For those who may get a bit confused by all of the jargon and stages associated with startup investment, Funders and Founders presents the below infographic by Anna Vital offering a visual representation of the different funding options a startup may go through.
Of course these numbers mostly describe the U.S. startup scene, but they do paint a relevant picture for entrepreneurs in the Arab world as well. This hypothetical startup will begin with a modest $15,000 from family and friends, receiving $200,000 from an angel investor after three months, and after another six months, securing $2 million from a venture capital firm (VC) in a Series A round and eventually going for an initial public offering (IPO).
It’s an ideal and simplified situation; in the Arab world, Series A funding is also often between $1-3 million, but most recent deals are closer to the $1 million mark. An IPO is also not always a realistic goal; although there are rumors that, for example, Just Falafel, could be readying for an IPO in the next few months, local IPOs are few and far between. Most startups should focus on building revenue models that will sustain them in the long term as the regional investment community expands alongside the startup ecosystem.
The most valuable piece of this infographic is perhaps the equity pie charts, which depict examples of how much equity entrepreneurs might want to give to whom, although again, these are only guidelines. In the Middle East, where several majority stake investment models proliferate, this might also look very different.
Stages of funding
As the graphic details, at the idea stage, an entrepreneur controls the entire company and later splits it fairly evenly with cofounders. As the idea turns into an actual startup, the team may continue bootstrapping by bringing in family or friends to take a small percentage of equity. It’s important here to remember not to give away too many pieces of the pie right away; setting aside a percentage of equity as an “option pool” for future employees gives a buffer for doling out future shares.
By the time a company needs money to really get cranking, an angel investor (or more than one) can come in and invest a small amount in the tens or hundreds of thousands in exchange for a small share of the company; their equity will likely be larger than family, but smaller than a cofounder. The infographic doesn’t mention the incubators and accelerators becoming more active across the region, which often offer seed investment in exchange for small percentages of equity. These can sometimes replace or come before angel investment.
As a startup sees more traction, it may begin looking to scale, and VC investment often provides the needed capital to scale quickly; this is the first time the cofounders may go below 50% ownership combined, depending on the investment terms. Every VC is different, and many in the Arab world feel that if an entrepreneur isn't incentivized to perform due to a loss of control, it may be better in the long run to take a smaller percentage. This depends on the agreement negotiated via a term sheet; inevitably, entrepreneurs may have to give up a bit of their stake to see the greatest returns. After all, as the infographic says, “100% of nothing is a lot less than 17% of a big company.”
The regional reality
While many entrepreneurs, like some at our recent Mix N’ Mentor Beirut, may be leery of joining up with certain VCs out of fear of losing control, the cofounders in this scenario still command the largest amount of shares when combined. Every deal is different, and most companies don’t make it through every one of these stages, but the infographic gives a good estimation of the traditional funding stages and who gains what amount of control. Right now in this region, later series of VC investment reach tens of millions of dollars often come from outside the region, as in the cases of MarkaVIP, Namshi, and Souq.com.
Of course there are plenty of companies that never take VC or angel investment and grow slowly on their own, reaching relative success without handing out any equity; although fundraising can be a constant process, many investors say that entrepreneurs should look for funding only when they know exactly what they will use it for.
What is your experience with investment recently? (Click on the graphic for a larger image)