Newton, David. "Understanding the Financing Stages." Entrepreneur. Entrepreneur.com, 2001. Web. 28 July. 2015.
Stages of Funding
To begin to understand the terms describing the different fundraising stages, think of the new venture on a timeline. On the far left end of the timeline is the date the idea was created and the business model conceived. The company then moves along from left to right as the idea gains credibility and forward momentum. Along the way are various milestones in the life of the enterprise, and several of these are funding benchmarks.
The first funding benchmark is the seed stage. This represents the initial capital used to do product and/or service development, patent filings, market surveys and research and business partner recruitment. The emphasis is on examining business idea feasibility and getting the firm ready to commence operations. These funds come predominantly from either the entrepreneur's personal savings, a severance package from a prior job, or cash raised from friends and family members. Many venture capital funds do not invest at the seed stage because the risks are very high.
The second benchmark comes when the venture is ready to launch. Also known as start-up financing, at this stage the business is seeing its first revenues but has yet to show a profit. This is often referred to as the series A round of investment and is typically where the enterprise brings in its first "outside" investors.
After a successful launch proves the viability of the business model, funds will be needed to further develop the marketing plan, hire more staff and management, and establish strategic alliances in the market. That third benchmark is often referred to as the second-stage, or series B, round. I've sometimes seen the seed round (all "internal" funds from the entrepreneur, friends and family) referred to as the series A round, followed by series B "start-up financing," then series C and so forth. But for purposes of talking to investors, the first round of external funds should generally be called series A and the second external round series B. This way, each subsequent round of external investors knows where they stand with respect to prior investors who go in post-seed.
The fourth benchmark involves securing a line of credit from a commercial bank at a time when revenues are gaining momentum. At this point--when monthly cash flow is at break-even--the business merits "working capital." No investors are involved at this point.
When the fifth benchmark arrives, the firm is typically looking to expand its operations at a faster pace. Internal funds (profits and lines of credit) are insufficient to support the development of assets and internal capabilities necessary for stronger sales growth. At this point, the firm seeks to raise another external round of capital from investors, the series C round. Here, capital is used to substantially ramp up existing operations and move the company into a significant position in the industry.
Many businesses will have a seed round, then series A and series B rounds, followed by plans to be acquired or to make an IPO of common stock. This next stage is usually all short-term debt and referred to as "mezzanine," or "bridge," financing. Some firms may even have a distinct series D round (I've even seen rounds E, F and G) to further grow the business before considering a mezzanine round. This debt is used to support continued growth opportunities while preparing for an acquisition, a management buyout, a leveraged buyout or an IPO.
Remember that at each stage, the firm will need to be valued, and too many rounds can overly dilute the founders' stakes in the venture. But it is also important to avoid an IPO too early, as the firm's positioning in the industry might not yet be assured. Some firms bootstrap their growth with internally generated funds only and avoid having to look for external investors. The key is to know your growth track, determine your sales and profit benchmarks, and be shrewd when it comes to valuing each stage.
For many founders, raising money is the single most stressful part of getting their startups off the ground.
After all, a multi-billion dollar idea doesn’t become a multi-billion dollar company without the funds needed to purchase capital, hire staff and capture the attention of prospective customers.
For many founders, this means taking an investment from a venture capital firm in exchange for a stake in the company. With the media trumpeting a seemingly endless number of new funding rounds across the startup landscape, it’s no wonder that the single biggest question I get from first-time entrepreneurs is, “How do I find a venture capital firm to invest in us?”
And yet, despite the many venture-backed successes we’ve seen these past few years, the truth is that fewer than one in 10 startups are able to get a VC firm onboard.
The good news is that venture capital is just one of a number of ways founders can get the cash they need to bring their visions to fruition.
Here are the three main categories of funding every entrepreneur should be familiar with before they try their hand at launching a company.
Bootstrapping
Bootstrapping typically entails building a company from some combination of personal savings and borrowed money from friends and family.
While this might sound like a dicey proposition, smart founders are able to get the most bang for their buck by launching their companies in countries like Vietnam or Chile, where the cost of living is relatively low, and by applying for government grants to tide them over until the revenues start rolling in.
In recent years, bootstrapping has been made more attractive by crowdfunding platforms like Kickstarter and Indiegogo, which allow members of the public to give cash donations in exchange for early access to a company’s product or other perks. This tool allows founders to gain access to capital without giving up potentially valuable equity, and helps them get a gauge of consumer demand prior to launch.
Equity funding
If bootstrapping isn’t a possibly, founders might do well to trade a stake in their company for a capital infusion. While venture capital firms are best for startups who need lots of cash and intend to grow extremely quickly, there are plenty of other equity options for founders with different business strategies.
