will be borne by the buyer.

The sellers may still need to provide warranties even if the sellers do not know for a fact if a warranty statement is entirely accurate or not. One way of dealing with this tricky situation is by using the phrasing “seller’s knowledge.” Then, only the circumstances that a seller knew about applies when the warranties were provided. An example of wording is “insofar as the seller knows, none of the company’s ten largest suppliers intend to terminate an agreement with the company.” Note that “seller’s knowledge” does not include what the management or an employee of the company know about a circumstance – provided that the seller was not informed.

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Circle
Serial entrepreneur

An entrepreneur who, after having successfully sold his first enterprise, invests anew and starts another enterprise. Many successful entrepreneurs who have built up an enterprise and sold it don't want to just play golf. They are eager to go further and to seek out challenges in building new enterprises.

Investors are positively disposed towards investing in parallel with and supporting serial entrepreneurs. They have experience and have shown that they can start, develop and sell enterprises at a profit.


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Deal
SHA

SHA is short for "shareholders' agreement". It is an agreement among the largest owners in a company where the parties agree on what rules are to govern important ownership decisions, decisions at meetings of the shareholders and of the board of directors. Read more under "Shareholders' agreement".

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Share
Share allocation

After the existing and new shareholders have subscribed for shares in a new issuance, the company's board of directors decides to whom the newly issued shares are to be issued (who will be allowed to purchase them). The board of directors also decides how many shares shall be allocated to each subscriber.

In the event of over-subscription, i.e., when there are more subscribers who want to purchase shares than there are shares available to be purchased, the allocation will be made in accordance with specific principles. Common principles for allocation are that no one may receive more shares than a certain proportion per subscriber or the number which corresponds to that person's current proportion of the total number of shares, i.e., pro-rata.


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Share capital
That part of the shareholders' equity capital on the balance sheet which corresponds to the face or par or nominal value of the issued shares. See also "Equity".
Deal
Shareholders agreement, SHA

An agreement among the largest owners in a company where the parties agree on what rules are to govern important ownership decisions, decisions at meetings of the shareholders and of the board of directors. Customary clauses which regulate joint ownership are clauses which govern rights of first refusal, consents, and pre-emptive rights.

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Among other things, the agreement will regulate:

  • Identity of the contracting parties.
  • Background, purpose, with the cooperation.
  • The company's business.
  • Issues which will require unanimity, for example, the annual budget, acquisitions, dispositions.
  • The composition of the board of directors.
  • The company's top management (CEO, CFO, etc.).
  • Allocation of profits, dividends.
  • Any continued, future, financing, e.g. how a new subscription of shares will be carried out.
  • If, how and when a shareholder may sell her or his shares.
  • Pre-emptive rights and/or rights of first refusal for shares.
  • How the company is to be appraised in conjunction with sales of shares.
  • If, how and when shareholders may make any joint sale (exit).
  • If the shares of natural persons are to be "separate property".
  • Confidentiality.
  • Any prohibition of competition.
  • Governing law.
  • How and where disputes are to be resolved, for example by means of arbitration or in the courts.

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Board Of Directors
Shareholders' meeting

The shareholder (owner) meeting is the highest decision-making body in a corporation, and the meeting when all shareholders meet. If a shareholder cannot be present at the meeting, a proxy can be given to some other legally competent person. At the meeting, the shareholders make the basic decisions on the company's direction and management in conformity with the Companies Act and the certificate or articles of incorporation.

When and how shareholders hold a shareholders' meeting varies depending on business tradition, jurisdiction, and type of company (large, small, listed, closely held, etc.). Also, what questions are considered and what decisions the meeting makes varies.

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We will try here to give a general description and to illuminate certain questions with generalized examples.

A shareholder may vote the shares she or he owns. Ordinarily, the rule is one vote per share, but in certain countries legal rules may permit, and the certificate or articles of incorporation may prescribe, that different classes of shares have different voting rights (for example, one A-share has ten votes and one B-share has only one vote per share).

If the country's laws and the company's certificate or articles of incorporation so provide, the company must hold a regular annual meeting each year (often abbreviated as AGM, i.e., Annual General Meeting). This must often be held within a specified time (for example, six months) after the end of the fiscal year. Here the owners select the Board of Directors and make decisions on the disposition of the profits or losses from the company's operations. In some countries the shareholders meeting also appoints the company's auditors.

