The world of startups, entrepreneurship, and businesses can be very exciting. Every day we see and hear about different startups raising money in various funding rounds from different investors. Needless to say, this depends on the stage of the startup. There are multiple things that come into consideration when someone wishes to start his/her own venture, and how he/she deals with numerous challenges along the way to make it a successful one. While there are countless such challenges faced by an entrepreneur, we'll focus on one basic and most important factor which every entrepreneur faces while starting up - where would he/she get the money to fund the idea. A nascent startup cannot raise $500 million from KKR or Blackstone straight away! So here, we primarily focus on the origin of businesses and how they grow over the years(in terms of funding and raising money) before the IPO - the Initial Public Offering, an event after which the company no longer remains private and it's stocks are traded publicly on a stock exchange. We'll discuss more about IPO and post IPO scenarios in the upcoming articles.
Scenario 1 - The Angels
Imagine a budding entrepreneur with a brilliant business idea. He's confident about the idea and is willing to launch this into a business. Considering that he does not have the luxury of a business background and is not able to attract any investor at an early stage, the only feasible option for him is to raise money from his family or friends.
Let's assume that he convinced two of his friends to put in their money. These two friends are the angel investors - the ones who invest in a pre-revenue stage, meaning that they're investing in a startup that is not making any money! So now you can understand why it can be very tough to convince serious big names in investors at the initial stage. However, the angel investors do not give their money as a loan, it is an investment made by them.
The money which the entrepreneur collects and the angel investors invest (the two friends in this case) is termed as the seed fund. The angel investors, in return for their investment, get some share in the company. For example, we can assume that the promoter(the entrepreneur himself) retains 40% of the share, and the two angels get 5% each, and the company retains 50% of the shares to be issued in the future. The only asset which the company has right now is the cash balance from the promoter and the angels, which is called the company's valuation.
Scenario 2 - The VCs
Let us assume that the business performed well in the initial few years and the promoter is now willing to expand his operations. Because of the fact that his business is now generating some revenue and has performed well, he now has the luxury of reaching out to the bigger investors. The investor that invests in such an early-stage company is called the venture capitalist. The VCs usually invest more than the angel investors and also take up more stake as well. The money that the business gets at this stage is termed as Series A funding. Investment rounds can be classified into various rounds - Series A, Series B, Series C, and so on.
The VC invests can be risky at times. Simply because they are investing at a very early stage startup hoping that the startup will do well in the long run and they can make a successful exit. As the investment rounds go on, from Series A to further rounds, the VCs do a lot of analysis so as to make sure they are investing in the right company. They dwell deeper into fundamental analysis, financial analysis including cash flow generation, future growth, EBITDA, payback period, and portfolio analysis. However, these technical aspects are not usually discussed in the initial rounds as the company is still very young to provide these financial metrics.
Scenario 3 - The Private Equity Investments
Once the company raises multiple rounds of VC investments and has been successful over the years, the ambitions of the company grow. The founders might wish to expand to different geographies and the CapEx(Capital Expenditure) requirement for this might be huge. Raising this heavy amount through debt is not usually a very good option for the company because of the interest rate burden. Also, the company cannot raise this amount through VCs as VC funding is usually small. This is when Private Equity comes into the picture.
The PE investors are quite savvy, highly qualified, with an excellent professional background as well. These are the people who've been involved in the world of finance and investing for a long time. They invest a huge amount of money and take up the board of investee positions to make sure the company grows on the right path and steers in a required direction.
The PE usually does not invest in an early stage (like the VCs). They focus on companies with a revenue stream and that are in operation for a few years. The PEs also invest in distressed companies. Here, the PEs look for good companies with a poor balance sheet.
Scenario 4 - The IPO and beyond
After several years of successful operations and expanding to multiple locations, diversifying the portfolio, good steady revenue, and happy investors, the company can now be on track for it's IPO - the Initial Public Offering. There are multiple reasons why a company might want to go public - to finance it's current growth, valuation of the firm, to be able to buy stocks of other companies, and many more. Moreover, listed companies are preferred partners for many businesses. The IPO process in itself is a very important one. Various stages are involved in this process. This is where Investment Banks come into the picture as well. We will cover the IPO process in detail in the second part of this blog. Stay tuned for more interesting stories and concepts!
Insightful. Well described in plain and simple terms!
Very well put!