For starters, new founders may want to try getting their company into an accelerator, a two- or three-month program designed to help startups work through the early stages of their development and find potential investors at the program’s conclusion.
Related: 6 Tips for Overcoming a 'No' When Seeking Funding
Accelerators have launched success stories like Dropbox and Airbnb, whose founders received a small amount of funding and valuable mentorship from experienced entrepreneurs in exchange for somewhere between a 7% and 10% stake in their companies.
Startup founders can find a similar combination of funding and mentorship by seeking out angel investors, a group of rich individuals -- often former entrepreneurs themselves -- who make small investments in new companies. Founders looking for somewhere to start can try searching for angels at networking events or on the website AngelList.
On the other end of the spectrum, startups also sometimes receive what are called “strategic investments” from larger, more established companies looking for an edge over their competitors. For instance, Microsoft made a $15 million investment in Foursquare last year in a deal that allowed it to start using the company’s check-in data.
Debt funding
It’s not always a good idea for a young startup to go into the red early in its lifespan, so debt funding is best thought of as something of a last resort. However, in certain situations where a small amount of money is needed very quickly, it might make sense for a company to take out a regular, old loan and spare itself the hassle of finding an investor.
In these cases, I’d advise founders to research whether their businesses are eligible for government-backed loans, which usually have favorable interest rates and flexible repayment schedules.
As you can see, there is no shortage of ways founders can get access to the capital they need to make their businesses successful, even if they can’t find a VC firm to commit to them.
And regardless of which route a new founder ultimately chooses to go down, it is crucial that he or she takes the time to carefully consider the startup’s goals and how its funding strategy will help it achieve them.
Debt funding is also a viable funding option. With debt funding, you borrow cash that you will have to pay back, regardless of whether or not your company is making a profit. While you may choose to incur debt (i.e. borrow cash) from friends and family, there are other kinds of debt funding you could also pursue. The most common are:
· Venture debt. In some ways this kind of debt feels a lot like equity—at least in the short term. The difference comes in the long term: at some point, you will have to repay this debt, regardless of company performance. For term loans, typically repayment terms are multi-year (with three years being the most common). Non-formula lines of credit usually have a shorter term of just one year.
· AR line (accounts receivable-based credit lines). If your company has accounts receivable (in other words, you are already generating revenue), this can be a great funding option—cheaper and less risky than other forms of venture debt. There are many lenders who are willing to finance accounts receivable. If you are experiencing a working capital gap between the time it takes to collect payments and make payments, you can leverage your billed accounts receivable at a significantly discounted rate. In other words, you’re essentially taking out a loan on payments yet to be paid. Most of what we see with our clients in terms of debt funding is venture debt and/or AR lines.
· Asset loan. This is essentially a loan that is collateralized by equipment. If you need a significant amount of capital equipment, you can finance these purchases. This kind of loan doesn’t always require that the equipment you are purchasing is specifically tied to the funding you receive. Sometimes you can even use this loan to fund growth in other areas. This kind of debt is pretty hard to get so we don’t see it too often, but it’s worth seeking out if you have equipment needs.
· SBA loan. These are bank loans guaranteed by the Small Business Administration (SBA), usually with a lower interest rate than that of loans not guaranteed by the SBA. This guarantee doesn’t mean that you are off the hook if your business fails; in the case that your business goes south, you still need to pay back the loan. The main advantage to this type of loan is access: with the backing of the SBA, you might be approved for loans that you wouldn’t have received otherwise. Though none of our clients have received SBA loans, it’s still worth looking into if you’re a new startup in need of funds.
Now that you have a basic understanding of the most common funding types, you’re ready to take your company to the next level. First outline exactly what that “next level” looks like—specifically, what milestones do you hope to achieve? Then use these milestones to create financial projections that you can use to calculate how much funding you will need and what funding type is the best bet for your company.
David Ehrenberg is the founder and CEO of Early Growth Financial Services, a financial services firm providing a complete suite of financial services to companies at every stage of the development process. He's a financial expert and startup mentor, whose passion is helping businesses focus on what they do best. Follow David @EarlyGrowthFS.
There is a common misconception that securing a round of funding means success. In reality, a round of funding is a stepping stone down a long path -- like a tool to an equation, far from the end result.
If you’re one of the few to get funded, you’ll realize your road to success is just starting. I remember when my friend, Morgan Schwanke, secured his first round of funding for his startup, On My Block. He walked in our front door with a mix of excitement and fear on his face. He knew he was now able take his startup to the next level, yet understood he was far from making what really matters -- profit. Instead of celebrating that night like most people would, Morgan was thinking of the future.