The owners also make decisions on amendments to the certificate or articles of incorporation, changes to the share capital, and incentive programs for the management and the Board of Directors which may affect the number of shares in the company (e.g., options, convertible securities). In some jurisdictions, the shareholders meeting may also decide upon compensation for the Board of Directors and the auditors and provide guidelines for compensation for the principal members of management.

Where shareholders' meetings are to be held varies, but it is common for them to be held in the place where the Board of Directors has its seat (e.g., the place which is specified in the paragraph on principal place of business in the certificate or articles of incorporation and which is recorded in the register of companies). It is commonly the Board of Directors which calls the shareholders meeting and in the manner which is provided in the certificate or articles of incorporation. In some cases auditors, or a minority of at least 10% of the shareholders, can request the Board of Directors to call a special, or non- ordinary or extra shareholders meeting.

The agenda for an annual meeting may cover the following points:

  1. Election of a chairperson for the meeting.
  2. Approval of the list of attending shareholders and qualified voters.
  3. Election of a person to take the minutes, and one or two persons to verify the minutes.
  4. Determination that the meeting has been properly called.
  5. Approval of the agenda.
  6. Presentation of the annual financial reports and, when required, the auditors' report.
  7. Decisions on:
    • approval of the profit and loss statement and the balance sheet,
    • dispositions of the corporation's profit or loss in conformity with the approved balance sheet,
    • granting of a release from liability (for the previous fiscal year) for the members of the Board of Directors and the chief executive officer.
  8. Election of the Board of Directors and in appropriate cases of the auditors.
  9. Approval of the fees of the Board of Directors and of the auditors.

In larger companies, it is common for the company's CEO to provide her or his views on the year just past, on the conditions in the market, and on the company's more significant strategic efforts.

"Other matters" added to the agenda before the meeting may also be taken up if that is established by law or in the certificate or articles of incorporation.


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Shareholders
Shareholder value

Focusing on "Shareholder value" is an investment and management philosophy which gives priority to the interests of the shareholders and in which the company is operated so as to maximize the value of the shares (the price of the shares).

There are divided opinions as to whether it is optimal (for the business) always to put maximizing the value of the shares first on the list, especially if the temporal horizon is short. Listed companies have been criticized for not having a longer temporal horizon for the creation of value than the next quarter -- the "quarterly view" of company finances.

In any case, a long-term, sustainable increase in "shareholder value" is an important guiding principle in the development of a company.


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Share repurchase

A share repurchase means that a company buys its own shares. The method is mainly used as an alternative to a dividend or to distribute cash when retained earnings can't be invested to get sufficient returns. But it can also be used as an attempt to control the company's share price if the price is undervalued. A repurchase reduces the number of outstanding shares which means that profit and net worth per share increase, and the share price need to be reassessed. If the share price is undervalued it may thus increase the share's price. Note, however, that the company's profits remain the same.

A share repurchase may also be an advantage for certain investors who have different tax rates on dividends as compared to a repurchase. For example, in certain cases a repurchase can be seen as a tax-free sale while an ordinary dividend would be taxed as financial income.

Futures balance
Short selling, Shorting

Short selling (Selling short, Shorting or Short sale) means taking "a short position" in a financial investment, and is a way of making money when a share's market price falls. If you think that the market price of a particular share is going to fall, you borrow those shares with a promise to return them within an agreed period of time. In the next step you sell the shares at that day's market price. If the share's market price falls, you buy back the same number of shares at a lower price and then return the shares you have borrowed. You have now made a profit equal to the difference between the value you sold for and the cost of buying back the shares.

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Selling short thus gives protection against a downturn in a securities exchange, but it is also associated with a significant risk. If the market price of the shares goes up, you will be obliged to buy them back at a higher price than what you sold them for. You will then suffer a loss which corresponds to the difference between the price you sold the shares for and the cost of buying them back. The loss can quickly become substantial and may even be greater than your initial investment for borrowing and shorting the shares. It is especially risky to short shares in a company which is a candidate for a takeover or a buy-out.

