Entrepreneurs, learn your financials and investment terms [Know your VC]
This article is a crosspost from Nuwait. It is the first part of a series on startups lifecycle.
Before startups start seeking investments, they should familiarize themselves with the different investment rounds, the investment terminologies and the amount they should raise.
First, let’s start with the few stages to make sense in the region:The ability to invest in hard working teams with bright ideas is known as the seed round. This is when investors and entrepreneurs plant the seeds to sow future success. Prior to the seed funding round, there is usually a pre-seed round where entrepreneurs may or may not have an idea or corporate license, but exhibit the entrepreneurial spirit and are ready to venture off on their own into the world of business. This round is also comically known as the FFF round which endearingly refers to the Friends, Families and Fools that typically invest in the earliest primordial days of the company. Also common in the pre-seed round are the many grants (typically government) and competitions that entrepreneurs sign up for, which offer ‘free’ money, i.e. funds that are typically gifted to a promising idea or prototype without any (or very limited) reciprocation required from the entrepreneur.
The early stage round is typically dominated by angel investors, or rich people that like to invest early on in startups. Just like accelerators and incubators, angel investors can either be generalists or focused on a particular industry. They may also be principals of either an accelerator or incubator (or both) or even executives in a venture capital firm or large corporation.
But before looking for investment, here are few terms you need to familiarize yourself with:
Burn rate – the monthly cost of maintenance (cash outflow) of the company. This gives investors an idea of when the enterprise is running out of cash. A common mistake many entrepreneurs make is that they do not pay themselves a salary at the start, or even account for their own monthly requirements to move through life. As Napoleon once said, an army marches on its stomach, so entrepreneurs must ensure that they are well fed, clothed and housed as well.
Option pool – are shares of stock reserved for employees of the company that are used to attract talent. The amount of stock an employee gets typically decreases polynomially throughout the entrepreneurial life cycle.
Bootstrapping – is a term used to symbolize self-reliance. Imagine a cowboy wearing a slick shiny pair of boots. Now imagine that same cowboy stuck in mud or a trapped in rushing quicksand. The cowboy is alone and devoid of any external help. Now imagine that same cowboy reaching down and grabbing hold of the straps of his once shiny boots with his own two hands and literally pulling himself up out of the mud. Bootstrapping is a synonym for self-sufficiency where entrepreneurs are encouraged to venture on their own using whatever savings or resources they have accumulated without accepting any outside financial investment.
How much should you raise on each funding round?
There are no set amounts for each of the investment rounds that mark the different stages of the life cycle. It is really more of an art than a science - a balance between the vision of the founders and the investors, market conditions (what other founders/investors have raised) combined with the requirements of the business from a financial perspective: how much money the entrepreneur needs to execute his or her vision and business plan. Having said that, seed rounds in the digital space typically range from $50,000 to $150,000 for a 5 to 10 percent equity stake of the company. It is at this stage where both the founders and the potential investors must concern themselves with the two ‘m’s – market and money. Together they outline if there is a given market opportunity for this venture and can this venture eventually turn a profit or be profitably sold to another investor or company.
Seed rounds are also the stage at which entrepreneurs may elect to join an incubator, an accelerator, or coworking space. While small distinctions exist between these platforms, the common denominator entrepreneurs can basically expect is to part with a small minority of their equity (usually 3 to 7 percent) in exchange for mentorship, cross pollination of ideas and experiences with other entrepreneurs and some cash to play with; typically in the range of $50,000 to $150,000. Perhaps the most important benefit of joining these collective entrepreneurial groupings is the promise of leveraging the rolodexes and experiences of the principals of these platforms, who can then provide valuable introductions and act as a much needed sounding board to continuously vet different ideas suggested by the founders.
Feature image via Pexels.com