If you have the drive and determination to make your startup profitable, then realize money earned is much more powerful than money raised. Securing an investment is just the beginning. Along your road to securing funding you’ll realize these five facts about venture capital:
1. It's time consuming. Seeking outside funding will take up a ton of your time. You will either be shooting off many emails to potential investors, or if you’re lucky, meeting face to face with them. If you’re having trouble securing investment, refocus your time towards dialing in your business model and driving sales.
2. Consider the source. Don’t be the entrepreneur who accepts any money thrown at them. Just as an investor screens your startup, you should be screening them as well. Remember, securing funding is a relationship, not a transaction. Also realize that investors aren’t always experts in the subject areas in which they’re spending. Though their money is valuable, their insight in your field may not be.
3. The added stress. An investor will want to know about anything and everything you’re doing. You’ll need to be as transparent as ever with them, which is crucial to building trust. If you’re having trouble managing your existing partners, think about how much trouble you would face when dealing with someone else’s money.
4. Reporting in. Though an investor is not your boss, it does mean you need to report to someone. They will expect you to keep them in the loop and failing to do so could hurt your relationship. Entrepreneurs seek freedom, and an investor can potentially tie you down while simultaneously opening doors.
5. Others will follow. The hardest part of securing a relatively big round is getting your first investor on board. Venture capitalists tend to follow in others’ footsteps because they don’t want to be the only one to potentially lose money. If you have the talent to pull together a pool of investors, you’ll likely have others knocking on your door.
Though an investment can take your business to the next level, realize money earned is much better than money raised. As my mentor, Will Caldwell, founder of Rivolix, says, “If you’re making money, investors will notice and come to you.” Start focusing more on driving sales and you’ll be more likely to secure a round of funding.
One of the most difficult tasks for startup entrepreneurs who seek early investment is determining the value of their company.
Face it, when you ask Aunt Nellie to be a silent partner, the stake you exchange in your business is based on how you both value it. Armed with an understanding of early-stage investments, you can greatly reduce the stress of reaching an agreed upon value.
Through my experience at Startup.SC, I have learned that the true goal of early-stage investment is to delay actual valuation until later stage fundraising, when a more accurate valuation can be made. With that said, you still need to have an agreed upon value with your early investors. More important, how you value your company at these early stages is crucial for long-term success (not to mention peace of mind for you and your investors), so it should not be taken lightly.
Here are a few tips for novice startup entrepreneurs to consider.
Know your 18-month runway. How much working capital will you need to get your idea developed and launched within 18 months? This includes the cost of development, hiring (and retaining) key talent and acquiring customers (marketing). This runway can vary from 12 to 18 months, but the latter is widely accepted by most angel investors. Also, remember the number-one rule of investors: do more with less. Do not be frivolous with your estimates and be certain that every dollar you raise goes to launching your business.
Remember the 20 percent threshold. In startup rounds of fundraising, you should avoid giving up too much equity. The amount will vary between 15 percent and 25 percent, depending on the source, but in general, the idea is that in later fundraising rounds (series A and beyond), new investors will also want a cut of the equity, so if you have given away too much in the beginning, there will be very little of the pie left to share.
Calculate your value. So you have determined that you need to raise $200,000 to get your company launched over the next 18 months. If you target a maximum of 20 percent of your business in exchange for this startup capital, then you have valued your company at $1,000,000.
Now this will be difficult for many novice entrepreneurs to swallow. How do you ask early investors to invest in a startup company that you have valued at $1 million? Assuming you have validated your startup idea, most sophisticated angel investors will understand how you determined this valuation and the reasoning behind it. Whether they agree with it or not is another story.
For other investors, such as your Aunt Nellie, who may not understand the reasoning, it is important to explain that the goal is to delay the valuation until later rounds of funding, at which time your startup company will have (hopefully) launched and had some success. Saving equity for later investors only helps to increase the value long term.
Consider this scenario:
· After you have successfully met your 18-month runway plan, you might look to an experienced venture capital (VC) firm to raise another round of capital to grow and scale. At that point, determining your company's valuation will be much easier and more accurate.
· If you have protected your startup investors with an agreement (convertible or safe debt) and a market cap (a maximum valuation of the company that all investors agree upon, in this example, $1,000,000), then their 20 percent investment is secure.
· If the VC firm decides to invest $1,000,000 in exchange for 20 percent of your business at that time, which comes out of the entrepreneur's equity, they have just valued your business at $5,000,000. Your startup investors have just made five times their money.
The biggest concern for all investors, and to a great extent the entrepreneur, is equity dilution. If you dilute the equity too much and too early, then later investors have no incentive to invest. Early investors need to understand and appreciate that later round investors are key to growing a business, increasing the value of the company and, hence, the value of early investments.
