Let’s say you and two friends decide to pursue a company in Internet technology, Gray Matter. You three will be co-founders and hope to one day take the company public. Initially, the company will be incorporated as a C Corporation, typical for most public companies or those hoping to go public.1
Seed Money: FFF
The next phase for the company will typically involve funding. You’re now looking to receive an initial startup investment or seed money. This will probably cover your research and development, marketing research, and any other preliminary expenses. Options for seed money usually include self-funding, friends and family, angel investors, and more recently, crowdfunding. For all stages of investment one must always make sure to pick the right investor. The right investor is not necessarily the one putting up the most dollars but rather, may be the one who can mentor or connect you with a larger network. Bottom line: while investors are researching your idea; make sure you are researching them. It is important to be upbeat, communicate perceived risks, and to not be afraid to ask questions.2 Be aware that at this stage, depending on your idea and network, angel investors may not be an option. Angel investors typically enter at the second round of funding, the angel round.3
Second round: Angels to the Rescue
Now, the initial investment funds are starting to run low. The business looks prosperous but is still not generating revenue. At this point, venture capital is not an option. Venture capitalist are extremely selective; they usually want to see some real revenue generated, or extremely rare and innovative technology, before investing. This is where angels make their move. Usually, for a piece of your company pie, they are willing to provide the necessary capital to facilitate taking your business to the next level. Most angels invest their own funds, putting their own skin in the game. Typical angel investment amounts range from $150,000 to $2,000,000.4 For that very reason, angel investors are almost always looking for an extremely high return on their investment. Angel investor returns fall around 2.5 times their investment.5 Your angel investor’s returns will normally be set in an exit strategy, which in this case, would be your company’s initial public offering. While extremely expensive, for most startups at this stage, it’s the only option.
With the help of the angels, you’re company is finally off the ground and running. The business has launched its first version of your groundbreaking technology and users are lining up to try it. With all this initial excitement and the understanding that further funding will be necessary to take your company to the next level, you turn to venture capitalists.
Series A: Venture Capital
As mentioned, venture capital is extremely hard to secure. Venture capitalists hear hundreds of pitches and may only select one idea from the bunch. What a lot of early startups don’t realize is that venture capitalists are not only investing in your idea, but also the most important element of the startup, you. A fund wants to know that you and your co-founders are passionate, invested, creative and strategic.6 Prior to meeting with a venture capital firm, it is important to have a good management team in place and a great business plan that addresses the competitive market, goals, risks, and the financials necessary in order to eventually scale the company.7
In addition to surrendering company equity, in order to secure venture capital, it is sometimes also necessary to give up significant control over company decisions. A venture capital fund may be hesitant to provide heavy capital without a say in the way the company is operated.
Venture capitalists are similar to other investors in that they are always considering returns. They want the potential for an early exit or extraordinary yearly returns. In your case, the exit would coincide with the initial public offering. Hopefully, with the help of venture capital, your company will thrive and the hard work is finally paying off. The plan of going public you and your co-founders developed so long ago is coming to fruition. You are ready for your initial public offering.
What is an Initial Public Offering?
Initial Public offering (IPO) is defined by the U.S. Securities and Exchange Commission as the first time shares of a stock in a company are sold to the general public.8 Companies are generally known as either private or public. Initially, most companies start off private and only through a long and complicated journey do they make it to the IPO stage. When a company reaches the point of IPO, it is usually considered the time to cash out and exit. But not so fast; there are millions of companies in the U.S. and according to the National Association of Securities Dealers Automated Quotations (NASDAQ), only 4,731 are publicly traded in one of the big U.S. Stock exchanges. The “big three” consists of the NASDAQ, New York Stock Exchange (NYSE), and the American Stock Exchange (AMEX); they have cumulatively seen listings fall 54%, from a peak of 7,888 publicly traded companies in 1997.9
Why offer an IPO?
There are two main reasons most companies hold an IPO. The first is the use of the IPO as another method of raising capital. The second is everyone’s favorite day of the week – payday. You, your co-founders, investors, and early employees that are holding stock are finally looking to sell some or all stock and cash out. Hopefully, your IPO is a win-win for all.
Dwight Drake, Business Planning: Closely Held Enterprises 90 (3rd ed. 2011). ↩
Martin Swilling, How to Get Funding From Friends, Family, and Fools, Business Insider (Nov. 29, 2010, 10:14 AM), http://www.businessinsider.com/how-to-get-funding-from-friends-family-and-fools-2010-11?op=1. ↩
See id. ↩
Tanya Prive, Angel Investors: How The Rich Invest, Forbes (Mar. 12, 2013, 9:27 AM), http://www.forbes.com/sites/tanyaprive/2013/03/12/angels-investors-how-the-rich-invest. ↩
Steven Rosenbaum, Why Startup Timelines Requires Stamina, Forbes (Feb. 27, 2013, 11:00 AM), http://www.forbes.com/sites/stevenrosenbaum/2013/02/27/why-startup-timelines-requires-stamina. ↩
Martin Zwiling, 10 Tips For Building The Most Scalable Startup, Forbes (Sept. 6, 2013, 7:39 PM), http://www.forbes.com/sites/martinzwilling/2013/09/06/10-tips-for-building-the-most-scalable-startup. ↩
Initial Public Offerings (IPO), http://www.sec.gov/answers/ipo.htm (last visited Sept. 20, 2013). ↩
Alix Stuart, Missing: Public Companies, CFO (Mar. 22, 2011), http://www.cfo.com/article.cfm/14563859. ↩
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