The Story of Startup Funding

Startup funding is a vast and mysterious land. Few have ever ventured there and to do so alone, is dangerous. Worry not, for Startup-Stuff shall be your guide! We will pass over Bootstrapping Bridge and into the land of Accelerators and Angel Investors. Together, we will venture through the valley of Venture Capital before climbing the Peaks of Private Equity. Then, we will reach the shores of the Stock Market and the open oceans of the IPO. This is the story of Startup funding.

Our story begins with a women called Julia. One day, Julia has an idea. An idea that stands out amongst all the others as something really worth doing. As Julia begins to work on her idea she realises it’s costing more time and money than expected (it normally does). So Julia approaches James. James is smart, enthusiastic and has the right skills. Julia can’t pay James so instead Julia forms a company and gives James 50% of the Equity. Julia and James, now Co-founders, continue working together using what little time and money they can spare. However they soon realise that in order to keep going, they’re going to need more cash. So they approach their friends and family for some help. Together Julia and James manage to scrape together £10k, buying them a few extra months. Everything that’s happened so far is called The Bootstrapping Stage and makes up the fragile early months of a Startup’s life.

After a few months of Bootstrapping, Julia and James can now see their way to launching a prototype. But to do that they’ll both need to work on it full time. This next round of funding is called The Seed Stage. The Seed Stage involves wealthy individuals who invest in early stage companies in exchange for equity, AKA Angel Investors. An Angel will typically invest anywhere from £50k to £600k. The figure will depend on how much your company is worth. Keep in mind that an Angel normally brings more than just his wallet. A good Angel will also have experience and connections in the space you’re launching into. If you already know a few Angels and they’re keen to invest, then congrats.

Unfortunately, Julia and James don’t know any Angels. Thankfully, there are organisations which offer a stepping stone into the land of the Angels. Incubators, Accelerators and Excubators will provide mentorship, free working space and a modest cash injection in exchange for a small equity stake in the company (typically around 5-10% equity). As well as helping you ready your prototype, these companies will also connect you with Angel Investors and advise you on how best to pitch to them. Perhaps the most renowned Accelerator is Google’s tech focused ‘Y Combinator’ which attracts swarms of Angel investors. Y Combinator can boast the likes of Paul Graham among the ranks of their mentors and their ‘graduates’ include companies like Airbnb and Dropbox.

At this point in our story, Julia and James have spent three months with an Accelerator in exchange for 10% equity in their company. With the cash and advice from the Accelerators mentors they finished their prototype and impressed the Angels enough to secure £500k of investment in return for 20% equity in their company. 10% remains with the Accelerator and between them, Julia and James own the 70% that’s left.

With the cash and connections from the Angel Investor and their prototype ready, Julia and James launch into their first markets and a loyal customer base begins to grow. To keep up with demand, the Company employs its first staff. As the team begins to buzz and yet more customers flock to try their product, Julia and James pat themselves on the back. Soon however, they face a cold financial reality. With the cost of the new staff and their new office space, they’re burning through cash at a furious rate. Their product is hot news but it needs refinement and the team is stretched to breaking point. The company seems poised to go global but to do that, they need to invest in building a better product and a bigger team. Enter the Venture Capitalists.

Most of us have heard of Venture Capitalists AKA “VC’s”, but what do they actually do? Well, quite simply they invest Capital (money) into Ventures (risky or daring projects). In exchange for investing in riskier projects, VC’s seek higher rates of return. Unlike Angels who invest their own money into a relatively small number of investments, VC’s are small groups of professional investors who invest other people’s money. A Venture Capital company will raise their funds from a combination of Pension Funds, Foundations and High-Net-Worth Individuals (HNWI’s) who are looking to allocate some of their money to slightly higher risk/return investments.

Another difference between Angels and VC’s is the size of their investments. Where Angels play in the region of £50 — £600k, Venture Capital investments range from around £500k right up to several hundred million. Those are intimidating numbers for Julia and James but after taking a serious look at their plans and talking things over with their Angel it soon becomes clear, that’s exactly the kind of investment their company is going to need if it’s going to keep growing.

Luckily for our two Entrepreneurs, their Angel introduces them to some eager VC’s who’ve been following their success and within a few months they’re signing off a £50 million investment in exchange for 30% equity in their company. This first round of Venture Capital investment is called Series A and many companies go on to have Series B and C as more VC’s seek to invest and gain an equity stake in the company.

For a brief moment, I’m going to pause our little story. We’ll return to Julia and James in just a moment but first, I need to mention Crowdfunding. I haven’t mentioned it so far because it’s not yet a ‘typical’ stage of Startup funding. Emphasis on the yet. Crowdfunding is very much the new kid on the block, everyone’s talking about it but the jury’s still out. That’s partly because it hasn’t yet stood the test of time and partly because not everyone understands it. However, some of the most successful Crowdfunding projects have managed to raise tens of millions in just a few months. So, it’s possible that the entire journey Julia and James have taken so far, through Bootstrapping to Accelerators, Angels and VC’s, could have been achieved with Crowdfunding alone in just a few months… food for thought. For now, let’s head back to our Entrepreneurs as their journey continues.

It’s been 3 months since Julia and James signed off their £50m Series A investment and the company has gone from strength to strength. The team has grown, the product is slicker than ever and it’s fast becoming a global must have. At this point in the story, a variety of things can happen. A larger company might notice your product and want to buy it from you. For example, Facebook recently paid a whopping $19 billion for WhatsApp. Many companies that continue to grow successfully find themselves with an offer from a Private Equity firm. Private Equity firms, like Venture Capital firms invest money from other sources (Pension Funds, HNWI’s etc) into a variety of ventures, including companies. However, when compared to Venture Capital the average Private Equity investment tends to be on the larger side, with some of the largest Private Equity investments in the tens of billions. A Private Equity firm typically seeks to financially restructure the company and then sell it on for a profit. Sadly, it’s not all happy days and many companies discover that despite initial enthusiasm their product quickly becomes stale. When they seek series B and C funding, investors have become wary and the company eventually dies from a lack of funding. Thankfully, this isn’t the case for our Entrepreneurs.

Julia and James succeeded in securing their Series B and C investments but their journey doesn’t end there. It’s been 3 years since the day they first met and discussed an idea. An idea that grew into a company and took them on the journey of their lives. Now they decide that they’re going to take the company public. ‘Going Public’ is effectively just another way of raising money by listing your company’s shares on the Stock Market. Once there, your company’s stock is available for purchase to the millions of people who trade their day after day. The process of listing your company’s shares on the stock market is called an Initial Public Offering (IPO) and involves an investment bank like Goldman Sachs or Morgan Stanley preparing your paperwork and calling prospective investors to buy your stock. In return for this service, the investment bank will charge a fee equal to 7% of all the money raised.

More importantly, for Julia and James the IPO is an opportunity to convert their ‘Restricted Stock’ into the kind that can be sold and either cash in, or hold on to their stock and sell it at a later date. Of course, their piece of the equity pie is a lot smaller than when they had 50% each. But in equity terms, it’s usually better to have a small piece of a big number than a big piece of a small one. Our Entrepreneurs sell some of their shares and watch as the company grows into the world conquering hero they knew it could be. In the months following the IPO they both decide to take some time out for themselves and take a long overdue holiday. After a week or so on the beach, James gets a call. It’s Julia, and she has an idea.