Of course, all of this is an oversimplification of the sensitive process of valuing a startup company, but it can serve as a guideline for new entrepreneurs with little experience. Additionally, startup entrepreneurs should:
Leverage entrepreneurship centers. Take advantage of services for startup entrepreneurs, such as SCOREand business incubators, such as Startup.SC.
Find mentors. Find experienced entrepreneurs to help and advise you through the process. Use them as a sounding board for your concerns and ideas.
Do not get desperate. Not every early investor is sophisticated enough to understand the importance of protecting against dilution. You may find yourself faced with an investor who is willing to invest a large sum of money but has unreasonable demands. As tempting as it may be, do not sacrifice to the point where it hurts your long-term goals.
Remember that everything is negotiable. There are always creative ways to structure deals that will make all parties comfortable. Be willing and flexible to entertain ideas, as long as they do not compromise these early-stage fundraising tips.
In the end, remember that raising startup capital is a long and difficult process. Put yourself in the shoes of investors, and remember that patience, honesty and determination will ultimately help you meet your fundraising goals.
Your Aunt Nellie will appreciate it too.
Do you have any other advice for startup entrepreneurs who are looking to raise capital? Please share your valuable thoughts and experiences with others in the comments section below.
I am going to explain it with an example, in order to make it easier for you to understand. I am going to give an example of you and your friend who plan to start a company in a particular industry.
STAGE 1:
To begin with, let’s assume you are having an idea of starting an e-commerce business. You along with your friend decide to start a company. You both have complimentary skills, one being a techie and the other being a business guy. You both decide to be equal share holders of the company (50-50).
Initial Equity Distribution in a startup
[ Please have a note: I will indicate the company by the balance sheet. In generalAssets = Equity (e.g. stocks/shares, cash) + Liabilities(e.g. loan). If we don’t decide to take loan then we don’t have any liability that means Assets = Equity. Equity is basically what the owners of the company have a right to. Got it? Cool! ]
So, Let’s assume you and your friend decide that you won’t take any loan as you don’t want to have any liability of giving back money to someone else.
So, to begin with let’s assume that you introduce 10,000 shares in the company at a minimum valuation of 1 lakh rupees (i.e. 10rupees/share, got it?). That means you will have 5000 shares and your friend will have 5000 shares.
You alone with your friend can’t start the company. You need employees for building the product, for marketing, for making an online presence of the company.
So for all this you need to raise money. Then comes the concept of investment in picture.
STAGE 2 (Angel Round)
You approach an angel investor and try to show him that the industry in which you are working has a huge market, your team is great, have an ability to build a good product and market it.
[Please have a note: At a very early stage, successful entrepreneurs or a person who has money to invest at personal level invests in your startup – he is called an angel investor.]
So you approach the Angel Investors with your idea and try to sell it. If the Angel Investor is impressed with the idea he will be ready to put in money.
So now when the Angel Investor agrees to invest, there will be negotiations on what he will get in return for the investment made. This process is called as ‘Valuation’.
You need to come up with a Pre-Money Valuation of your company before you get the investment. So let’s assume (on the basis of your market size, team and other factors) that the Pre-Money Valuation of your company is INR 1.8 crores. You need INR 20lacs to build a basic product and get first 100 customers on board. To do that, you will be hiring new employees, you will buy a basic office space. This funding will be used for 1 year
Now suppose the Angel Investor agrees on the Pre-Money Valuation.
Equity Distribution After Angel Investment Round
Now the Post-Money Valuation is INR 2 cr i.e. the total assets = INR 20 Cr, with no liabilities yet.
As members of the board of the company, you will issue shares. Let’s say now total shares are 10 Lacs. So, on the basis of the valuation, the investor will have 20lacs/20CR*100 = 10% shares in the company
You and your partner now get diluted by 10%, so now you have 45% each.
STAGE 3 (VC SEED ROUND)
With the help of Angel Investment, you work hard to build a product, do sales, get more customers. So now you need more money to expand throughout the country. As your company has become more mature because of better product, more sales & revenue, the valuation of your company has now increased.
You start approaching the Next Stage, The Venture Capitalists are the professional people who give you money in return for the stake in the company but at a later stage.
You start talking with the VCs. This is the real professional institutional Funding. Consider You are able to convince them and you raise INR 5 Cr at a pre money valuation of INR 15 Cr.
Equity Distribution after VC Seed investment round
So, the post money valuation will now be 20Cr and the Venture Capitalists will own 25% of the total shares. You, your partner and your angel investor will get diluted by 25%, that means you and your partner will now own 0.75*45%=33.75% of the company.
Interestingly, as you see in the figure, Angel investor had invested INR 20 lacs and now his shares value is INR 1.5Cr, more than 500% increase in his shares’ value. Startup investment is always great but riskier as well.
