How Startup Investing Works
How Startup Investing Works
Startup companies, which are basically newly emerged businesses that are aimed at meeting a marketplace need by developing a viable business model around an innovative product, service, process or platform, are a fast-growing entrepreneurial venture. This article will attempt to look into how these companies are financed by investors from conception onwards.
A startup can either be funded through Angel investing, from Venture capitals or private equity. Angel investing is where either as part of an angel group or syndicate, a startup is financed through writing of a check or wiring money to the company. Most angel investors are usually friends and family. Venture capitalists will go out and pitch institutions and high net-worth persons and once they have the capital they can use it to finance a startup. Some startup founders, a minority, will look to bootstrap their own companies but a majority always look for external investment.
The initial stages of a startup are usually financed by family, friends and angel investors. For one to qualify as an angel investor they have to have a net worth that will lead to a level of excess income where in case the startup fails, and majority do, then the investor’s lifestyle won’t change much. It will also take some time before the investor can start to see a return on their investment.
Once the startup company is up and running, investment maybe required in order to scale up operations. This is when most companies turn to venture capital investors. This is because most companies at this stage of their development are likely to spend quite some time in the red while they are trying to build up their profiles and operations. The fact that startups normally don’t have valuable physical assets to offer as collateral to offer against a bank loan. Raising money through the venture capital route is therefore important as it allows startups to access money they will be under no obligation to pay back.
However, while bank loan has a fixed interest rate, when individuals invest money in a startup as say a venture capital, they are end up buying a stake in the company. The investor is therefore assured of a percentage of any profits as long as they don’t sale their stake. It is however not a guarantee and startups and this early level pose a significant risk to investors, but their potential mean the upside is equally as significant. Venture capitalists are also usually very successful individuals with a wealth of knowledge which could be useful to the founders. While it is attractive to bootstrap your startup until you reach profitability, there are some companies which need a large amount of capital up-front and therefore venture capital financing is something which such companies might find very attractive.
After this early stages, the company may begin getting some money and the need to scale up even more and boost sales and even introduce new products may arise. Further investments may need to be made and venture capital investors may be sought at this juncture too. The venture capital investor who had gone in earlier on may be inclined to go in on further rounds of investments for maybe a larger stake in the company or not depending on how you had structured your initial agreement. Likewise, the existing venture capital investor may choose to exit. This usually happens after 5 years, and they may look to sell their stake to other companies, investors or the founder can buy back the stake especially if there was such an agreement in the initial purchase. Large companies may also look to invest in your startup at this stage if they find that your products or services align with their products. Strategic partnerships or investments with such companies are an attractive pursuit if you are so inclined.
Part of the pie of startup financing is the slice that has to do with its valuation. This is usually very complicated and especially if it is done at the stage before the company has started to make any money. Terms like pre-money valuation and post-money valuation begin to crop up and it is important to get acquainted with them. Pre-money valuation is the amount of money already in the business and its current valuation while post-money valuation is the potential valuation likely to be brought about by a given amount of investment. Terms in which the valuation are likely to be prescribed in the existing venture capital term sheets but are also not set in stone and negotiations are also likely to play a role as well. That is why companies with more than one investor interested in them usually hand the founder an advantage as they find themselves in a better negotiating position since they can pit the competing parties against each other.
Startup investment and how it works can be a complicated affair but hopefully this article helps enlighten you on some of the main aspects. Remember, as always you can learn a lot more on the same by visiting authoritative sites such as bitgale.com