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Trending: Call for Papers Volume 3 | Issue 2: International Journal of Advanced Legal Research [ISSN: 2582-7340]

Seed Funding to IPO: Stages of VC Financing

 

India has become a hub for start-ups becoming the world’s third-largest start-up ecosystem with 38 firms being valued at over $1 Billion, becoming unicorns. In 2020, the country minted around 12 such unicorns despite the disruption to the economy in the pandemic period. The Indian government opened up the space sector for private players, opening the flood gates for entrepreneurs with more than 40 start-ups working in space and satellite projects with funding, teams, and structure, the survey said citing industry estimates. Measures taken by the government were:

  • 1.      Startups definition broadening
  • 2.      Simplification of regulations
  • 3.      Income Tax exemptions
  • 4.      ₹10,000 Crore fund for start-ups operated by SIDBI.
  • 5.      Startup India Seed Fund Scheme (SISFS)
  • 6.      Startup Yatra

Every start-up starts with a problem or issue identified by the entrepreneur and solved with the help of it. From the fundamental and humble initiation and launch of the start-up, it proves its potential, the model of its business, and the quality of the products. With the steady increase in the customer base, the business begins the journey of expansion in real estate, workforce, and an initial public offering (IPO). These hypothetical business plans are seeming too good to be true as there is a small chunk of the population of fortunate companies and startups that grow according to the above-mentioned plans. From this population, a small share of companies grow out without any external funding, but the rest of them engage in many efforts to raise capital through rounds of external funding allowing external investors to invest cash in a growing company in exchange for equity, or partial ownership of the company.

Funding Round

A funding round is a process of growing a business through external investment. It has its different types, depending on the following factors:

  • 1.      Industry type
  • 2.      Level of interest among potential investors

The different types of funding can be Seed funding, angel investor funding, Series A, B, C with earning capital, and bootstrap.

The time for funding is different from a start-up to another one, while some have to spend several months or years in the search for funding, on the contrary, others go through the roller coaster and raise funds quickly. These funding rounds are the stepping stones in the process of turning an ingenious idea into a revolutionary global company, ripe for an IPO.

How does Funding work?

In a funding process, there are the following parties involved with their objectives to participate:

  • 1.      Entrepreneurs or company owners: Objective of gaining funds for the company
  • 2.      Potential investors: Support to entrepreneurship spirit and gain returns

The investment made during the stages of developmental funding is organized in such a way that the investor or the company investing retains partial ownership of the company or startup.

Valuation

Before the funding round initiates itself, the valuation of the company or startup is undertaken by analysts. The valuation is done based on the following factors:

  • 1.      Management
  • 2.      Proven track record
  • 3.      Market size
  • 4.      Risk

The consideration of the maturity level and growth opportunities of the company or startup is done in the key distinction between funding rounds and the valuation of the business.

Pre-Seed Funding

This is the earliest stage of funding a new venture. This is not included among the rounds of funding theoretically. Pre-Seed Funding, which is also known as Pre-Seed Capital, is a small amount investment offered by a potential investor in return for equity or debt and interest repayment.

The objective for the owner is:

  • 1.      Validate the problem-solution fit
  • 2.      Real Customer traction
  • 3.      Develop MVP and actual offering
  • 4.      Get key employees and partners
  • 5.      Initiation of the business operations
  • Mostly the Pre-Seed funders are founders, close friends, and family.

Seed Funding

Seed Funding, also known as Seed Capital, is a small amount of investment offered by an investor in return for equity, to the start-up owner to boost their initial business growth. It is the first official equity funding.

The objective for the owner is:

  • 1.      Finance market and product R&D
  • 2.      Salary payment
  • 3.      Large manufacture of products
  • 4.      Penetrating existing or creating a new market for business
  • 5.      Building Brand
  • 6.      Team Growth

The seed funding is like planting a seed of a tree, which will give a good boost for growth. It helps in R&D ultimately deciding the end product structure and plans for the target audience. The valuation in the Seed funding can be from $2M to $6M.  One of the investors participating in seed funding is an “angel investor”, who appreciates riskier ventures. Others are founders, friends, family, incubators, venture capital companies.

Series A Funding

With an established user base, stable revenue, and other indicators, to further optimize its user base, and better product, it may opt for Series A funding. The important step to be taken in this round or stage is to create a plan to develop a long-term profitable business model. With seed startups having brilliant ideas, the major issue is with monetizing the same.

In 2020, due to high tech industry valuations, Series A funding was approximated to $15.6M.[1]The main aim and requirements for a start-up are not only to have an exceptional idea but to have a concrete strategy to mint money out of the idea. Traditional venture capital firms like Sequoia Capital, Capital Greylock, and Accel Partners are the potential investors in this round of funding.[2]With an investor coming in, more such investors get pulled in. Angel investors have a share in the investment influence, but significantly less than seed funding. Equity Crowdfunding is a common process for capital raise since it is difficult to attract investors after seed funding with less than half of them going further to this stage.

Series B Funding

Penetrating through the developmental stage, Series B funding is the third stage in startup financing and the second stage in venture capital financing.[3]In return for equity, for expanding business operations, an established startup company secures funding from VC firms.

The objective for Series B funding is:

  • 1.      Scale-up startup operations
  • 2.      Hiring top talent
  • 3.      Tackling growth competition

Reaching this stage means to be proven in front of the investor of having preparation for success to a broader level of growth by having a substantial user base and larger market reach. An increase in talent hiring, business development, sales advertising, support, costs a good amount of funds. The average valuation of a Series B funding company is between $30M and $60M, with an average of $58M.

The later stage is about the same investor bringing in other investors with the only difference of new venture capital firms coming in which specialize in later-stage financing.

Series C Funding

Being the last stage of private equity fund in Startup financing, it is done for:

  • 1.      Expansion and penetrate new markets
  • 2.      Acquisition of new business
  • 3.      Develop New offerings

The objective for the investor is to invest in the meat of the business to mint doubles of return by the company scaling and growing faster than ever. The acquisition is done to fade away the competition and attract new investors. The investors in this stage are investment banks, private equity firms, and extensive secondary market groups. Some firms stopping at this stage and some going further till Series D and E. Some companies also use Series C funding to boost the valuation in the anticipation of their IPO. The companies till this stage have a humongous consumer base, rather global reach, revenue streams, proven growth through histories with average valuations of $118M.

Initial Public Offering (IPO)

IPO is a process by which a privately held business starts selling stocks to external investors, becoming a public company. The company can raise capital by the sale of shares. The shares are sold to the public, institutional investors, and HNIs. By this, it becomes a public listed company with its shares trading on a stock exchange.

The objectives of IPO are:

  • 1.      Raise funds from a wider pool of investors
  • 2.      Facilitate M&A
  • 3.      Visibility
  • 4.      Exit for early investors

The conditions of IPO are making the financial statements and accounts open for public, for compliance with the market regulations. The eligibility for listing on NSE or BSE is having a minimum paid-up capital of ₹10 Crore with post-issue market capitalization not less than ₹25 Crore. Also, it should have at least three years’ track record of an applicant seeking listing or promotors / promoting company.

Venture capital financing is a way to take the startup to the next level, fulfilling the dreams and ambitions of the startup and its entrepreneur. It gives the startup the fuel to expand to humongous feats of success and stature.



[3]This is not included among the rounds of VC funding theoretically


Authored By: Saptak Pandya

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