You can access to various links of funding here.
Stages of Funding
To begin to understand the terms describing the different fundraising stages, think of the new venture on a timeline. On the far left end of the timeline is the date the idea was created and the business model conceived. The company then moves along from left to right as the idea gains credibility and forward momentum. Along the way are various milestones in the life of the enterprise, and several of these are funding benchmarks.
The first funding benchmark is the seed stage. This represents the initial capital used to do product and/or service development, patent filings, market surveys and research and business partner recruitment. The emphasis is on examining business idea feasibility and getting the firm ready to commence operations. These funds come predominantly from either the entrepreneur's personal savings, a severance package from a prior job, or cash raised from friends and family members. Many venture capital funds do not invest at the seed stage because the risks are very high.
The second benchmark comes when the venture is ready to launch. Also known as start-up financing, at this stage the business is seeing its first revenues but has yet to show a profit. This is often referred to as the series A round of investment and is typically where the enterprise brings in its first "outside" investors.
After a successful launch proves the viability of the business model, funds will be needed to further develop the marketing plan, hire more staff and management, and establish strategic alliances in the market. That third benchmark is often referred to as the second-stage, or series B, round. I've sometimes seen the seed round (all "internal" funds from the entrepreneur, friends and family) referred to as the series A round, followed by series B "start-up financing," then series C and so forth. But for purposes of talking to investors, the first round of external funds should generally be called series A and the second external round series B. This way, each subsequent round of external investors knows where they stand with respect to prior investors who go in post-seed.
The fourth benchmark involves securing a line of credit from a commercial bank at a time when revenues are gaining momentum. At this point--when monthly cash flow is at break-even--the business merits "working capital." No investors are involved at this point.
When the fifth benchmark arrives, the firm is typically looking to expand its operations at a faster pace. Internal funds (profits and lines of credit) are insufficient to support the development of assets and internal capabilities necessary for stronger sales growth. At this point, the firm seeks to raise another external round of capital from investors, the series C round. Here, capital is used to substantially ramp up existing operations and move the company into a significant position in the industry.
Many businesses will have a seed round, then series A and series B rounds, followed by plans to be acquired or to make an IPO of common stock. This next stage is usually all short-term debt and referred to as "mezzanine," or "bridge," financing. Some firms may even have a distinct series D round (I've even seen rounds E, F and G) to further grow the business before considering a mezzanine round. This debt is used to support continued growth opportunities while preparing for an acquisition, a management buyout, a leveraged buyout or an IPO.
Remember that at each stage, the firm will need to be valued, and too many rounds can overly dilute the founders' stakes in the venture. But it is also important to avoid an IPO too early, as the firm's positioning in the industry might not yet be assured. Some firms bootstrap their growth with internally generated funds only and avoid having to look for external investors. The key is to know your growth track, determine your sales and profit benchmarks, and be shrewd when it comes to valuing each stage.
For many founders, raising money is the single most stressful part of getting their startups off the ground.
After all, a multi-billion dollar idea doesn’t become a multi-billion dollar company without the funds needed to purchase capital, hire staff and capture the attention of prospective customers.
For many founders, this means taking an investment from a venture capital firm in exchange for a stake in the company. With the media trumpeting a seemingly endless number of new funding rounds across the startup landscape, it’s no wonder that the single biggest question I get from first-time entrepreneurs is, “How do I find a venture capital firm to invest in us?”
And yet, despite the many venture-backed successes we’ve seen these past few years, the truth is that fewer than one in 10 startups are able to get a VC firm onboard.
The good news is that venture capital is just one of a number of ways founders can get the cash they need to bring their visions to fruition.
Here are the three main categories of funding every entrepreneur should be familiar with before they try their hand at launching a company.
Bootstrapping
Bootstrapping typically entails building a company from some combination of personal savings and borrowed money from friends and family.
While this might sound like a dicey proposition, smart founders are able to get the most bang for their buck by launching their companies in countries like Vietnam or Chile, where the cost of living is relatively low, and by applying for government grants to tide them over until the revenues start rolling in.
In recent years, bootstrapping has been made more attractive by crowdfunding platforms like Kickstarter and Indiegogo, which allow members of the public to give cash donations in exchange for early access to a company’s product or other perks. This tool allows founders to gain access to capital without giving up potentially valuable equity, and helps them get a gauge of consumer demand prior to launch.
Equity funding
If bootstrapping isn’t a possibly, founders might do well to trade a stake in their company for a capital infusion. While venture capital firms are best for startups who need lots of cash and intend to grow extremely quickly, there are plenty of other equity options for founders with different business strategies.
