Fundraising in a Nutshell
Stage 1: Seed Round
So, you have an idea, product or service that is the coolest thing since sliced bread. The business concept is sketched and the brand designed. Now to raise funds to kickstart the journey to world domination. Welcome to fundraising.
You decide to start a company, rent some server space and hire a corporate secretary to draft legal documents like the company constitution (previously known as memorandum of association and articles of association), statutory books and shareholders’ agreement.
How can it be funded at this early stage? Who will take a risk with this germ of a company to fund it? Typically, at this stage, sources of funds are from family, friends or crowd-sourcing.
Say the company issues 80 shares and a friend agrees to invest $1.6 million for a 20% stake or 16 shares*. This brings the company’s worth to $8 million or 80/16 X $1.6 million.
You heave completed the seed round, incorporated the company with seed funding. The investment also means that your 80% stake, or 64 shares, is now worth $6.4 million. Congratulations, you are a millionaire!
Stage 2: Series A Round
A year has passed. The company – and you – have been busy working on the MVP, or minimum viable product. Seed money is running out but with the MVP, there is finally something to show for all the effort, and it is time to raise the first serious bag of cash. You look to either an angel investor or venture capitalist (VC).
The VC asks some hard questions about product market fit, differentiation, scalability, competition and execution. At this stage, they will be evaluating the team, rather than the business plan. Ideas are a commodity, but the ability to execute is not.
When things get serious, the VC starts talking about valuation. They bring up the terms, ‘premoney’ and ‘post-money’ valuation.
Post-money Valuation = Pre-money Valuation + Series A Investment.
The VC will focus on post-money valuation since a lower valuation would give the VC a bigger share of the company for the same amount of money. The founders want the opposite.
The VC comes back with an offer to invest. For our scenario, the VC offers $10.5 million for 20% of the company at a $52.5 million postmoney valuation**. If accepted, the current shareholders – yourself and the friend who put in $1.6 million in Stage 1 – will see their holdings diluted. You keep your original 64 shares but print more shares for the VC.
Your 64 shares now represent 64% (or 80% X 80%) of the company’s equity. That means the VC receives 20 shares.
Your 64 shares are now worth $33.6 million (which is 64% X $52.5 million).
Stage 3: Series B Onwards
So far, you have raised seed capital to incorporate a business and determine product market fit, and Series A to develop a minimum viable product and define your business model.
In Series B, users give feedback for the product or service to be honed. Now it is time to go big. Funds will be used to scale up, either through user acquisition or hiring sales and marketing growth hackers. Vertical growth through acquisitions is also possible with Series B funding.
With every subsequent funding round, there is a different focus, but the mechanics remain the same. With vision, management and luck, valuations keep increasing. The original shareholding gets further diluted, and more shares are printed.
I Stage 4: Exit
Congratulations, you have made it! You have a product that customers love, online reviews are rave, and the business has become profitable. It is now time to exit. The payday that your loyal shareholders have been waiting for is finally here. Those who invested in earlier rounds took more risk and therefore expect a larger return on investment.
The two most popular ways to exit are selling it on the stock market through an Initial Public Offering (IPO) or to another company through a merger or acquisition (M&A).
If it takes the merger and acquisition route, all the investors will exit but you, as
founder and CEO, will not. More than likely, the acquiring company will want the original C-suite to stay on to run the business. Your shares will likely be swapped with the acquiring company’s shares. You are now a rich, high-level executive of a much larger company.
If the decision is to IPO instead, the public now becomes the new investors. The main advantage of IPO is that the shares can be easily traded. It is like cash since you can sell your shares in the open market.
It has been a long journey, and you are now older, wiser and more importantly richer.
*Seed average round size, Mattermark US Venture Capital & Startup Traction Report 2015 (“Mattermark 2015”).
** Series A average round size. Mattermark 2015.
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