GURUKUL > Creating your Startup: Part 4
"These articles were originally published in VentureKatalyst, India’s first e-zine aimed at entrepreneurs, started by Sanjay Anandaram in 1999. He brings two decades of experience as an entrepreneur, corporate executive, venture investor, faculty member, advisor and mentor. As a passionate advocate of entrepreneurship in India, he’s associated with Nasscom, TiE, IIM-Bangalore, and INSEAD business school in driving entrepreneurship. He can be reached at "
Creating your Startup: Part 4
In the earlier Gurukuls, we saw how critical it was to select the right team members, understand how to evaluate markets and technologies and to define products and services for specific markets. But all this understanding and knowledge will come to naught, if a key catalyst, namely finance, is absent. Before rushing out to make pitches to VCs and others, you should develop an understanding of the financing terminologies used by VCs apart from getting familiarized with them (both the terminologies as well as the VCs!). It is important to understand what these investment and growth terms mean if you are to properly represent your situation to prospective investors, team members, and employees. Your naiveté could lower your valuation by 50% in the investors’ eyes! A startup goes typically goes through several financing stages, each of which is a key financing event. So be prepared!
In this Gurukul, we’ll take a look at various Startup Financing Terminologies. Remember, these are not mandated usage (especially in these over-hyped times) terms but serve as guidelines. Some of the stages mentioned below could get compressed as well.
There are various definitions in use amongst the investment community, but there are three broad categories:
Let’s take a closer look at each of these.
- Early-Stage Financing (Usually, less than US $1m) usually covers the following stages:
- Seed Financing: Here, a relatively small amount of capital is provided to the entrepreneur to prove a concept. It typically involves product development and development of business model but rarely involves initial marketing. In many cases, companies in this stage don’t have a business plan and a complete team in place. Up to $100,000 can be expected to be the investment in your company.
- Start-up Financing: This covers product development and initial marketing expenses. Companies will have been in business for less than a year but have yet to have sold their products commercially. The team is in place, a business plan is ready and the company is all ready for business. Up to $2,000,000 can be expected at this stage.
- First-Stage Financing: Companies in this stage are those who have successfully demonstrated proof-of-concept/prototypes such that technical risks look minimal. Similarly, market opportunities should show explosive potential. The financing will be used to shore up product development, sales and marketing. The company will still be showing negative cash flows at this stage. Up to a $5M can be planned for at this point.
- Expansion Financing (unto $20m) usually covers these stages:
- Second-Stage Financing: The fast growing company needs working capital to manage and accelerate growth in sales, support, development, and marketing. Typically, the company will have a growing list of debtors. Clearly, the company is growing rapidly but may still be unprofitable with negative cash-flows.
- Third-Stage Financing: The company is almost breaking even or may even be profitable. The increased funds are used to keep growth in high acceleration.
- Bridge/Mezzanine Financing: The company still needs outside cash for rapid growth but is successful and stable enough so that risk to investors is significantly reduced. The exit/cash-out point for the VCs is well within sight (less than 18 months)
- Exit Financing: This is the stage that is eagerly awaited by the investors as it gives them an opportunity to cash their stock and show returns on their fund. The two most preferred routes to exit financing are:
- Initial Public Offering (IPO): Here, ownership in the startup is sold to the public through a stock exchange
- Mergers/Acquisition (M & A): The startup is merged with or sold to another company
From the investors’ standpoint, an IPO offers the best returns for their investment. According to studies, returns from an IPO are typically seven times the original investment while an acquisition delivers two times the original investment.
So now that you are aware of all the basic issues (need for passion, team building, evaluation of markets and technology, defining products and services, and financing terminology), you are ready to start writing a business plan.