For starters, new founders may want to try getting their company into an accelerator, a two- or three-month program designed to help startups work through the early stages of their development and find potential investors at the program’s conclusion.
Related: 6 Tips for Overcoming a 'No' When Seeking Funding
Accelerators have launched success stories like Dropbox and Airbnb, whose founders received a small amount of funding and valuable mentorship from experienced entrepreneurs in exchange for somewhere between a 7% and 10% stake in their companies.
Startup founders can find a similar combination of funding and mentorship by seeking out angel investors, a group of rich individuals -- often former entrepreneurs themselves -- who make small investments in new companies. Founders looking for somewhere to start can try searching for angels at networking events or on the website AngelList.
On the other end of the spectrum, startups also sometimes receive what are called “strategic investments” from larger, more established companies looking for an edge over their competitors. For instance, Microsoft made a $15 million investment in Foursquare last year in a deal that allowed it to start using the company’s check-in data.
Debt funding
It’s not always a good idea for a young startup to go into the red early in its lifespan, so debt funding is best thought of as something of a last resort. However, in certain situations where a small amount of money is needed very quickly, it might make sense for a company to take out a regular, old loan and spare itself the hassle of finding an investor.
In these cases, I’d advise founders to research whether their businesses are eligible for government-backed loans, which usually have favorable interest rates and flexible repayment schedules.
As you can see, there is no shortage of ways founders can get access to the capital they need to make their businesses successful, even if they can’t find a VC firm to commit to them.
And regardless of which route a new founder ultimately chooses to go down, it is crucial that he or she takes the time to carefully consider the startup’s goals and how its funding strategy will help it achieve them.
Debt funding is also a viable funding option. With debt funding, you borrow cash that you will have to pay back, regardless of whether or not your company is making a profit. While you may choose to incur debt (i.e. borrow cash) from friends and family, there are other kinds of debt funding you could also pursue. The most common are:
· Venture debt. In some ways this kind of debt feels a lot like equity—at least in the short term. The difference comes in the long term: at some point, you will have to repay this debt, regardless of company performance. For term loans, typically repayment terms are multi-year (with three years being the most common). Non-formula lines of credit usually have a shorter term of just one year.
· AR line (accounts receivable-based credit lines). If your company has accounts receivable (in other words, you are already generating revenue), this can be a great funding option—cheaper and less risky than other forms of venture debt. There are many lenders who are willing to finance accounts receivable. If you are experiencing a working capital gap between the time it takes to collect payments and make payments, you can leverage your billed accounts receivable at a significantly discounted rate. In other words, you’re essentially taking out a loan on payments yet to be paid. Most of what we see with our clients in terms of debt funding is venture debt and/or AR lines.
· Asset loan. This is essentially a loan that is collateralized by equipment. If you need a significant amount of capital equipment, you can finance these purchases. This kind of loan doesn’t always require that the equipment you are purchasing is specifically tied to the funding you receive. Sometimes you can even use this loan to fund growth in other areas. This kind of debt is pretty hard to get so we don’t see it too often, but it’s worth seeking out if you have equipment needs.
· SBA loan. These are bank loans guaranteed by the Small Business Administration (SBA), usually with a lower interest rate than that of loans not guaranteed by the SBA. This guarantee doesn’t mean that you are off the hook if your business fails; in the case that your business goes south, you still need to pay back the loan. The main advantage to this type of loan is access: with the backing of the SBA, you might be approved for loans that you wouldn’t have received otherwise. Though none of our clients have received SBA loans, it’s still worth looking into if you’re a new startup in need of funds.
Now that you have a basic understanding of the most common funding types, you’re ready to take your company to the next level. First outline exactly what that “next level” looks like—specifically, what milestones do you hope to achieve? Then use these milestones to create financial projections that you can use to calculate how much funding you will need and what funding type is the best bet for your company.
David Ehrenberg is the founder and CEO of Early Growth Financial Services, a financial services firm providing a complete suite of financial services to companies at every stage of the development process. He's a financial expert and startup mentor, whose passion is helping businesses focus on what they do best. Follow David @EarlyGrowthFS.
There is a common misconception that securing a round of funding means success. In reality, a round of funding is a stepping stone down a long path -- like a tool to an equation, far from the end result.
If you’re one of the few to get funded, you’ll realize your road to success is just starting. I remember when my friend, Morgan Schwanke, secured his first round of funding for his startup, On My Block. He walked in our front door with a mix of excitement and fear on his face. He knew he was now able take his startup to the next level, yet understood he was far from making what really matters -- profit. Instead of celebrating that night like most people would, Morgan was thinking of the future.
