As new founders mature in understanding the language of entrepreneurship, they soon discover the need for an even deeper mastery of its unique terminology. Therefore, it is absolutely essential that we expand our coverage of these distinct terms to now include the following:
- Due Diligence
- Lead Investor
- Seed Round
- Series A
- Series B
- Stocks: Common/Preferred and
- Stock Options.
But first, a personal context. When we chose to move to our new community, we were captivated by the beauty and maturity of the densely wooded landscape. Among the variety of plant species in our new wooded terrain were these towering soft needle pine trees. This particular species of trees is known for its elegance as during seasonal breezes, they engage in a gentle entertaining sway. It wasn’t long shortly after we had settled into this beautifully wooded area, that the entire region experienced powerful windstorms. During one of these intense storms, we heard a loud crash. As we quickly looked outside, we were devastated to see that many of the beautiful towering soft needle pine trees were lying uprooted on the ground. Later upon inspection, we noticed that while these majestic looking pine trees appeared to be strong and secure, in reality they were not. With disappointment, we also noted that these seemingly established pine trees actually had very shallow root systems, due in part to the unusually rocky soil at their base. Therefore, while capable of enduring typical rains, they were incapable of enduring the intensity of powerful windstorms.
In a similar way, as founder of your startup, it is absolutely essential that you continue to establish deep roots in your understanding of the vocabulary used by angels/venture capitalists as you seek to empower your startup through these anticipated partnerships and associated funding. In light of this natural phenomenon therefore, it is only fitting that we continue our SIMBA Global Startups’ Language of Raising Money for Your Startup, Part 2 of our Success Essentials Series to cover the following additional terms:
1. Due Diligence
Due Diligence refers to the thorough investigation a potential angel/venture capitalist (VC) spends on the critical analysis of your startup. The exclusive intent of this review is to ensure that your company is worthy of their investment. Credible investments are those that have the greatest probability to generate significant and timely profit margins as defined by the mutually agreed upon exit strategy. Of particular significance to the startup founder, is the understanding that during this due diligence, the angel/venture capitalist will conduct an intensive review of at least the following critical analyses: 1) Capitalization of your startup – the market capitalization or total valuation will help angels/venture capitalists understand the extent of your startup’s equity ownership and size of its target markets; 2) Profit & Loss (P&L) Statement and Profit Margin Trends of your startup; 3) Competitors and Industries/Sectors of your startup; 4) Valuation Multiples including price-to-earnings (P/E) ratio, price/earnings growth (PEG) ratio, & price-to-sales (P/S) ratio of your startup; 5) Management and Equity Ownership in your startup; 6) Balance Sheet Statement (B/S). The Balance Sheet will show your startup’s assets and liabilities as well as available cash on hand to operate your startup; 7) Stock Price History – if your startup has matured to the stage where it’s publicly traded on a stock exchange such as the Dar es Salaam Stock Exchange or Nigerian Stock Exchange; 8) Founder Stock Dilution possibilities – angels/venture capitalists must know how many outstanding shares your startup has available to investors as compared to industry competitors; 9) Expectations – Angels/Venture Capitalists want to know what to expect regarding your startup’s earnings growth, revenue, and profit estimates for the next 3-5 years; and 10) Long-Term & Short-Term risks of your startup – Angels/Venture capitalists will want to understand both your industry/sector risks and startup-specific risks.
A reminder – while most of the above 10 due diligence analyses may be undertaken by angels/venture capitalists, depending on where your startup stands on the startup evolution journey, many of them may not readily apply to your startup if it doesn’t have the track record worthy of conducting such a comprehensive review. Nevertheless, most of these due diligence analyses are appropriate for most startups, and therefore as a founder, you must be prepared and ever ready for all of them.
