There are over 305 million startups in the world with more than 100 million startups opening each year. But only 20 percent of them make it through the cut-throat competition with sufficient funding.
Let me tell you a story.
In 1975, two young entrepreneurs sold their favorite belongings to find a startup. The business was a success and it was incorporated after a year. A multimillionaire provided essential business expertise and funding of $250,000 to the company. During the first five years of operations, revenues grew exponentially, doubling about every four months. Yearly sales grew from $775,000 to $118 million, an average annual growth rate of 533%. After rounds of funding and years of ups and downs, now the company’s net worth is over $1 trillion.
The story is about Apple Inc. and the young entrepreneurs are Steve Jobs and Steve Wozniak.
Ronald Wayne, one of the founders, had left and sold his share of the company back to Jobs and Wozniak for $800 only twelve days after the company’s inception. Now his share is worth over $95 billion and missed a spot in the list of the top 10 richest people in the world.
One of the reasons why Apple was such a huge success is proper funding and backing of the investors.
But how do startup funding works and how many rounds of funding can a startup take?
In this post, I am gonna break down the typical startup funding rounds and how a startup valuation works throughout process. Throughout the post, I will try to explain the funding stages and valuation with the help of a company called Greenleaf founded by A and B.
1. Pre-seed :
It is the stage where A and B use their savings kept in multiple accounts, and approach their friends and family. This stage involves fewer complexities and documentation, and even your friends and family may be ready to lend at a cheaper rate. Crowdfunding is also a way to raise money at this stage.
Somehow, A and B managed to pull Rs.50,000 at this stage. Every startup, at its initial stage, has to issue a certain number of shares. Greenleaf has issued 1,00,000 shares at this stage. A and B each get 50,000 shares worth of Rs.25,000.
2. Seed funding:
It is the stage where Greenleaf can raise money from early-stage Venture Capitalists, angel investors, banks and mentors in the industry. Seed funding is the first official equity funding stage. Funds raised at this stage are used for knowing the customers’ demands, preferences, and tastes, and then formulating a product or service accordingly.
The Greenleaf’s prototype is sound and an angel investor invested Rs.50,000 in the company for a 20 percent stake.
At this stage:
- Company’s worth = Rs.2,50,000 – as 20% of the company is worth Rs.50,000 as set by the investor, the 100% is worth Rs.2,50,000.
- Investor’s equity = 20,000 shares – 20% of 1,00,000 shares (remember, the company has issued 1,00,000 shares).
- A and B’s equity = 40,000 shares each – as investor gets 20,000. But its value raises to Rs.1,00,000 from Rs.25,000.
3. Series A funding:
When the company’s final products or services reach the market, venture capital funding comes into the picture. At this stage, startups formulate a specific plan for their product or service. It is mostly used for marketing and improving the brand credibility, tapping new markets and helping the business grow.
At this round, Greenleaf has an offer from a VC (venture capitalist) offering Rs.10,00,000 for Rs.50,00,000 post-money valuation (PMV). Post money valuation is the valuation set by VCs in the market so that if anyone wants to acquire the company, they have to offer more than post-money valuation.
At this stage:
- Company’s worth: Rs.10,00,000 (equal to investment value (IV) by the VC)
- VC’s equity: IV (Rs.10,00,000) / PMV (Rs.50,00,000) = 20%
Now 1,00,000 shares is equivalent to 80 percent of the company ( as 20% goes to the VC). Additionally, 25,000 shares will be issued making the total number of shares to 1,25,000.
- Share price of the company: 10,00,000 (company’s value) / 1,25,000 (total no. of shares) = Rs.8/-
- A and B’s equity: 40,000 shares * Rs.8 = Rs.3,20,000 each.
- Angel investor’s equity: 20,000 shares * Rs.8 = Rs.1,60,000 ( remember angel investor has invested just Rs.50,000)
The same process is repeated for multiple rounds of funding i.e., Series B, Series C and so on.
IPO (Initial Public Offer) is commonly related to ‘going public’ as the general public now wants to invest in the company by buying shares. IPO helps you grow and diversify in areas of choice. The funding and valuation operates in the same basic manner as the previous rounds but here the investors being the public. Once the company goes public, its shares can be traded between the public.
A plan, persistence, perseverance, a willingness to be flexible are what makes a startup successful. You also need to be frugal, bright and cultivate strong mentors. The best way to do all these things well and efficiently is to follow a systematic process.
If you want to explore more on this, you can watch a show called SILICON VALLEY. You can also read my post on 5 Tv shows every entrepreneur should watch.
Thanks for reading. Stay safe.
If you liked reading the post, share the knowledge.