If you have the drive and determination to make your startup profitable, then realize money earned is much more powerful than money raised. Securing an investment is just the beginning. Along your road to securing funding you’ll realize these five facts about venture capital:
1. It's time consuming. Seeking outside funding will take up a ton of your time. You will either be shooting off many emails to potential investors, or if you’re lucky, meeting face to face with them. If you’re having trouble securing investment, refocus your time towards dialing in your business model and driving sales.
2. Consider the source. Don’t be the entrepreneur who accepts any money thrown at them. Just as an investor screens your startup, you should be screening them as well. Remember, securing funding is a relationship, not a transaction. Also realize that investors aren’t always experts in the subject areas in which they’re spending. Though their money is valuable, their insight in your field may not be.
3. The added stress. An investor will want to know about anything and everything you’re doing. You’ll need to be as transparent as ever with them, which is crucial to building trust. If you’re having trouble managing your existing partners, think about how much trouble you would face when dealing with someone else’s money.
4. Reporting in. Though an investor is not your boss, it does mean you need to report to someone. They will expect you to keep them in the loop and failing to do so could hurt your relationship. Entrepreneurs seek freedom, and an investor can potentially tie you down while simultaneously opening doors.
5. Others will follow. The hardest part of securing a relatively big round is getting your first investor on board. Venture capitalists tend to follow in others’ footsteps because they don’t want to be the only one to potentially lose money. If you have the talent to pull together a pool of investors, you’ll likely have others knocking on your door.
Though an investment can take your business to the next level, realize money earned is much better than money raised. As my mentor, Will Caldwell, founder of Rivolix, says, “If you’re making money, investors will notice and come to you.” Start focusing more on driving sales and you’ll be more likely to secure a round of funding.
One of the most difficult tasks for startup entrepreneurs who seek early investment is determining the value of their company.
Face it, when you ask Aunt Nellie to be a silent partner, the stake you exchange in your business is based on how you both value it. Armed with an understanding of early-stage investments, you can greatly reduce the stress of reaching an agreed upon value.
Through my experience at Startup.SC, I have learned that the true goal of early-stage investment is to delay actual valuation until later stage fundraising, when a more accurate valuation can be made. With that said, you still need to have an agreed upon value with your early investors. More important, how you value your company at these early stages is crucial for long-term success (not to mention peace of mind for you and your investors), so it should not be taken lightly.
Here are a few tips for novice startup entrepreneurs to consider.
Know your 18-month runway. How much working capital will you need to get your idea developed and launched within 18 months? This includes the cost of development, hiring (and retaining) key talent and acquiring customers (marketing). This runway can vary from 12 to 18 months, but the latter is widely accepted by most angel investors. Also, remember the number-one rule of investors: do more with less. Do not be frivolous with your estimates and be certain that every dollar you raise goes to launching your business.
Remember the 20 percent threshold. In startup rounds of fundraising, you should avoid giving up too much equity. The amount will vary between 15 percent and 25 percent, depending on the source, but in general, the idea is that in later fundraising rounds (series A and beyond), new investors will also want a cut of the equity, so if you have given away too much in the beginning, there will be very little of the pie left to share.
Calculate your value. So you have determined that you need to raise $200,000 to get your company launched over the next 18 months. If you target a maximum of 20 percent of your business in exchange for this startup capital, then you have valued your company at $1,000,000.
Now this will be difficult for many novice entrepreneurs to swallow. How do you ask early investors to invest in a startup company that you have valued at $1 million? Assuming you have validated your startup idea, most sophisticated angel investors will understand how you determined this valuation and the reasoning behind it. Whether they agree with it or not is another story.
For other investors, such as your Aunt Nellie, who may not understand the reasoning, it is important to explain that the goal is to delay the valuation until later rounds of funding, at which time your startup company will have (hopefully) launched and had some success. Saving equity for later investors only helps to increase the value long term.
Consider this scenario:
· After you have successfully met your 18-month runway plan, you might look to an experienced venture capital (VC) firm to raise another round of capital to grow and scale. At that point, determining your company's valuation will be much easier and more accurate.
· If you have protected your startup investors with an agreement (convertible or safe debt) and a market cap (a maximum valuation of the company that all investors agree upon, in this example, $1,000,000), then their 20 percent investment is secure.
· If the VC firm decides to invest $1,000,000 in exchange for 20 percent of your business at that time, which comes out of the entrepreneur's equity, they have just valued your business at $5,000,000. Your startup investors have just made five times their money.
The biggest concern for all investors, and to a great extent the entrepreneur, is equity dilution. If you dilute the equity too much and too early, then later investors have no incentive to invest. Early investors need to understand and appreciate that later round investors are key to growing a business, increasing the value of the company and, hence, the value of early investments.