2. Lead Investor
As inferred by its name, the Lead Investor is the main individual or firm identified as the major investor in the startup. While the money that the lead investor provides is of great value in empowering your startup’s scalable growth – beyond the money, the lead investor establishes the investor brand for your startup. In accordance with the common expression that “birds of a feather flock together”, the lead investor’s personality and profile have the power to attract additional angels/venture capitalists with similar fiscal capacity and character attributes. It is therefore, readily apparent that this Lead Investor resource will be of great fiscal value to your startup. This fact is self-evident because a Lead Investor is a public testimony to other investors. As you might already know, investors look for specific signs when evaluating startup opportunities to fund. One of such signs is whether any other angel/venture capitalist has already made commitment to the same deal. Since angels/venture capitalists have limited amount of time to conduct a comprehensive due diligence across many of the startups they may be considering funding, they look at other investors such as the Lead Investor for clues as to whether a startup has been vetted to some extent, and thus worthy of their investment consideration. While having a Lead Investor is proof to other investors, the need to understand the quality of such Lead Investor is of paramount importance, and therefore requires a careful due diligence by the founder prior to fully committing to the deal.
3. Seed Round
The term Seed Round typically is a descriptor used to refer to the startup’s first financing sequence. It is the preparatory stage during which the founder secures money needed for the company’s launch. The Seed Round is commonly seen as the first official equity funding stage. Often the money raised from this round is used to invest in product development, wages and other foundational startup needs. The expression Seed Round is borrowed from the farming sequence as rhythmically experienced through the planting and harvesting of crops. It is for this reason, you won’t find it surprising to learn that in addition to the Seed Round, funding your startup will often require a pre-seed stage during which the soil for funding relationships is nurtured. The pre-seed stage is commonly funded by the founder, friends, family and other supporters. In most cases however, pre-stage funders are the startup founders themselves. As a consequence, a second Seed Round may be required during which additional fiscal partnerships are secured to raise enough money to get the startup off the ground.
4. Series A
The Series A round of the startup funding is an extremely significant milestone for your startup. This funding round happens once a startup has developed a track record with a solid customer base and consistent revenue streams. Therefore, with such momentum, the startup is ready to undertake Series A funding to further optimize its customer base, product offerings, and scale its products across different markets including internationally. During the Series A round, the founder has determined that by the startup’s market, mission, margins and sustainability, the startup is now viewed as desirable by the public. Consequently as the founder, you are now ready to present to consumers an opportunity to buy shares or stock in your startup. As a founder, what is thrilling about the Series A round is the fact that after careful due diligence scrutiny, potential shareholders also share your excitement specific to your company’s potential and possibilities, so much so that they are confident that together, you will experience parallel growth in wealth. Now, as the founder who has been used to saying “I’m going to do this”, you instead start saying “Together let’s do this”. In mature economies such as the United States and the European Union, the average Series A funding as of the year 2020 is $15.6 million. For Series A funding, angels/ventures capitalists are interested in both great ideas as well as strategic vision for turning those ideas into a business that will generate consistent revenue growth with huge profit margins.
5. Series B
The Series B round of funding is energized by excitement from the scalable growth that your startup is not only experiencing, but sustaining. While in the Series A funding round your company is most likely losing money, during the Series B funding round, your startup experiences the credibility and profitability of your business model for profit generation and sustainability. It is for this reason that more and still more investors will want to purchase shares in your startup. For startups that have gone through the Seed and Series A funding, they have proven substantial customer base and have a track record for being prepared for success on a larger scale worthy of further funding. This is where Series B funding comes in to meet the rapid growth of your startup so that it can support the levels of customers’ demand in the market. As of the year 2020, the average Series B funding in mature economies such as the United States and the European Union is $33 million. Keep in mind that companies that undergo Series B funding rounds are already well established with a track record of healthy and consistent profit margins.
As the founder, you will find similarity between Series A and Series B funding in terms of the processes and key investors – they are often executed by many of the same angels/venture capitalists, including a Lead Investor who helps to attract other investors. The difference with Series B beyond Series A is the fact it brings in the game, a new wave of angels/venture capitalists that typically specialize in later-stages of investing, often leading to the Initial Public Offering (IPO) of a company.
