Valuation, funding and Startups

There are six different startup funding sources:

• friends and family,
• angel investors, an angel investor is a wealthy person who invests his or her own money in a company—usually a start-up—that is in the early stages of development. Angel investors expect to take ownership positions in the companies they support because their capital is unsecured—they have no claim on the company’s assets.
• venture capital,
• crowdfunding,
• debt financing, and
• grant funding.

The six stages of startup financing are pre-seed, seed, series A, series B, series C, and IPO funding.

• Pre-seed funding, as the name suggests, is an investment round that is secured pre-product market fit and pre-revenue. It comes right at the start of the startup’s life, when the founders are being fueled by great ideas and plenty of coffee, but have yet to start to make inroads in developing the product.
• Seed funding is for businesses worth three to six million dollars.
• Series A funding is for businesses worth three to twenty million dollars.
• Series B funding is for businesses worth ten to thirty million dollars.
• Series C funding is for businesses worth thirty to one hundred million dollars.
• The final stage of startup financing is the Initial Public Offering (IPO)

Every bull market has fund managers who have not seen abear market. Their views on valuations are not tempered bylessons from the last downturn.
They are also driven by FOMO — the fear of missing out.  Such markets also have investors who had missed out on the last rally and are tryingto catch up. These investors buy the stories that fund managers sell — especially when markets are inundated with easy money. So, there is a ring of truth in the words of Infosysco-founder NR Narayana Murthy who recently blamed venture capitalists (VCs) for leading startups up the gardenpath. According to Murthy, VCs push the theory that it’s the ‘topline’ that matters, and not the ‘bottom line’, driving startups to ‘grow at any cost’, making this line of thinking ‘a Ponzi scheme’ in many ways. This sounds like Gordon Gekko ‘Greed is good’ bad stuff.

However, this is over simplifying the story. First, both VCs and startup founders may be young, naïve, and people in a hurry. They may be equally hooked to stories that look too good to be true. Second, investors who put a slice of their wealth with VCs are usually the rich and the ultra-rich who, unlike the quintessential small investor, are supposed to have a better understanding of businesses. Third, not all startup stories are the same. For some the operating costs do not keep on rising and profits can grow exponentially beyond a point.

In such businesses, scaling up and boosting the topline at the cost of bottom line may be worth the risk compared to a startup whose cost of operation rises with scale. Also, it may be more difficult for VCs (typically bankrolling unlisted companies) to exit freely, leaving the next lot of investors holding the baby. So, the venture capitalist startup story is rarely black and white. And, with higher interest rates drying up easy liquidity, all the actors in the story — VCs, startups and investors — would be more careful on where they bet, and how they spend.