Startup Funding Explained:
If you want to start your business or running your business and want to know about what is startup funding? then here is the complete explanation from startup to the stock market. It all starts with a vision, the project, the product, and the service no one has done it before. Unbelievable! it’s so painfully obvious can you pull it off maybe. Your two friends you are excited, design a logo designer name all fun, and games designed a concept things get serious we decide to make this a company. Before you know it startup funding you have to know these two things “What is a Startup?” and “What is Funding?”
What is a Startup?
A startup or start-up is a young company founded by one or more entrepreneurs to develop a unique product or service and bring it to market. By its nature, the typical startup tends to be a shoestring operation, with initial funding from the founders or their friends and families.
What is Funding?
Funding is the act of providing resources to finance a need, program, or project. While this is usually in the form of money, it can also take the form of effort or time from an organization or company. Sources of funding include credit, venture capital, donations, grants, savings, subsidies, and taxes. Okay now, let’s jump to the point.
Startup Funding Process:
Seed Investment (Day 1):
Seed Investment is the next level of startup funding. You need a structure a legal structure how much will that cost you it depends on the countries (In the US and cooperating a company will set you back anything between $25 and a few thousand dollars). That’s in part registration fees which actually vary depending on where you are and legal fees which vary depending on how fancy you need your first channel disagreement to be. Your corporation turns out to be on the pricey side.
Also, you need to rent a server in order to develop your product, therefore, you decide to collect some other people’s money for it. This early in your venture who on earth would give you their money you will get it from family friends or by crowdsourcing it. Usually, a nudging corporate company issues 100,000 shares which are equal pieces of ownership. You need to decide who will get how many of those. You agree on 40,000 shares or 40% of the company for each founder and 20,000 shares or 20% of the company for a well-off family friend who buys them for 50 dollars.
It’s called an investment and at such an early stage in your startup, it’s called a seed investment. The money he pays now belongs to the company if the company fails in the near future which statistically speaking is the most likely scenario you will probably never see a dime of it again. $50,000 for 20% of the company puts the value of your enterprise at $250,000 which puts the value of your 40% at $100,000. You incorporated your company and finished your seed round of investment.
Series Round (Day 365):
Series A:
A year has passed you’re having a successful beta trial with customers time to hire a few more people to rent not just a server but a small office space. The $50,000 of seed capital only got you so far time to collect your first big round of cash you will do this in a so-called “Series A” round. You’re looking for an investment of 1 million dollars this time you’re contacting angel investors and venture capitalists also called VCs. VCs of people who work for venture capital firms which raise venture capital funds they take other people’s money which they then invested to young risky companies such as yours, Angel investors are individuals who professionally invest their own money into young companies often they successfully sold their own start of many years ago and are now looking to support early ventures.
You contacted a few VCs and angels some of them you found online, some you got in touch with via friends and colleagues. You sent them emails, you sent them a business plan. Usually, they don’t care much for the business plan they want to see if the team is competent the idea is it special they know. It’s not easy what have you already achieved is promising what could you achieve can you dream big. You set up some Skype calls a bit of small talk a lot of business talk describe the vision easy you’ve done countless times by now. They ask you tough questions have you heard of that other startup? which does a similar thing? how are you different? Do you spark interest? you have second calls, you have third calls you meet them in person then might invest time to talk valuation. There is pre-money valuation and post-money valuation:
Pre-money valuation:
The pre-money valuation of your startup is how you currently value it.
Post-money valuation:
The post-money valuation is the pre-money valuation plus the investment you’re looking to collect.
This is hugely the one that you reference when you negotiate because the investment divided by the post-money valuation equals to the investor’s share in your startup. Investors want a low post-money valuation to get more for their money you or the high post-money valuation to keep a larger share. You suggest a post-money valuation of 8 million dollars for the investor who was put in 1 million dollars this would mean the 12.5% stake in your company.