6. Stocks: Common & Preferred
The terms, Common and Preferred Stocks are used to describe ownership in a company by different classes of shareholders. For example, the term Common Stock is typically used to describe the type of stock given to the founder(s). Used as Incentive Stock Options, it is the equity ownership extended to employees of the company. Stock Options give an employee the right to purchase the startup’s stock shares at a discounted price at a pre-determined future date with some added value of a tax break on capital gains. Preferred Stock on the other hand refers to the type of stock ownership through which angels/venture capitalists are assured that their equity shares in the company will not be diluted as more investors buy ownership in the startup. Through each of these stock options – pride, engagement and momentum for a thriving organization are extended from the founder to a group of shareholders who now become invested and increasingly committed to the success of your startup.
7. Stock Options
The term Stock Options, is used to refer to an agreement to purchase stock in a company at a designated price. Often the stock options opportunity is presented first to your company employees. The incentive to your employees for taking advantage of stock options is the fact that these members of your workforce are extended the exclusive opportunity to decide when they will exercise their option, or rather obtain cash in exchange for relinquishing their ownership. This fiscal resource is viewed as extremely appealing, given that it creates a financial resource to your team members through which their own goals for wealth creation are achieved. Some of the key characteristics that define employee stock options include: 1) grant date – the date at which the employee is granted the options; 2) the vesting schedule – the timetable under which the employee gain is fully vested to exercise the options; 3) the strike price – the price at which the employee may purchase the company’s shares; and 4) the expiration date – the date by which the employee must exercise the options.
- Create a comprehensive spreadsheet which contains every current or past legal document, agreement or contract entered into either to launch or grow your startup. Be sure to include on this spreadsheet the date, purpose, status, contact information and timeframe for each of these items.
- Within the first 90 days of the launch of your startup, designate an hour during which you think about and write down the character traits of your ideal Lead Investor. Next, research and identify potential lead investors whose attributes align with these character elements. Finally, determine which of these potential lead investors has the fiscal capacity to strengthen the cash flow and operational capacity of your company. Note: This sequence of determining character clarification before funding needs is crucial. Despite the essential need for money to fund your startup, if you identify a potential lead investor who later on you discover is unethical and manipulative, not only in exchange for funding will you open the door to your company’s failure, but you will unintentionally invite emotional distress and perhaps criminal vulnerabilities into your own life. No money is worth that type of exchange!
- Depending on the funding stage of your startup, identify the benchmarks for your startup’s pre-seed, seed, second seed, Series A, and Series B funding rounds. Then develop a list of potential angels or VC’s for these designated pre-seed, seed and second seed, Series A, and Series B rounds. Finally, align this list with your startup’s round stages. Include with this designation the associated timeline for implementation.
- Carefully analyze your startup’s growth potential, then determine the preferred purchase value for your company’s shares.
- Create a graph on which you track shareholder growth. Not only will this be a valuable source of inspiration for you as the company founder, but it will be a compelling resource through which new angels and VC’s will be convinced of your company’s value proposition.
- Develop a model for your company’s common and preferred stock options for your employees. Identify a timeline for the launch and execution of these options.
- Identify the performance benchmarks for your company that you will use to establish the purchase price for your startup’s stock options. Share these benchmarks with your workforce. Obtain their buy-in. Then immediately implement these benchmarks so that maximum engagement and momentum for the success of your business is created.
NOTE: As a reminder, SIMBA Global Startups offers mentoring assistance for the design and implementation of the above Call-To-Action formulation to qualified entrepreneurs. We therefore invite you to review our qualification criteria and to subscribe to our newsletter at our SIMBA website: https://simbaglobalstartups.com/entrepreneurs/
Mentoring Moment: York Zucchi, Swiss born global entrepreneur
When it comes to securing money to fund your startup, the distinguished entrepreneur York Zucchi once again gives the following invaluable advice: “Funding will certainly allow you to afford new resources but keep in mind that you’ll be under even greater pressure to create ROI ASAP (Return on Investment As Soon As Possible). Hence make sure you already have commercial traction and that the funding is used predominantly to increase the traction you created.”
NOW Just IMAGINE!