Confused by the Funding Terminology in Start-up? We’ve Got You Covered
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One of the perks of working for Click2View is that we are always meeting and interviewing smart, interesting people from different industries.
It was during an interview with a venture capitalist about start-ups that we realised there are a lot of terms and lingo that the average person doesn’t know.
In fact, creating a start-up is like entering a completely different world. Suddenly you’re looking for angels to turn you into a unicorn, your ABCs refers to funding, and as you build your business, you’re constantly looking for an exit.
So we decided to help by putting together a short primer on start-up and vc jargon.
Sources for funding
Angel Investor
Having adequate capital is necessary to get your business idea off the ground. This is where an angel investor comes in. It refers to individuals that believe in your vision enough to put some money into your business. These individuals can be your family members, friends or close relatives.
Look at Jeff Bezos. When he started Amazon, he accepted $245,573 from his parents in 1995. If that investment was kept until today in stocks, it would be worth approximately $30 billion.
Nowadays, angel investors also come in the form of angel clubs, where high-net-worth individuals form networks to find and fund the next big thing. These investors will participate in “angel rounds”, where businesses pitch their ideas to get funding.
A SAFE note (simple agreement for future equity) is often drawn up as a legal binding agreement. It’s a document that allows an investor to purchase a specified number of shares for an agreed-upon price at some point in the future. By doing so, the investor gets a return on their investment if the business turns out to be successful.
Venture Capital
Funding through venture capital means that you get sufficient capital or cash from a seasoned entrepreneur or expert, either individually or through a venture capital firm. They usually have a proven track record and willingness to invest in companies that show promise in being a disruptor of how traditional things have been done. Take a look at Lazada, Grab, and Gojek, to name a few.
It’s common for these experienced individuals to offer guidance and mentorship free of charge to founders who are just starting in exchange for shares and stock options. They’re like a guardian angel that will guide you through the uncertainty of the startup grind. Think of it as if you’ve participated in the TV show “Shark Tank,” and Mark Cuban has decided to invest in your company and provide advice till it reaches the mature or IPO stage.
Crowdsourcing
With the evolution of technology and the Internet, you can now raise capital from websites like GoFundme or Kickstarter, enabling you to get capital beyond your home country. One successful project was the Oculus VR, which was funded through Kickstarter in 2012, totalling up to US$2.4 million, surpassing its original goal of US$250,000.
Fast forward to 2014, Facebook bought the product for US$2.4 billion.
The stages of funding
Funding comes in stages; seed, series A, series B, and series C. Essentially, the stages attempt to raise more and more money so that your business can grow and scale accordingly to meet demands.
The first stage is seed funding (and sometimes pre-seed), when you need enough money to get your company started. The term seed implies there will be institutional investors involved. At this stage, your business usually has only an idea or a prototype. Seed funding is used for commercial fine tuning to bring the prototype to market.
The funding collected at this stage is often in the form of convertible loans, meaning that it will be converted into equity at a future date.
You may also want to join a startup acceleration programme, where you’ll receive mentorship from experts in the field, capital to get you started, and a co-working space to meet people who have similar goals. This fixed-term program usually results in a demonstration day for potential investors.
Series A funding is typically when your product is completed and selling and you need to scale. Most investors can see how the business is performing along with the sales figures. At this stage, the funding will be used to expand your salesforce, your marketing channels, etc.
But not every company follows the same path. Bassam Tabbara, founder and CEO of cloud computing startup Upbound skipped seed funding and went straight from idea to Series A.
Tabarra says, “We were obviously going for something quite ambitious… and skipped a few rounds and went to a series A , which is really just a matter of what the size of the round is…we knew we needed quite a bit of capital to actually bootstrap a project and to build a set of commercial offerings around it. That’s been our journey, obviously it varies for different companies and for different parts of the industry.”
Series B funding means that you want to expand your footprint beyond borders, such as a Singaporean company opening branches in neighbouring countries like Malaysia or Indonesia. The funds raised will be used to hire people in the various countries to set up the new operations.
Meanwhile, Series C is when you want to raise funds to really scale up. Once you get beyond C it’s basically what’s known as private equity, or capital that’s not listed on a public stock exchange.
Before each round, you need to determine your burn rate, meaning the amount of cash you’re spending in correlation with your capital. Divide your capital by the burn rate to determine how long your business can survive until the subsequent funding round.
Also, it’s not uncommon for startups to pivot and change their direction, depending on market research, sentiment and trends.
The mythical animals
Have you ever seen a unicorn prancing by? Probably not. And if you did, it was surely a rare sighting. Back in 2013, seeing a unicorn was as rare as a startup achieving a billion dollar valuation, thus the term was coined. Since then, unicorns have become more common and valuations have grown. Once a startup reached a value of ten billion dollars, people needed a new term, so decacorn was born. And later, hectacorn was used to describe 100 billion dollar companies.
Valuation refers to the value of the company. It comes in two forms, pre-seed, and post-seed valuations. As the name implies, pre-seed means the value of the business before external investors or injections are given, whereas post-seed valuation refers to the value after external investors or cash is counted.
Differentiating the amount between these two stages is crucial as it impacts the price of shares within the company and has the possibility of diluting its shares. For example, if the pre-seed value stands at $1 million and an investor adds another $250,000, the investor contributes 20% to $1.25 million. Meanwhile, if the post-seed value stands at $1 million and the investor contributes the same amount of $250,000, his stake or ownership increases to 25%.
The 5% difference can represent millions of dollars, especially if the company wants to go public.
The exit strategy
Once a company has matured, there are three options for investors to withdraw their investment and enjoy their rewards: through an initial public offering (IPO), a trade sale, or setting up a Special Purpose Acquisition Company (SPAC).
IPO refers to when investors sell their shares on a stock exchange and the company goes public.
A trade sale usually entails selling all the shares and intellectual property to a third party.
A SPAC is for companies not quite ready for an IPO but that still want the benefits. Essentially, a public company is created for the “special purpose” of raising money from investors in the form of stock. Then that company “acquires” a startup.
In January, there were three SPAC listings in Singapore’s Stock Exchange, namely Vertex Technology Acquisition Corp (VTAC), Pegasus Asia (Pegasus) and Novo Tellus Alpha Acquisition (Novo Tellus). All of which focus on tech-enabled companies as their target acquisitions.
The dream lives on
Whether you feel drawn to the world of start-ups or not, the dream of entrepreneurship and venture capital is spurring record investment. According to crunchbase, total world venture funding reached $643 billion in 2021, up 92% from the previous year.
While it’s true that here in Singapore, startup valuation is smaller compared to more established regions, like Silicon Valley, Singapore still has a robust startup scene. This can be seen by the fact that Singapore startups successfully raised S$11.2 billion in the first nine months of 2021, doubling the whole of 2020.
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