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Many terms of art are used in venture capital transactions that can be difficult to understand. Most of them relate to key issues that may be points of negotiation in your venture capital transaction. Below are a few of the common terms of art used in venture capital transactions and their common meanings:

• Conversion: Conversion refers to the conversion of shares of preferred stock into shares of common stock. Conversion provisions can be optional or mandatory. An optional conversion is when a shareholder has the option to convert its shares of preferred stock to shares of common stock at any time or when certain events happen. A mandatory conversion requires that all shares of preferred stock be converted into shares of common stock upon the occurrence of a certain event, such as consent of the majority of the holders of the preferred stock or a public offering. In a venture capital transaction, the typical negotiation points regarding conversion provisions, in addition to those mentioned under "Anti-dilution", are the events that trigger mandatory conversion, such as a public offering, and the dollar threshold that the event must reach before the conversion is mandatory.
• Anti-dilution: Anti-dilution provisions allow a preferred shareholder to keep the same or a similar ownership percentage in the company when the company sells more stock. This may be accomplished by giving the shareholder preemptive rights (see the definition below). Other terms that you may hear in conjunction with anti-dilution are weighted average and full ratchet. These are two methods for adjusting downward the conversion price per share of stock issued to the preferred shareholder when additional shares of stock are issued to new investors at a price lower than the price the preferred shareholder paid. In other words, if a preferred shareholder purchased its shares for $1.00 per share, and is able to convert its preferred shares into common shares at a deemed $1.00 per common share, the anti-dilution provisions may operate to make that conversion price lower, allowing the preferred shareholder to convert its preferred shares into a larger number of common shares. In a venture capital transaction, a typical negotiation point regarding anti-dilution provisions is whether a weighted average or full ratchet formula is used. A weighted average formula is currently the most common, but there are a number of ways a weighted average formula can be calculated.
• Preemptive rights: Preemptive rights are the rights of a shareholder to purchase its pro rata portion of any new shares of stock issued by the company at the same price and on the same terms as the new shares are being offered to new investors. A preemptive right, if exercised by the shareholder, allows the shareholder to retain its ownership percentage in the company. In a venture capital transaction, the typical negotiation points regarding preemptive rights are (i) who will receive the preemptive rights, such as the venture capital investors, major shareholders or all shareholders and (ii) what issuances are exempt from the preemptive rights.
• Right of first refusal: A right of first refusal gives each shareholder or certain specified shareholders the right to purchase its pro rata portion of shares offered by another shareholder to a third party, on the same terms. The company may have the first right of refusal and the shareholders may have a secondary right of refusal if the company elects not to purchase the shares. In a venture capital transaction, the typical negotiation points regarding rights of first refusal are (i) who is subject to the right of first refusal (i.e., who must offer their shares to the company and/or other shareholders prior to selling to a third party), (ii) who will receive the benefit of the right of first refusal, such as the venture capital investors, major shareholders or all shareholders and (iii) what transfers are exempt from the right of first refusal.
• Tag-along rights/Co-sale rights: Generally, a tag-along right is a protective provision for a minority shareholder. It allows a minority shareholder to sell its pro rata portion of shares of stock along with a selling significant shareholder. This right is often combined with the right of first refusal to allow a shareholder who does not exercise its right of first refusal to sell its pro rata portion with the selling shareholder, on the same terms and conditions. In a venture capital transaction, the typical negotiation points regarding tag-along rights are the same as those for rights of first refusal.
• Drag-along rights: Drag-along rights allows a defined group of shareholders (usually a single shareholder or group of shareholders who own a majority of the company) to require the remaining shareholders to sell their shares of stock in, and/or consent to, a transaction approved by the defined group, such as a sale of the assets of the company or a sale of all of the shares of stock of the company. In a venture capital transaction, the typical negotiation points regarding drag-along rights are (i) who are the shareholders that can initiate the transaction, and (ii) the percentage threshold of such shareholders that must approve (i.e. a majority, two-thirds, etc.).
• Redemption: Redemption happens when the company buys shares back from the investor. Redemption can be mandatory or optional on the part of the company or the shareholders. Generally, the redemption cannot occur before a certain date, such as five years after the first sale of the series of preferred stock, and must be approved by a certain percentage of the shareholders (i.e. a majority, two-thirds, etc.). This is designed the protect the venture capital investors' return on the transaction but also provides the company with some comfort that, absent special circumstances, it will not be required to come up with the cash to redeem prior to the agreed-upon date. There may be more specific negotiated redemption provisions that relate to the occurrence or non-occurrence of certain events by agreed upon dates. For example, if the venture capital is being used primarily to finance a construction project, there may be deadlines that have to be met in order to avoid mandatory redemption. In addition, the company may negotiate provisions that allow the company to redeem at its option after certain time periods have passed or certain events have occurred. In a venture capital transaction, the typical negotiation points regarding redemption provisions are (i) whether and under what circumstances redemption is required or allowed , (ii) the price for which each share is redeemable (e.g., the original purchase price plus accrued dividends or the greater of the original purchase price plus accrued dividends and the fair market value), (iii) the first date on which a redemption may be requested and (iv) the percentage of shareholders that is required to effect a redemption.
• PIK preferred: "PIK" stands for "paid-in-kind". This means that the dividends on PIK preferred are paid in the form of additional shares of preferred stock. In other words, rather than accruing dividends that must be paid in cash now or in the future, the preferred shareholder is deemed to own additional shares. The calculation of the number of PIK preferred shares issued in connection with any particular dividend is a point of negotiation between the parties.