Startup Funding: Jargons & Process

Startup funding is a critical process that can make or break a company’s journey from inception to growth. For entrepreneurs, investors, and anyone involved in the ecosystem, it's important to understand the terminologies used. Whether you're a first-time entrepreneur trying to secure seed money or an investor looking to fund a promising new venture, knowing the right keywords will help you navigate the complex world of startup funding.

In this comprehensive article, we will explore some of the most popular and essential keywords associated with startup funding. Understanding these terms can help entrepreneurs better communicate with investors, structure their pitches, and ultimately secure the funding they need to succeed.

1. Bootstrapping

Bootstrapping refers to starting a business without external funding, relying solely on personal savings or operating revenue to finance the business. Many entrepreneurs begin their journeys this way before they are able to attract outside investment. The primary advantage of bootstrapping is that founders retain full control of their business, but it can also be financially risky as they bear all the monetary burdens.

2. Angel Investors

Angel investors are high-net-worth individuals who provide early-stage funding to startups, usually in exchange for equity ownership. Angels are often the first external investors a startup will encounter, providing smaller amounts of money than venture capitalists but offering guidance, mentorship, and valuable business connections.

3. Venture Capital (VC)

Venture capital is a form of private equity investment provided by firms or individuals to startups and small businesses that have high growth potential. Venture capitalists (VCs) invest in exchange for equity in the company, often taking an active role in shaping its strategy and direction. VC funding typically comes in multiple rounds, including seed, Series A, Series B, and so forth, each stage reflecting the company's growth and development.

4. Seed Funding

Seed funding is the initial capital that a startup raises to begin developing its product or service. It's the earliest round of financing and is usually used for product development, market research, and initial marketing efforts. Seed funding often comes from angel investors, friends and family, or early-stage venture capital firms.

5. Series A, B, C (Funding Rounds)

As startups grow, they typically go through multiple funding rounds:

• Series A: This is the first significant round of venture capital funding. Companies use this capital to scale their operations, develop a more refined product, and expand their user base. Investors at this stage are looking for companies with a strong business model and solid market potential.
• Series B: In this round, companies are typically scaling their operations further, often across multiple regions or markets. Series B funding is used to optimize business processes and expand hiring efforts.
• Series C: At this stage, startups are often on the path to profitability or preparing for an exit through acquisition or an initial public offering (IPO). The focus here is on massive expansion, potentially through mergers and acquisitions, and capturing significant market share.

6. Equity Financing

In equity financing, a company sells shares of ownership to raise capital. This is a common method for startups to raise funds without taking on debt. In return, investors own a stake in the company and are entitled to a share of future profits or the proceeds from a future sale or IPO. Equity financing can dilute the founders' ownership, but it allows them to secure necessary funding without the burden of loan repayment.

7. Convertible Note

A convertible note is a type of short-term debt that converts into equity at a later stage, usually when a startup raises its first round of financing. Convertible notes are popular in early-stage fundraising because they allow investors to provide capital without having to agree on a valuation of the company at the time of investment.

8. Valuation

Valuation is the estimated worth of a company. Startups are typically valued based on factors like the potential of their product, the size of their market, and their current revenue streams (if any). Valuation is critical during fundraising rounds because it determines how much equity investors will receive for their investment. Valuations can be pre-money (before new funding) or post-money (after the new capital is injected).

9. Term Sheet

A term sheet is a non-binding agreement that outlines the basic terms and conditions under which an investor will make an investment in a startup. It sets the groundwork for negotiation and helps ensure that both parties are on the same page before finalizing a deal. Important elements in a term sheet include valuation, the amount of funding, investor rights, and dilution protections.

10. Dilution

Dilution occurs when a company issues additional shares, reducing the ownership percentage of existing shareholders. For startups, this typically happens when raising new funding rounds. While dilution is an expected part of the growth process, founders often aim to minimize it to retain more control of the company. Some investors also negotiate anti-dilution provisions in their term sheets.

11. Cap Table (Capitalization Table)

A cap table is a spreadsheet or table that details the ownership structure of a company. It shows who owns what percentage of the company, including founders, investors, and employees with stock options. A cap table is an essential document in fundraising as it helps investors understand the company's ownership distribution and potential dilution.

12. Initial Public Offering (IPO)

An IPO is the process by which a private company becomes publicly traded by offering shares of stock to the public. For startups, an IPO can be the ultimate exit strategy, providing liquidity for investors and a significant influx of capital for further growth. Going public is often seen as a major milestone in a company's lifecycle, though it comes with increased regulatory scrutiny and pressure to deliver consistent performance.

13. Exit Strategy

An exit strategy is a plan for investors to realize a return on their investment, usually through a sale of the company or an IPO. Common exit strategies include:

• Acquisition: Another company buys the startup.
• IPO: The startup goes public.
• Merger: The startup merges with another company.

Investors are particularly interested in understanding a startup’s exit strategy because it directly impacts their potential returns.

14. Crowdfunding

Crowdfunding is a relatively new method of raising capital, allowing startups to secure funding from a large number of small investors, usually through an online platform like Kickstarter or Indiegogo. Equity crowdfunding platforms like SeedInvest and Republic allow individuals to invest in startups in exchange for equity. Crowdfunding is often used to validate demand for a product while raising initial capital.

15. Burn Rate

Burn rate refers to the rate at which a startup is spending its capital. It is typically expressed in terms of monthly expenditure and is an important metric for both founders and investors. A high burn rate can indicate aggressive expansion, but it also poses the risk of running out of cash. Startups must carefully manage their burn rate to ensure they don’t run out of funds before achieving profitability or raising their next round.

16. Runway

Runway is the amount of time a startup can operate before running out of cash, assuming no additional funds are raised. It is usually calculated by dividing the available cash by the burn rate. A startup with a longer runway has more time to reach key milestones before needing additional funding. A short runway, on the other hand, may force the company to raise funds quickly or risk shutting down.

17. Due Diligence

Due diligence is the process of investigating a potential investment before finalizing a deal. Investors will often conduct due diligence to verify a startup's financials, business model, legal status, and market potential. The goal is to ensure that there are no hidden risks and that the company is a sound investment.

18. Lead Investor

A lead investor is the primary investor in a fundraising round. They typically negotiate the terms of the deal, set the valuation, and may take a seat on the company's board of directors. Other investors, known as follow-on investors, often join the round after the lead investor has committed.

19. SAFE (Simple Agreement for Future Equity)

A SAFE is an agreement that allows startups to raise money in exchange for the promise of future equity, typically without determining a valuation at the time of the investment. SAFEs have become a popular alternative to convertible notes because they are simpler and often more founder-friendly.

20. Incubator/Accelerator

An incubator or accelerator is a program designed to help startups grow by providing resources like mentorship, office space, and early-stage funding. In exchange, these programs often take a small equity stake in the company. Incubators usually focus on nurturing startups over a longer period, while accelerators run shorter, more intense programs designed to help startups scale quickly.

Feel free to contact Dr. Shishir Gupta for any further query.