Startup Investing – Stages, Financials, and Investors

Pre-Seed – since most seed rounds typically come 2.4 years after a company is founded, these initial pre-seed funds are used to help fund the business just enough to build a product, distribute it, and gain enough traction to convince seed investors to invest. This could be capital from friends and family, Angel Investors, founders, or early-stage incubators.

Seed – a Seed round is when the first Super Angel or micro-VC funds may get involved, and where the startup has an idea or MVP, but needs capital to find product-market-fit. Typical Seed round amounts would be a $100k-$2M raise (depending whether Angels or micro-VCs are getting involved) at a $3M-10M valuation.

Bridge Round – in the event that a startup has raised Seed capital, is making solid progress, but needs a little more capital to find product-market fit, they may raise a “bridge round”. These can typically close much quicker than a full-blown Series A, and allow the startup to have a little more time to prepare for their Series A.

Series A – a Series A financing round, typically led by a lead investor (Angel or VC firm), usually demonstrates that the startup has found product-market-fit and can demonstrate strong traction and potential to grow and scale. This influx of capital is used to help scale as fast as possible since product-market-fit has been achieved. Typical Series A amounts would be a $3M-12M raise at a $10M-30M valuation.

Series B+ – after a Series A, the subsequent rounds continue increasing in total funds raised and valuation (hopefully), and could go on from Series B, to Series C, D, E, and more. The size of the rounds, due to larger VC and institutional investors getting involved, continues to increase with each round. Thus, it can be harder for even larger Angels to maintain their percentage ownership due to the capital required (e.g. owning 5% of a $5M company requires much less capital than maintaining your 5% ownership in a $500M company).

IPO – an Initial Public Offering (IPO) is a private company’s initial offering of stock to the public by being listed on public stock exchanges. It is often looked at as the holy grail for early-stage investors since the capital returns on companies that make it this far are substantial. However, the fees and regulations for being listed on a public exchange are also substantial; thus, it is typically only the large companies that have sufficient resources that will look to go through an IPO.

Startup Financials

Burn rate – the burn rate is the amount of monthly cash expenditures a startup incurs for its operations. For example, $100,000 a month. Burn rate is used to calculate a startup’s runway.

Gross-burn – the burn-rate of a company based only on monthly operating costs that are incurred is referred to as the gross-burn. It does not include any revenues produced by the company, referred to as net-burn. Example: if a company burns $50k a month in expenses and has $5k in revenue, the gross-burn is still only $50k a month.

Net-burn – the burn-rate of a company that also takes positive cash flows (revenues) into account is called net-burn. Example: if a company burns $50k a month in expenses and has $5k in revenue, the net-burn is ($50k-$5k) = $45k a month.

Runway – runway is the number of months that a business has left before it runs out of money. It is equal to (cash + revenues) / burn rate, or simply (cash / net-burn). For example, if a company has no current revenues, $1M in the bank from a Seed round, and a $100k burn rate, they have 10 months of runway ($1M + $0) / ($100k/month) = 10 months.

ARR / MRR (Annual Recurring Revenue / Monthly Recurring Revenue) – monthly recurring revenue is the amount of income from recurring sales, such as subscription services. Annual recurring revenue (ARR) is simply the MRR*12, or the past 12-months of cumulative MRR. e.g. if a company has 100 paying customers at $1k a month, their MRR is $100k, and their ARR from the current month is $1.2M.

Margin (in business)– the difference between the seller’s cost of goods sold (COGS) and the sales price (revenue), expressed as a percentage. For example, if selling a single item costs the seller $7, and they sell it for $10, the profit is $3, which is a 30% margin (margin = profit / revenue).

TAM (Total Addressable Market) – the total addressable market is the total possible demand for a product or service if 100% market share was achieved. This is larger than the serviceable available market (SAM) or the serviceable obtainable market (SOM).

Dilution – dilution is the decrease in an investor’s ownership in a company due to the company’s issuance of additional equity to new investors. In Angel Investing, dilution can be prevented by exercising pro-rata rights; however, for most equity crowdfunding deals under $25k, dilution will occur when the company raises additional funds.

Cap Table – short for capitalization table, is a summary table showing the equity percentage of ownership in the company by the founders, owners, and other investors. Cap tables are much more common to see in Angel Investing than in equity crowdfunding.

Traction – traction is proof, often via paying customers and users, that a given business solution meets a particular customer’s needs by solving a problem. Typically, traction also assumes a certain amount of geometric growth, such that a “hockey stick” shape in customers/users is present.

Revenue – a business’ revenue is the gross sales (also known as top line) prior to subtracting any operating or other expenses. For example, if a company had $1M in annual software sales to customers, the annual revenue would be $1M, prior to accounting for any expenses to arrive at profit (bottom line).

Profit (also known as bottom line) – profit is the surplus remaining after total costs are deducted from total revenue.

Customer Acquisition Cost (CAC) – the Customer Acquisition Cost (CAC) is the per-user cost for the company to market and attract a new customer. It is the total marketing and acquisition budget spent, divided by the number of new customers gained, over a specified time period. For example, if a company has spent $10k and resulted in 1000 new paying customers in the past month, the CAC would be $10k/1000 = $10.

