Startup Sunday Season 2 Episode 33 (How Funding Works)

As an entrepreneur when you have entered a market or you are in a development phase of your product or everything is set and you want to grow your business, MONEY becomes the key for driving these next steps. It helps you hire new talented people, grow your market share, enter a new market and build up your office space etc.

In this episode of Startup Sunday, we will learn about Funding, its various stages and how and when a company should go about it.

how-funding-works-infographic

At the beginning when you (Founder/founders) just have an Idea and want to start working on it. At this stage since its just a conceptual stage the founders themselves have to put in their own money from their savings etc. this is called Bootstrapping. At this stage you and your Co-founders are the sole owners of the company.

It might be the case that the product development is taking longer than expected and you are just living on the edge and are in need of funding. at this stage your family and friends come and help. Nothing comes free my friend you do have to share a part of your company say 5% equity with them. But with this funding you will be able to survive the next 6 months or so and at that point you are optimistic that the product will be ready.

Here is a catch, how did you give your uncle or aunt those 5%, for that you first had to register your company, issue some common stock and from it gave those 5%. You may also set aside some 20-30% for your future employees which is optional.

Now your team is ready and you need further funding for completing your minimum viable product(MVP) and taking your product to the market, where will you go. Well guys its time for Angel Funding ( keep in mind that you have started preparing for this round back when you got money from your uncle/aunt itself say at-least 4 months ago). Here before reaching out to the Angel Investor you need to be clear on the purpose for which you need funding- is it for working capital, expanding business, or any other reasons but having a clear purpose is important at this stage. Another important aspect is to have a road-map ahead as to what will you do with the funding that you are asking, how much revenue you are expecting, how much return the investor can expect etc. in a nutshell the end outcome of the project is very important.

So, the nature of your business, the net outcome and why you need the money determines whom you should be approaching for funding. At the Angel round you got the following options:

  1. Incubators, accelerators and excubators- all these provide cash, working space and advisors. The cash given is tight (around $25-30K) but here advisers are what matters as you are new to market don’t have any prior work experience or any knowledge of running a business, so reaching out to them helps. They take around 5-10% stake in your company.
  2. Angel Investors- They are HNIs (High Net-worth Individuals) who invest in the range of $100,000 – $500,000. Their prime motive is financial, they are looking for handsome returns from their investment. You should be ready with the expected figures in front of them if you want this money. Beware the money is good but so is the return they are expecting and also the equity. Now here the equity they will get depends on the valuation of your Start-up.

Let’s say your Start-up is valued at $1000000 and the Angel investor decided to invest $200,000 then the amount of equity he will hold is 1/6 = 16.67%.

Also your and your co-founders equity will also take a hit by 1/6.  Or what we say your stakes will be diluted by 1/6 as well. So, in one hand your pie is getting bigger but on the other your stakes are diluting (losing control of your company) so it is always advisable to take investment only when it is necessary and from those people whom you respect.

As a result of the above funding you have been able to create a MVP (minimum viable product) and a team. The Next step is taking business to product market fit. Here you do two things:

  1. Demonstrate that your product solves the problem it is intended to solve
  2. Get some initial traction wherein users visit and revisit and you generate some value for them and have been able to get a couple of clients if you are in B2B or customers if you are in B2C.

After you have been to manage to meet the above, you are now ready to take the next step in funding that we call as SEED ROUND of funding to take that next big step. Here the funding range from $200,000 – $2000000. Here the investors can be of different types as well, they can be:

  1. HNIs
  2. Seed stage Capital Funds
  3. Venture capital funds

Here the typical dilution is between 25% to 35% depending on the cheque size, the valuation and the conviction investors have in your business etc.

The next step is scaling up the business which is generally called as Product Market Fit Scalability, here you are at a stage to go into SERIES A Funding, reaching this stage means that your business has a huge potential and you with this funding can scale up the business from let’s say 20 orders a day to 1000 orders a day. The funding that generally you get at this stage range from $2 million to $5 million and dilution of 20-30%.

Next up are Business Growth Stages in which a company goes for SERIES B, C, D etc rounds of funding wherein with each stage you are aiming to expand the market opportunities and launching in multiple cities, other demographics, other customers etc. e.g. Flipkart has is in Round J.

Generally, up-to Series C it is the venture capitalist who puts in the money and it is SERIES D and beyond the Private Equity Players come into picture. The private equity players look into aspects like stability, predictability and a longer viability as they are the ones who are writing the bigger cheques. Here the dilution is around 5-7%, though the cheque size is bigger but your company’s valuation is even bigger.

Though Money is important but one should also vary about the investor, whenever an investor puts his money in your company he/she becomes a stakeholder of your company. So, it is very important for Start-Ups to find the right kind of investor and some factors should be considered while approaching an investor like-

  • Alignment with the vision of the company set by you.
  • Capacity for future investments- will engaging with the person will also help you raise future investments.
  • Easy to work with- you should be able to enjoy his/her company as the person is on your board
  • Nature of engagement- is he involved too much in the business operations or just comes for the board meetings and doesn’t bother you much.

Finally, it is up to you, you should be able to make out what is right for you at what stage.

 

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