A startup demands much more than just a great idea. It demands a lot of time, discipline, dedication, and most importantly, funding.
With startups booming across with world, fund raising is the buzz word. Every business whether small or big needs to raise capital to start its operations. A start up may require several rounds of funding before it can generate sufficient cash flow from sales to finance its operations. The amount of capital and sources for each round vary by company and industry.
What is Venture Capital?
Venture capital is a source of funds for a new business. Most of the venture capitalists (VC) pool the cash and loan to it to the entrepreneurs or small businesses with strong growth potential. The venture capitalists are the people like investment bankers, wealth investors and other financial institutions.
Who needs Venture Capital?
Small businesses generally can't raise capital through debt or equity and has limited operating history so they need funds for their operations. For entrepreneurs, VCs are a vital source for cash but it often comes at a high price as the VC ask for large equity positions and sometimes also ask representation on the board. They also help the company with managerial and technical expertise.
Stages in Fund Raising
1. Seed Stage Funding
The first stage of financing is Seed stage funding. The sources of this stage funding include the founders' personal savings and investments from friends and family. Banks generally do not lend to startup companies because of the high risks associated and uncertainty of the business. The VCs stay away from seed funding.
Early financing is for the initial development of product or service. Also, this may help the company setup the basic infrastructure and building the management teams, market research or enhancement of the business plan.
Angel investors are venture capitalists who take a hands-on approach as advisers to the new business. They are often themselves successful entrepreneurs who are using some of their profits to get involved in newer ventures. The network of the angel investors help the entrepreneurs grow in scale and size through various contacts. They also provide management expertise and guidance in the complete process.
2. Early Stage funding
For companies that have started their operations but yet to begin the commercial manufacturing and sales. It helps in setup capabilities so that the company starts selling its products. At this stage the firms need huge sum of money to facilitate the operations and execute the business plan. The firms already have the key management team in place and have completed the market research. The companies start generating revenue at this stage but there is still some time to break-even.
Valuation for a company
Valuation of a startup helps in getting the idea about the fair market value on physical assets and assigning values to employees and other patent applications. It helps in determining the return on investment. If a startup company's valuation were $2million before seed funding of $2 million, then the founders and seed investors would each own 50 percent of the company. If the company raises additional money, the owners share would diminish further. Private equity funds pool money from individuals and institutions to invest in high-growth companies.
Investors generally estimate what could be the worth of a startup in five years and then divide that number by 10 to arrive at the current valuation.
What is Series A round of Funding?
This is the first round of funding in which the company has to share its ownership by giving preferred stock. The risk involved is at the highest in this round of funding as the company has not started earning profits. Series A round of funding is done on the basis of the progress made on the seed funding. At this stage the investors analyze the market size, quality of the team and risk associated with the business.
What is Series B Round of Funding?
At this stage the company is already in the market and has started selling products. Series B round of funding is required by the company to scale up its operations, to face competitors and have a market share at the national level. Aim of this round of funding is not only to break-even but also to have net profit.
What is Series C Round of Funding?
A company reaches this stage when it has proved its mettle and is a success in the market. The company goes for Series C round of funding when it tries to capture greater market share, acquisitions, or to develop more products and services. This round of funding is used for market consolidation. This can also be used to prepare the company for acquisition. If all goes well this is the last round of funding before Initial Public Offering. Valuation of company at this point is done on the basis of hard numbers. This round of funding is the last stage and generally the exit strategy of the VCs.
Disadvantages of Startup Funding
Startup capital, it goes without saying, is a risky business. The backers of startups hope that these proposals will develop into lucrative operations and reward them lavishly for their support. Many do not, and the venture capitalist's entire stake is lost. The few companies that endure and grow to scale may go public or may sell the operation to a larger company.
Benefits of Startup Funding: Big Winners
Venture Capital have underwritten the success of many of today's biggest Internet companies. Google, Face book, WhatsApp, and DropBox all got started on venture capital and are now established names. Other venture capital-backed ventures were acquired by bigger names: GitHub was bought by Microsoft, AppDynamics by Cisco, and Instagram by Facebook.
Startup Funding sources support business in the legal matter. Investors would like you to comply with the law of the land so that their business is not also put into a risk. This ensures business compliance. Startup Funding attracts a lot of investors. Investors expose you to the external market world. More clients through referral can be obtained. The network creates an opportunity to meet people with brilliant ideas that are ready and willing to transfer the same skills for the help of your business.
Investors can help boost your business idea but it is not a guarantee that you will succeed.
Before Starting a business, it is always important to analyze and get safe ways of getting Startup Funding so you don't get into trouble.