Lifetime Total Value (LTV) – the Total Lifetime Value (TLV), sometimes called the Customer Lifetime Value (CLV), is an estimate of the average amount each new customer will spend with the company over the time period that they are expected to remain a paying customer. This would include multiple purchases of different products, remaining a paying subscriber for a number of months, etc.

TLV:CAC ratio – after knowing the TLV and CAC, investors can calculate the TLV:CAC ratio, which is an indication of whether it is profitable to invest additional capital in acquiring new customers, or if the business is losing money in trying to acquire customers using the current assumptions. Some investors look for a TLV:CAC ratio of around 3:1. They consider 1:1 as you are spending too much (each $1 invested is only resulting in $1 of sales), and a value of 5:1 as spending too little (each $1 invested is returning $5).

Monthly Active Users (MAU) / Daily Active Users (DAU) – a measure of how many active users over a given time period, either daily or monthly, that are using a given product. This is typically one metric, when looking at its growth rate, that can inform the investor of whether a product has traction and achieved product-market-fit or not.

Churn – the opposite of customer retention rate, churn (or customer attrition) is the percentage of subscribers that terminate their subscription within a given timeframe. For example, if during the month of January a startup had 100 paying customers and 20 did not renew their subscription, their churn would be 20/100 = 20%. For a non-subscription business, it could be considered the number of customers that do not make a repeat purchase.

Retention Rate – the opposite of churn, retention rate is the number of customers that remain loyal and paying to the business. It is typically a good measure of how well a given solution is meeting a customer’s need. For example, if you had 100 customers total, and 80 customers from the prior month returned and placed a second order in the current month, the retention rate would be 80/100 = 80%. For a SaaS subscription product, it would be the number of users that renew their subscription in a given time period.

Types of Investors

Accredited Investor – according to the Securities and Exchange Commission (SEC), Rule 501 of Regulation D, an accredited investor is anyone that makes more than $200k per month for the past two years ($300k joint earnings with a spouse), or has a net worth exceeding $1 million, excluding any primary residence. There are also guidelines for professional qualifications that allow some professional investors to be deemed accredited investors.

Non-Accredited Investor – (also: un-accredited investor) – according to the Securities and Exchange Commission (SEC), Rule 501 of Regulation D, a non-accredited investor is anyone who doesn’t meet the definition for an accredited investor. Until recently, only accredited investors could invest in private companies, which has changed with Regulation CF of the JOBS Act.

Friends and Family – typically, prior to a Seed round, a startup may be financed by friends and family of the founders, to help give the idea enough capital to show potential seed investors that there is promise in the business.

Crowdfund Investor – due to the JOBS Act, both accredited and non-accredited investors can now invest as crowdfund investors through online funding portals. Similarly, certain websites, like AngelList, may provide a means for accredited investors to invest alongside a group of other investors, typically led by a “lead” Angel investor who handles most of the due diligence, valuation, and other interactions between the founders and the investors.

Angel Investor – an Angel Investor is any investor that invests their own capital in early-stage companies they believe in. They typically get involved earlier than most VC funds, when a company may only have an idea or little traction, and give the startups a chance to bring their product to market. Many VC funds must invest larger amounts of capital and have stricter requirements for proven traction, sales, etc., and so these earliest investors that take a higher risk on the entrepreneurs are referred to as “Angels”.

Venture Capital (VC) – as opposed to Angel Investors, Venture Capital (VC) firms are professional investors that invest other people’s money. They are paid via something commonly called the 2-20 rule, where they are given a set 2% fee based on the assets under management (AUM), and then a 20% bonus “carry” where they share in any profits they make for their clients. VC firms typically aim to control a certain amount of a company (e.g. 10%) at each round, and thus invest much higher amounts of capital on average than Angels.

Types of Companies

Unicorn – a unicorn is any company that reaches a $1 billion valuation, either in private or public markets. These “mythical creatures” are the goal of venture capital investments, since a $1B+ valuation implies significant returns for early-stage investors at valuation of $5M, $50M, even $100M.

Decacorn – even more rare than a unicorn, a decacorn is any company that reaches a $10B+ valuation in either the private or public markets.

Super-Unicorn – the rarest breed, a super-unicorn is a company that reaches $100B+ valuation, such as Facebook. The earliest investors in these companies are the legends of startup investing.

Zombie – like the undead being for which it is a named, a zombie firm in the early-stage investing world is a business that has not failed and continues to operate, but is not going anywhere, cannot raise capital, and does not provide any exits (or returns) for their investors.

Startup – a startup business, as opposed to a lifestyle business, is a new business focused on maximizing growth. Simply being a new small business is insufficient to qualify as a startup, since startups are designed for maximum growth.

Lifestyle business – a lifestyle business, in contrast to a startup, is a business built around providing its founders with a more balanced lifestyle and work-life balance, and may not be focused solely on maximizing growth.

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