Startup Funding Explained: Everything You Need To Know

Introduction

Every great venture begins with a vision. It's that spark of inspiration that sets the wheels in motion, the catalyst for something extraordinary. And so it begins, the project, the product, the service that no one has ever done before. It's painfully obvious, so obvious that it's unbelievable. But can you pull it off? That's the question that lingers in the air, as you and your two friends embark on this exciting journey.

From Fun and Games to Serious Business

At first, it's all fun and games. You design a logo, come up with a catchy name, and it feels like a whirlwind of creativity. But then things get serious. You decide to turn this passion project into a full-fledged company. And with that decision comes the need for structure, a legal structure. But how much will it cost? Incorporating a company in the US can set you back anywhere from a mere twenty-five dollars to a few thousand dollars. It all depends on the registration fees and the complexity of your first shareholders' agreement.

The Seed Investment: Other People's Money

Now that your company is incorporated, it's time to develop your product. But that requires money. So, you decide to collect some other people's money. Who on earth would give you their hard-earned cash at such an early stage? Well, you start with family and friends, or maybe even try your luck with crowdsourcing. Typically, a newly incorporated company issues 100,000 shares, which represent equal pieces of ownership. But now, you need to decide who gets how many of those shares.

The Seed Investment: Valuation and Value

After much discussion, you and your co-founders agree on allocating 40,000 shares, or 40% of the company, to each founder. And then there's that well-off family friend who decides to invest $50,000 for 20,000 shares, or 20% of the company. Congratulations, it's called an investment, and at this early stage, it's known as a seed investment. Now, the money belongs to the company, but if the company fails, you might never see a dime of it again. Nevertheless, this investment puts the value of your enterprise at $250,000, and your 40% share is worth $100,000. Not bad for a start, right?

The Series A Round: Seeking Big Cash

A year has passed, and your beta trial with customers is a resounding success. It's time to take things to the next level. You need more people, a small office space, and of course, more cash. This is where the series A round comes in. You're looking for a whopping $1 million investment this time, and you're reaching out to angel investors and venture capitalists (VCs). These are the people who work for venture capital firms, raising funds to invest in young, risky companies like yours. Angel investors, on the other hand, are individuals who professionally invest their own money into early-stage ventures.

Valuation and Negotiation: The Dance of Money

As you reach out to potential investors, you realize that they don't care much for your business plan. What they want to see is the team, the competence, and the uniqueness of your idea. They want to know what you've already achieved and what you could achieve in the future. It's all about the vision and the promise of greatness. You set up Skype calls, answer tough questions, and spark interest. Eventually, you find yourself with two offers on the table. One VC offers $1 million for a post-money valuation of $6 million, while an angel investor offers $500,000 for a $5 million post-money valuation.

The Art of Dilution: Growing While Losing

Now comes the tricky part - valuation and dilution. Investors want a low post-money valuation to get more for their money, while you want a high post-money valuation to keep a larger share. After some negotiation, you suggest a post-money valuation of $8 million for the investor who puts in $1 million. This would mean a 12.5% stake in your company. However, there's another factor to consider - dilution. With the new investors coming on board, your cumulative share will only add up to 75% of the company. This dilution happens proportionally, meaning you have fewer shares now than before.

Capital Raise: The Journey Continues

But don't worry, this is just the beginning. Your startup's journey is far from over. The series A round won't be the last capital raise. There will be series B, C, D, and so on. With each investment round, your company's valuation will hopefully increase. And each time you raise cash from investors, you will be further diluted. Yes, your number of shares remains the same, but there will be stock splits along the way, converting each single share into multiple shares. This is the dance of capital raise, the story of growth and expansion.

The Exit: Dreaming of Profits

Fast forward six years, and your company has successfully completed four investment rounds. You've launched your product, and customers love it. You're a huge success, making a profit for the first time. Now, it's time for the exit. For investors, it's the moment they've been quietly dreaming about. The earlier they invested, the bigger the risk they took, and accordingly, the bigger the profit they could make. There are two common ways to exit a company - selling to a big player or offering it on the stock market.

Selling Out or Going Public: Choices and Consequences

If you sell out to a big company, the investors will usually sell all their shares at once. But for you and your co-founders, it's a different story. Whoever buys your company needs you to stay motivated and run the show. So, your shares are transformed into shares of the acquiring company and made available to you over time. This is called vesting. On the other hand, you could choose to go public, offering your company's shares on the stock market through an initial public offering (IPO). It's a whole new capital raise, where the public can buy and sell shares among themselves.

The Journey Continues: From Vision to Reality

And so, the journey continues. From a simple vision to a company worth millions, you've come a long way. But this is just the beginning. There's still so much to do, so many heights to reach. As you bask in the success of your venture, you realize that this is not an exit but a new beginning. The possibilities are endless, and the future is bright. Keep dreaming big, keep pushing boundaries, and who knows where this extraordinary journey will take you next.

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