In theory the loss can be unlimited. Compare that with the alternative of your buying shares and in the worst case they become valueless. In this case, your loss is limited to your investment - there is thus an upper limit for losses in ordinary share transactions.

In order both to monitor the profit and to minimize the risk, you should choose a share with high turnover (liquidity). You want to be able both to sell and to buy the shares quickly. Shares with low turnover increases the risk, since it can be difficult to buy back the shares if the price rises rapidly.

You cannot short all of the shares that are traded on a securities exchange. Only certain selected shares can be shorted, most often shares in larger listed companies with large turnover (high market liquidity). Examples of those who lend out shares are mutual funds run by the banks, insurance companies and pension funds. Shorting of shares is accomplished through brokers in the same way as with trading in shares generally. Large "borrowers" are, among others, hedge funds, asset managers, mutual funds and, to some extent, even individual persons.

Example

Assume that you have €10,000 to invest in shares. You can choose to buy shares for €10,000 or to "short" for €10,000 (costs for commissions, fees and interest to the lender of the shares). You choose to short (since you believe that the market price of the shares is going to fall) and your €10,000 is sufficient to borrow 10,000 shares. Later you sell the borrowed shares on the securities exchange at that day's market price of €5 per share, which gives you an income of €50,000.

Your judgment proves to be correct and the share price falls to €3 per share. Now you choose to buy back the 10,000 shares for €30,000 and return the shares to the lender. Your profit on the "short sale" is €50,000 –€ 30,000= €20,000 before any taxes that may be involved. You have thus invested €10,000 and made a profit which is twice as large as your investment.

But if you are wrong and the share's market price instead goes up to €8 your cost to buy back the shares will be €80,000. Now you will suffer a loss of €30,000, which is three times more than your initial investment of €10,000. By selling short you can thus lose more than what you invested. You must thus be on your guard and quickly buy back the borrowed shares if the market price rises. Compare this with the alternative where you buy shares for €10,000 and the shares, in the worst case become worthless, then your loss is limited to your investment, that is, to €10,000.

Advantages of selling short:

  • You can profit if the securities exchange goes down or the market price of a particular share falls.
  • You can, with not much capital, increase your return on investment since it is cheaper to borrow shares than it is to purchase shares.

Disadvantages of selling short:

  • If the share's price goes up you will suffer a loss, and you may even lose a larger amount than you invested.
  • You must be very alert, experienced and know the financial markets, since the risk in your investment portfolio rapidly increases.

As said, with short selling you can balance your risk and earn money also even if the market price for a particular share goes down. But there are many critics of short selling. But there are many critics of short selling. Some think that short selling results in larger price downturns and increases the uncertainty (volatility) in the share's market price. They also think that hedge funds with large capital can create a sell pressure on the share's market price by means of short selling and thereby push the market price down before the buy back. When the shares are then bought back the share's market price increases again. The device of first selling and then buying large volumes produces increased swings in the share's market price without the company's underlying value having changed.

Proponents, for their part, maintain that the advantages outweigh the disadvantages and that short selling is an important device for increasing the average return on the investors' total capital. They also think that the volatility (the market swings) in the portfolio can be minimized by the investors to some extent being able to protect themselves to some extent against securities exchange downturns.

See also


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Signing
Signing
The occasion when the agreements which govern a business arrangement are signed by the parties. See also "Closing".

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Silent partner
A passive investor (shareholder) who is "hands-off”, does not sit on the Board of Directors and is not involved in the operational management of, or the strategic decisions in, the company.
Solidity

A term for the relationship between equity capital in the company and the total assets on the company's balance sheet. The equity capital/assets ratio is measured in percent and is a measure of the company's capital structure, i.e., the division of the total capital between equity capital (the shareholders' capital) and debts (loans). Synonyms are "Equity capital/Assets ratio" and "Equity ratio".

Soft loans

"Soft loans" usually are defined as loans and grants from governmental institutions. They may also be called "Risk-assuming credits". This is a form of financing which is appropriate for the start-up of a new company. Combined with financing from an active business angel, this type of credit can be the optimal financing (and ownership) for a newly-started company so that in its next stage it can take in venture capital. Repayment of "Soft loans" may be conditioned on the company/business generating a profit.