Of course, all of this is an oversimplification of the sensitive process of valuing a startup company, but it can serve as a guideline for new entrepreneurs with little experience. Additionally, startup entrepreneurs should:
Leverage entrepreneurship centers. Take advantage of services for startup entrepreneurs, such as SCOREand business incubators, such as Startup.SC.
Find mentors. Find experienced entrepreneurs to help and advise you through the process. Use them as a sounding board for your concerns and ideas.
Do not get desperate. Not every early investor is sophisticated enough to understand the importance of protecting against dilution. You may find yourself faced with an investor who is willing to invest a large sum of money but has unreasonable demands. As tempting as it may be, do not sacrifice to the point where it hurts your long-term goals.
Remember that everything is negotiable. There are always creative ways to structure deals that will make all parties comfortable. Be willing and flexible to entertain ideas, as long as they do not compromise these early-stage fundraising tips.
In the end, remember that raising startup capital is a long and difficult process. Put yourself in the shoes of investors, and remember that patience, honesty and determination will ultimately help you meet your fundraising goals.
Your Aunt Nellie will appreciate it too.
Do you have any other advice for startup entrepreneurs who are looking to raise capital? Please share your valuable thoughts and experiences with others in the comments section below.
I am going to explain it with an example, in order to make it easier for you to understand. I am going to give an example of you and your friend who plan to start a company in a particular industry.
STAGE 1:
To begin with, let’s assume you are having an idea of starting an e-commerce business. You along with your friend decide to start a company. You both have complimentary skills, one being a techie and the other being a business guy. You both decide to be equal share holders of the company (50-50).
Initial Equity Distribution in a startup
[ Please have a note: I will indicate the company by the balance sheet. In generalAssets = Equity (e.g. stocks/shares, cash) + Liabilities(e.g. loan). If we don’t decide to take loan then we don’t have any liability that means Assets = Equity. Equity is basically what the owners of the company have a right to. Got it? Cool! ]
So, Let’s assume you and your friend decide that you won’t take any loan as you don’t want to have any liability of giving back money to someone else.
So, to begin with let’s assume that you introduce 10,000 shares in the company at a minimum valuation of 1 lakh rupees (i.e. 10rupees/share, got it?). That means you will have 5000 shares and your friend will have 5000 shares.
You alone with your friend can’t start the company. You need employees for building the product, for marketing, for making an online presence of the company.
So for all this you need to raise money. Then comes the concept of investment in picture.
STAGE 2 (Angel Round)
You approach an angel investor and try to show him that the industry in which you are working has a huge market, your team is great, have an ability to build a good product and market it.
[Please have a note: At a very early stage, successful entrepreneurs or a person who has money to invest at personal level invests in your startup – he is called an angel investor.]
So you approach the Angel Investors with your idea and try to sell it. If the Angel Investor is impressed with the idea he will be ready to put in money.
So now when the Angel Investor agrees to invest, there will be negotiations on what he will get in return for the investment made. This process is called as ‘Valuation’.
You need to come up with a Pre-Money Valuation of your company before you get the investment. So let’s assume (on the basis of your market size, team and other factors) that the Pre-Money Valuation of your company is INR 1.8 crores. You need INR 20lacs to build a basic product and get first 100 customers on board. To do that, you will be hiring new employees, you will buy a basic office space. This funding will be used for 1 year
Now suppose the Angel Investor agrees on the Pre-Money Valuation.
Equity Distribution After Angel Investment Round
Now the Post-Money Valuation is INR 2 cr i.e. the total assets = INR 20 Cr, with no liabilities yet.
As members of the board of the company, you will issue shares. Let’s say now total shares are 10 Lacs. So, on the basis of the valuation, the investor will have 20lacs/20CR*100 = 10% shares in the company
You and your partner now get diluted by 10%, so now you have 45% each.
STAGE 3 (VC SEED ROUND)
With the help of Angel Investment, you work hard to build a product, do sales, get more customers. So now you need more money to expand throughout the country. As your company has become more mature because of better product, more sales & revenue, the valuation of your company has now increased.
You start approaching the Next Stage, The Venture Capitalists are the professional people who give you money in return for the stake in the company but at a later stage.
You start talking with the VCs. This is the real professional institutional Funding. Consider You are able to convince them and you raise INR 5 Cr at a pre money valuation of INR 15 Cr.
Equity Distribution after VC Seed investment round
So, the post money valuation will now be 20Cr and the Venture Capitalists will own 25% of the total shares. You, your partner and your angel investor will get diluted by 25%, that means you and your partner will now own 0.75*45%=33.75% of the company.
Interestingly, as you see in the figure, Angel investor had invested INR 20 lacs and now his shares value is INR 1.5Cr, more than 500% increase in his shares’ value. Startup investment is always great but riskier as well.
You can access to various links of funding here.
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