Startup Financing: How it Really Works
Let's look at the typical stages in a successful company's financings. We'll start with the last and finish with the first. Although there are rare exceptions to this sequence, in most cases it looks like this:
-The IPO
This is the big pay-off at the end of years of hard work. It means liquid stock selling at, hopefully, a high P/E multiple. (The second best alternative is to be acquired by a large company such as a member of the Fortune 1000.)
-Venture Capital C-Round
The IPO is now in sight and the C-round is used to "fatten the pig" as much as possible in addition to preparing the company for it. Often this preparation includes replacing management with C-level officers who are known to and respected by Wall Street.
-Venture Capital B-Round
Wall Street is starting to take notice of the company. Therefore, the VCs want to maximize its forward momentum.
-Venture Capital A-Round
VCs step in when the business looks like it has potential for an IPO or acquisition a few years down the road.
-Angel Round
Angels come in with money when you have started selling. They jump aboard because you now have tangible proof of concept. You're finally walking your talk. It's no longer all just hot air coming from the founder. Be honest, talk is cheap.
-Seed Round
At this stage you have no more than an idea. You are going to build the next Facebook or Google or Apple...only it will take a year or two of work before there is something that can be sold. Or maybe it's a dull little business which excites only you?
So, who comes in at this stage if you should be lucky enough to attract any money? The answer is the "3Fs", otherwise known as Family, Friends, and Fools. Yes, this means your parents and rich frat buddies from your days at Harvard or Yale. What's that? Your family is not wealthy and you didn't attend an Ivy League college? In that case, you are going to have to finance your seed stage the most common way: with a day job.
Welcome to Planet Earth. That's how 99% of startups get through the seed stage.
I am providing this information because so many people post online requests for funding to cover 2 to 3 years of coding or R&D. Then when they are ignored, they get angry.
If you are realistic about what types of scenarios attract investors, you won't get angry. Instead you will work to create an opportunity that will be attractive to investors at every stage.
If you think that you are going to attract money to cover your living expenses and provide a bit of fun money while you code or do R&D for 2 or 3 years, you are in for nothing but frustration.
Let's look at the typical stages in a successful company's financings. We'll start with the last and finish with the first. Although there are rare exceptions to this sequence, in most cases it looks like this:
-The IPO
This is the big pay-off at the end of years of hard work. It means liquid stock selling at, hopefully, a high P/E multiple. (The second best alternative is to be acquired by a large company such as a member of the Fortune 1000.)
-Venture Capital C-Round
The IPO is now in sight and the C-round is used to "fatten the pig" as much as possible in addition to preparing the company for it. Often this preparation includes replacing management with C-level officers who are known to and respected by Wall Street.
-Venture Capital B-Round
Wall Street is starting to take notice of the company. Therefore, the VCs want to maximize its forward momentum.
-Venture Capital A-Round
VCs step in when the business looks like it has potential for an IPO or acquisition a few years down the road.
-Angel Round
Angels come in with money when you have started selling. They jump aboard because you now have tangible proof of concept. You're finally walking your talk. It's no longer all just hot air coming from the founder. Be honest, talk is cheap.
-Seed Round
At this stage you have no more than an idea. You are going to build the next Facebook or Google or Apple...only it will take a year or two of work before there is something that can be sold. Or maybe it's a dull little business which excites only you?
So, who comes in at this stage if you should be lucky enough to attract any money? The answer is the "3Fs", otherwise known as Family, Friends, and Fools. Yes, this means your parents and rich frat buddies from your days at Harvard or Yale. What's that? Your family is not wealthy and you didn't attend an Ivy League college? In that case, you are going to have to finance your seed stage the most common way: with a day job.
Welcome to Planet Earth. That's how 99% of startups get through the seed stage.
I am providing this information because so many people post online requests for funding to cover 2 to 3 years of coding or R&D. Then when they are ignored, they get angry.
If you are realistic about what types of scenarios attract investors, you won't get angry. Instead you will work to create an opportunity that will be attractive to investors at every stage.
If you think that you are going to attract money to cover your living expenses and provide a bit of fun money while you code or do R&D for 2 or 3 years, you are in for nothing but frustration.
This is sound advice, investors want to see that you are willing to make sacrifices to make it happen. If you're not, you blow your chances.
Posted by: TGT | February 10, 2010 at 11:21 AM
My ideal way of starting a small business is to raise the capital myself, that is, if timing is not a huge factor. Seeding will eventually be good, but the thing is that there have been cases where friends and families got separated or hated each other because of the venture.
Posted by: Aaron Reiley @ ACE Financial Services | February 16, 2010 at 01:15 PM