SPA

SPA

An abbreviation of "Sales and Purchase Agreement", which is a term for an agreement governing the sale and purchase of an asset, for instance shares in a company or a piece of real estate.

In the "SPA" the seller commits itself to sell and the buyer commits itself to buy the assets which are involved at the price and on the terms and conditions which have been agreed upon between them in the agreement. Important parts of the agreement are the so-called price mechanism, which governs how the price is to be determined, as well as terms and conditions and limitations on the guarantees which may be given.

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The SPA will govern the following areas:

  • Which parties will be included?
  • Definitions of important concepts which are used in the agreement.
  • Background.
  • What transaction the agreement covers, e.g., sale and purchase of shares.
  • Price and price mechanism.
  • Important terms and conditions for the transaction (conditions precedent).
  • The buyers and the seller's guaranties (representations and warranties, R&W).
  • Undertakings (liabilities).
  • Confidentiality.
  • When and where the agreement is to be signed and the transaction closed (closing).
  • How any disputes are to be dealt with.

Apart from discussions of price, questions relating to guarantees and to the amounts of damages are the most complicated parts both of the negotiations and of the agreement between the parties.

Interpretation of the SPA concept may sometimes lead to painful misunderstandings, for instance if one party comes to the discussion about "the SPA agreement" thinking that it is an agreement about going to a spa for a swim and a shower.

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Spin-off

When a part of an enterprise, for example a subsidiary, a division or a product line, is sold. Is also called "spin-out".

Spin-out

A term for the process by which a subsidiary or a part of the activities of a large business is sold to a new owner. Also called "spin off".

Spoon feeding
Spoon feeding

Is a form of financing by stages. In connection with investments in a company which is in a start-up phase (early stage), an investor will often not pay out the whole amount which is required to take the company to positive cash flow.

The investor may commit himself or herself for the whole amount but make payments in stages according to when the company needs the financing. The payments are often conditioned on milestones which the management has promised to meet.

The purpose is partly to diminish the risk for the investor and partly not to give the company and its management more financing than is needed for a given situation.


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Jockey
Spreadsheet jockey
A person who likes to build theoretical, financial scenarios of the future with the help of computers and spreadsheets (excel). These can involve altogether too many and too complex alternatives which are not always entirely realistic.
Star
Star
A very successful enterprise, investment or product. A real star!

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Start-up
A new, young enterprise in a first start-up phase. The company's size really plays no role, but usually a small, newly-established company is meant.
Structuring a transaction
A transaction divided into appropriate parts which may even be carried out in temporal stages. A structured transaction will include finding appropriate financial instruments (e.g., loans, shares), both so as to produce a good mix of instruments in the financing and so as to make the transaction possible for all the parties which are involved.
Success
Success fee

Advisors involved in a business transaction may receive the whole or part of their compensation as a "success fee". This means that the advisors' compensation is based on the value of the transaction and is only paid if the transaction is brought to a successful conclusion. The intention is that the advisors are to have the same interest as the seller, so that given their exposure to the transactional risk (the risk that the transaction will not come off) they will work hard to obtain as high a price as possible.

An investment bank, for example, may be entitled to a success fee of 3% of the value of the transaction. If the company is sold for €100 million, the investment bank will receive compensation of €3 million.

The converse of a success fee is a fixed fee which is to say a fixed amount determined in advance, and sometimes paid even if the transaction is not brought to a successful conclusion. A success fee will potentially result in a larger compensation since the advisor is taking a risk, partly relating to the final value and partly relating to whether the transaction is brought to a successful conclusion at all.


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SWOT
SWOT

SWOT is an abbreviation of "Strengths - Weaknesses - Opportunities - Threats". It is a well-established and is a structured method of analysis for evaluating strengths, weaknesses, opportunities and threats in relation to a business and its environment. Strengths and weaknesses are internal factors, while opportunities and threats are external factors. SWOT analyses are often made in connection with strategic planning and business development and may be made for an entire enterprise, a business, or a product.

