The startup world is definitely growing and the number of entrepreneurs is increasing every quarter, if not every month. And that eventually leads to increased demand for capital investment.
But what is capital?
Capital — Accumulated assets of a business that can be used to generate income for the business.
But the question always remains, why would anyone invest in a startup despite the risk? For returns. Period.
A return in any investment is always proportional to the risk taken. There is no such thing as a low-risk, high-return investment.
Each startup depending on the industry and the entrepreneurs involved take approaches that suit them best — to self-fund, to take loan or to even take whatever they receive from anywhere. The different stages of start-up investments are laid down below.
A situation in which an entrepreneur breaks his savings or gathers as much fund as possible from operating revenues of the company and not rely on external sources. This usually involves little or no assets for the company. A boot-strapped company could decide to accept future investment to accelerate growth.
This usually involves the stage where entrepreneurs are still conceptualizing the idea and survive off of the generosity of friends, family or immediate networks. The revenues at this stage are practically nothing, in most cases.
Seed capital acts as the fuel for a start-up’s growth. This could come at large scale in place of pre-seed capital or from startup Accelerators like Y Combinator — where applicants receive seed capital to develop their product and access opportunities to pitch investors — or company builders like EntrepreneurFirst — where entrepreneurs are chosen by merit and then form a team, build an idea as well as validate the idea over the course of 3–6 months while receiving seed capital and eventually an opportunity to pitch investors. The seed capital is usually to help entrepreneurs sustain themselves and their employees until they build an MVP and funds range from 15K € to 500K €.
Just as the term ‘angle’ describes, angel investors usually include high net-worth individual(s) who find a lot of potential in the idea and the entrepreneurs to put their own finance into the start-up’s growth at an early stage as well as offer mentor-ship and access to a network that the start-up could leverage upon. The investment at this stage usually is less than 1 Million €.
Usually backed by a firm that includes investors, board members and other enablers(who provide access to networks and funds), this stage involves high levels of investments when the startup has started making revenues, not necessarily in profits but with a huge potential to grow. The product of the start-up usually remains validated at this stage and the aim of the venture capitalists will remain to maximize their returns when the startup eventually exits by being sold to a bigger firm or goes public. Securing a VC deal usually involves months of research and discussions conducted by the VC firm. VCs do not invest less than 1 Million € and the upper limit depends predominantly on the growth potential.
There are two major partners involved in venture capital funds: ‘General partners’ who work with individual companies and ‘Limited Partners’ who restrict themselves to just investments.
Venture capital investments can also be broken down into a series of funding levels that involves multiple investors or firms while giving opportunities for entrepreneurs to pitch their MVP and their growth track record as well as potential.
These funding rounds provide outside investors the opportunity to invest cash in a growing company in exchange for equity or partial ownership of that company. But all of these involves evaluating a company’s worth which impacts the types of investors likely to be involved. Each series funding is lead by a lead investor/firm and backed by a few others.
Series A Funding:
This stage offers the entrepreneurs to scale their product after establishing a track record that might include a few performance indicators such as strong user base, consistent sales or sustainable revenue model. The scaling at this stage usually involves receiving capital for infrastructure to develop the product and validate it. Stage A investments usually come in when the startups are valued at 15 Million € and investments range from 2 to 5 Million €.
Series B Funding:
The series B involves taking the product from the development stage to the market i.e from product development to business development such as an increase in marketing to increase sales and thus revenue, acquiring top talent for tech as well as support. It is during this stage mostly that businesses evolve from start-up to companies. The company-evaluation at this stage ranges from 25 Million to 50 Million Euros while the investments are anywhere between 5 to 10 Million €.
Series C Funding:
Companies entering this stage are already quite successful and depending on the vision of founders, current investors and board members, the company takes an exit by getting acquired, continues to grow if there is greater market potential or acquires another to scale, to maybe even cut down the competition. This stage usually involves scaling and growing as quickly as possible to receive as high returns as possible. The risk involved at this stage is usually less and thus it invites hedge funds, investment banks and private equity funds for further investments. The companies at this stage are evaluated at around 100 Million Euros.
If the company doesn’t anticipate going public, it could enter Series D or E for further funding to attain global scale.
The first time a company enters the stock market is called the IPO or Initial Public Offer in the mainstream investment world. The public here refers to the fact that the company will now raise money from the common public (instead of Angel investors or Venture Capitalists). This requires a lot of transparency in accounting and companies prepare this process for months. Google, Amazon and Tesla went public.
An Initial Coin Offering (ICO), the recent buzzword, is equivalent to an IPO but in the blockchain sector. ICOs act as fundraisers when a company looking to create a new coin, app, or service dependent or independent of the blockchain application. Interested investors, including public, buy into the offering, usually with existing digital tokens like ether and receive a new cryptocurrency token-specific. The cryptocurrency can then be traded back, to say, ether in the future, hopefully, more in value. The company holding the ICO uses the investor funds as a means of furthering its development, launching its product, or starting its digital currency. ICOs are seen by startups to bypass the rigorous and regulated capital-raising processes and reduce the influence of capital investors in decision making. ICO fundraising surpassed venture fundraising for early-stage companies in the last 2 years.
For a great understanding of the fundamentals in finance, I’d recommend reading this great Quora post by Balaji Vishwanathan.