Forums: Discussions for entrepreneurs and small business.

Hello all,

I have some very basic questions on startup funding.
Lets say investment firm X wants to invest $1M in startup Y.

1. What is the general % VCs take from the startup at first round fundings?

2. What happends to the % of the entrepreneurs in the company? Lets say the owner % before the investment are: 45%, 35%, 15%, 5%. What would the post % normally be after the investment?

3. How does the legal process look like? What happends when you get the money?

4. How do VCs base their evaluation of a startup? What are the key things they calculate?


Would very much appreciate some anwers about this, thanks alot!

D

brante,

Generally, VC firms do not invest in pure startups. As to your questions:

1. The amount of ownership will vary depending upon several factors -notably the amount invested. Acquiring one million at a pre revenue stage will likely involve transfer of 35 -50% of the ownership to the investor. [Note: I'd avoid using phrases like "how much they take" or how much we give up"]

2. Unless there is some special arrangement, each of the existing stockholders share would be diluted. For example, if the new investor purchased a 50% interest, each of the four people in your question would have their percentage diluted by half (ie 22.5%; 17.5%; 7.5% and 2.5%

3. I'm not familiar with the process in Sweden but in the US it would involve the issuing of shares or units and a purchase document (often a subscription agreement or a buy/sell)

4. There are a number of methods of setting a valuation for a company. VC firms typically use discounted Cash flow as a starting point. As far as evaluating the opportunity - the number one thing investors look at is "the team".

Thanks alot Robert, very appreciated!

Sorry, but I’d have to respectfully disagree with you Robert.

Depending on the market opportunity, there’re many VCs that won’t shy away from investing in seed or start-up deals. It all depends on your concept, the team behind it, and whether or not VCs are convinced that there’s money to be made.

Since Sweden is part of the European Union, you’re not even limited to pursuing Swedish financial backers as the EU provides a leveled playing field for all member states.

Valuation and equity stakes are usually determined based on the VC’s gut feeling rather than a discounted cash flow valuation. If there’s no historic cash flow factored into a discounted cash flow valuation, then all you’re discounting is guesswork anyways.

Robert is right assuming that existing shareholders will be diluted in order to accommodate incoming investors; however, straight equity deals in seed or start-up financings are extremely rare, so chances are that the initial form of financing will take the shape of debt or convertible debt.

If you’re interested in discussing your project in greater detail, please feel free to send me a PM or contact me via our website below.

I hope this helps.

Karl

Karl,

I think we are both accurate. I agree that there are several VC firms that will entertain the idea of investing in 'seed or startup deals".

However, when one considers the number of 'new" VC deals done in a year, their penchant for having an"experienced" team and their valuations - I conclude that it would be rare for a newcomer to secure VC funding, especially as the first external funds. So as a piratical matter, I say that one has a relationship with the VC community -one should plan that the VC community is not a probable source for their first capital.

Robert, the original poster was based in Europe. Please consider that the venture capital landscape in Europe differs significantly from that in the U.S. While most VCs in Europe tend to make smaller investments than their American counterparts, very few would shy away from investing in a development stage company, if the other fundamentals of the deal would support an investment. So, in Europe it won’t be a rare occurrence that a VC provides the first external financing for an entrepreneur or emerging growth company.

The reason for this is that the European financial system is substantially different from that in the U.S. First and foremost, it’s more trust-based. Second, you can’t just crank out a corporation for under $100 and play entrepreneur. Third, banks maintain longstanding relationships with their customers and most credit decisions are made face-to-face, rather than in an impersonal and centralized environment as it’s the case with most major banks in the U.S. Finally, more mature companies in Europe simply don’t have the same need for venture capital as they won’t face the same obstacles as in the U.S. to access capital for growth, which is often supplied by banks.

VCs in Europe simply operate in a different market and based on different risk/return profiles. The financial returns may be smaller, but so is the underlying risk.

Cheers!

Karl

Are there any other ways to pull capital other than venture capital? I mean I do know that you could get private investors to invest... but this seems like it's only possible when you are already established and have good connections. Bank seems like the last resort...

ATXlonghorn,

There are a number of ways to bring capital into a business. The first key to success is to select the optimum way (path) for you, your business and the situation.

Some quick numbers

1. While it is difficult to establish an "exact" amount (dollars or deals) of investment provided by "private investors" (including friends and family) -estimates by industry associations indicate that this "group" provides more than 3 times the amount of  "professional" investors.

2. According to the venture industry stats - about 2800 companies received funds from VC firms in 2009. Approximately 57,000 companies received funding from "angels". There are over 7 million households in the US who meet the standard of accredited investor. Tracking the actions of this group is impossible-but industry experts estimate the number of companies who received funds to be in excess of a half million.

If you want to discuss your specific situation in detail, feel free to drop me a PM or contact me directly.

Thanks alot Robert and Karl! Great to see your interest in helping out, much appreciated.

Karl, can you explain further what convertible debt would mean for me as the entrepreneur in this case?

"...so chances are that the initial form of financing will take the shape of debt or convertible debt."

Thank you Robert,

I am looking into some online retail business focused on niche market. It seems like start up cost won't be much but I don't have the resources to hire lawyer/ attorney to take care of my legal part of business... That is why I asked about the investment money from investors. Is there a way to hire, contract, or consult with lawyer cheaply?