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In the analysis of a company, a SWOT analysis may cover:

  • Strengths: Describes the strengths the company has and which provide advantages in relation to competitors. For example, financial strength, a strong trademark, or unique know-how.
  • Weaknesses: Describes the weaknesses which the company has and which are a disadvantage in comparison with competitors. For example, weaknesses may be high costs, antiquated products, or poor profitability.
  • Opportunities: Describes external positive factors and events which are an advantage for the company. For example, new opportunities may be that new markets are opening, that a large competitor is discontinuing its competitive business, or that a complementary acquisition is possible.
  • Threats: Describes external negative factors and events which may cause problems and threaten the company's business. For example, these may relate to a downturn in the economy, a rapid technology change, exchange rate changes which reduce competitiveness, or that a key supplier has financial problems.

Too often only an isolated SWOT analysis is made, which then has limited value and no connection to the actions to be taken and resources to be allocated in accordance with the business plan. In the next stage of the continued analysis, it is essential to describe the actions which are necessary in order to:

  • Counteract weaknesses.
  • Utilize and develop strengths.
  • Take advantage of opportunities.
  • Avoid and parry threats -- or how a threat can be converted into an opportunity.

It is important in the analysis to limit the number of opportunities and to try to find the absolutely most important (top five) factors which affect the company. With too long a list of strengths, weaknesses, opportunities and threats, without direct connection to an action plan, the SWOT analysis will become a theoretical exercise without real practical significance.


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Syndication

Syndication means that two or more investors invest in an enterprise jointly. The intention is to spread risk as well as to coordinate resources, competence and business networks. In conjunction with syndication, a dominant investor (lead investor) often takes on the principal responsibility for coordination among the investors and the development of the company. All investors together are often called "the consortium".

Syndication is especially common in investments at early states -- among Venture capital investors.

The investors usually prepare a "shareholders agreement" which governs their collaboration and the ownership and governance of the company.

Synergy

Synergy happens when 1+1 is more than 2. The combination of two businesses is most often done so as to receive and benefit from synergies. This may relate to synergies for reducing costs or increasing receipts.

What is optimal is if both sales and cost synergies are obtained at the same time. Cost synergies, for example, arise if the combined business obtains larger volumes in its manufacturing facility and can spread fixed costs over more units. Sales and market synergies arise if it is possible to offer common customers more products without increasing the cost of sales.

Retrospective calculations of many acquisitions have shown, however, that the synergies anticipated before the combination are not wholly satisfied. The causes are obviously many and different depending on the situation. One simple, overriding explanation is that in reality it is not possible to fully integrate businesses. There is always some little detail which was overlooked in the planning and which carries with it a doubling of costs in some areas of the combined business.

Synthetic option

This is an imaginary option which does not give a right to acquire shares in the company, and therefore does not produce any dilution for the shareholders. A "synthetic" option is designed in the same way as a real subscription stock option (which gives a right to subscribe for newly issued shares). Usually, the synthetic options are issued by the company and offered to personnel in the company. The intention is to give key personnel a part of the value created and of the increase in the value of the shares, but without the existing shareholders being diluted.

The risk for the synthetic option holder should be the same as that with a subscription option. Valuation and the setting of the prices of synthetic options must be done in the same way as with subscription options. Instead of shares synthetic options give the holder a right to cash compensation from the company which corresponds to the compensation which a subscription option would have given.

The profit on the option may be taxed as a capital gain (depending on the jurisdiction) if the valuation and terms and conditions are made and designed in a manner which is compatible with market practice.

Systematic risk

Systematic risk is the inherent risk of an entire market or an entire market segment. Other terms are "volatility" or "market risk". This risk cannot be reduced through diversification within the same market.

The systematic risk is both unpredictable and impossible to completely avoid. One way for an investor to reduce systematic risk in the portfolio is through hedging. Another way is to divide their investments among different types of assets, for ex. by buying shares, debt securities and real estate. Systematic risk in a market is affected by changes in interest rates, inflation, recessions, oil price changes and political events.

Systematic risk of a security, a fund or investment portfolio is measured by the so-called beta ratio (β). A beta greater than 1 means that the investment faces higher systematic risk than the market, a beta less than 1 means lower systematic risk than the market and a beta that equals to 1 means the same systematic risk as the market.