A few weeks down the road there are two offers on the table one VC offers an investment of 1 million dollars for a post-money valuation of 6 million dollars an angel investor you talk to offers to invest $500,000 for a 5 million dollar post-money valuation. You offer of the venture capitalist sounds like the better deal but the angel has great connections in the industry it’s called smart money, what do you do? You decide to go for both we tell the angel that you have a standing offer of 6 million dollars post-money valuation but you would really love to have her on board. She agrees to invest at a 6 million dollar post-money valuation.
Now, how’s the cake split this time let’s do the math. Together the VC and the angel will put in a total of 1.5 million dollars into your business for a 6 million dollar post-money valuation this means that they will own 25% of the company. You, your co-founder, and your family friend used to own 100% together with the new investors coming on board you will be diluted. After the A series investment, your cumulative share will only add up to 75% of the company this dilution happens proportionally.
Thus this means that you have fewer shares now no here’s how it works just like your company issued the first 100,000 shares when you incorporated it, it will now issue more shares for the new investors to buy the company can create shares just like a central bank and print money. The total number of shares of the company just changes while your number of shares remains the same. How many shares does the company issue if 100,000 shares are now only 75% of the company it means that 100% of the company will now be equivalent to one hundred 133 thousand shares, therefore, the investors receive 33 thousand newly issued shares for their investment since they pay 1.5 million dollars for their shares each share is now valued at $45. Your 40 thousand shares are now worth over 1.8 million dollars.
This whole process of a company issuing new shares to receive cash is called a capital raise if things go well and you want to expand more such as national and internationally the series A won’t be the last capital raised of your startup there will be a series B, a Series C, a series D and so on for each investment round the company valuation will hopefully increase. Also, each time your company takes in new cash from investors you will be further diluted. Remember how I said that your number of shares remains the same though I lied actually that will usually be stock splits along the way which converts every single share anyone holds into multiple shares hence your number of shares is doubled or tripled every now and then along with everyone else’s the purpose of this and many other things that are determined in the term sheet are a story for next time you don’t care much for legal work anyway your primary isn’t growing your business which is now on track to reach new heights
The Exit (Year 6):
It has been six years since you found at your company you have successfully completed four investment rounds since then you launched your product by now guess what customers love it. You’re a huge success the big blocks write about you and whatnot. Most importantly last quarter your company has not been losing money for the first time the business made a profit time for the exit exiting the company is investors talk for selling their shares everyone who invested cash into your business since the beginning has been quietly dreaming about a big profit
The earlier they invested the bigger of a risk they took and accordingly the bigger of a profit they will get if the company really takes off there are usually two ways of exiting a company:
1. Buy-Out
If you sell out to a big company the investors will usually sell all their shares at once. You and your co-workers on the other hand usually won’t whoever buys you needs you, people, to stay motivated to run the whole thing, therefore, all your shares will be transformed into shares of the company who bought you and then made available to you over time. This is called investing your shares if you leave early or you don’t reach some milestones you agreed on then you won’t receive all your shares.
IPO (Initial Public Offering)
The much cooler way to exit is to become big enough so that you will be able to sell your company’s shares on the stock market. The process of doing this is called an initial public offering or in short, IPO. Once again your company will issue new shares only that the investor who buys them this time is neither an angel nor VC it’s the public. The day you go public your company comes to a bunch of new shares on the stock market from then on people can buy and sell them among themselves furthermore you now hold tradable paper almost as good as cash. The price of which goes up and down every day. You can sell your stock into the stock market at a market price any time with the exception of IPO lock-up periods which are topic for another time.
You floated the shares at a starting price of $64 and they shot up to over $70 on the first day of trading. Due to stock split suited along the way you are now sitting on 10 million shares of your company your personal wealth is over 700 million dollars you could cash in but do you want that it feels like yesterday that you two just had a vision now you’re one in a million there is a lot you achieved and yet endless things to do even though investors call it an exit for many founders it’s just the beginning.