'Startup' is the buzz word these days. Everyone seems to head towards starting-up. And when you hear about start up, I can assure you that the first thing that comes up in your mind is the billion dollar valuation of the startups. The billion dollar startups are fondly know as Unicorns. As per the estimates of various agencies, India has now become a hotbed for startups and every third startup in the world now sets up in India. Let us understand how these startups garner fund and what results in such high valuations. The common terms used for the investors in funding of a company are Angel investors, Venture Capitalists, Private Equity firms and finally the Public Offering.
Let us know about them one by one:-
1) Angels: When an idea is generated, the entrepreneur hunts for an 'angel' for investing in his idea. The angels provide the initial fund to the start-up so that it can begin its operations. Angel investors invest their own money in the start-up as compared to Venture Capitalists which invest pooled money managed by a professionals. Angel investors fund the start-up only for a short period of time.
2) Venture Capitalists: Venture capitalists are those who invest in risky businesses. And after the start-up scales up, they are certainly into an 'adventure zone' which certainly require funding from those who are serious at risk taking. Because there is an equal chance of a venture 'failing' or 'disrupting'. Also the angels cannot fund new companies after a particular period as Angel funds are not big enough and they usually seek early exit. The start-ups don't reach break even at such an early stage (even many ought to break even after listing). Therefore, bigger fund houses i.e. the Venture Capitalists are invited to fund the startup. The entrepreneur and the Angel investor present a lucrative growth prospects for the startup and aim for a high valuation to get maximum return. For example, let us take the valuation methodology adopted for the e-commerce startups in India. These startups are valued at 'X' times of the GMV(Gross Merchandise Value).
The 'X' in times can be from 20 to 35, depending upon different factors. The Gross Merchandise Value is actually the total value of product sold by the e-commerce firm irrespective of the actual sales value. We can understand this better with the help of an example. Suppose an e-commerce firm sold an article having a market price of Rs. 20/- for just Rs.5/- (of course after heavy discounting), but for the purpose of GMV calculation, the value of merchandise sold will be taken as Rs.20/- and not Rs.5/- Thus after the firm has been valued, the Angel investors exit by selling their share to VCs.
3) Private Equity: The name itself suggests that such investors are large enough and falling short of only Public equity. Now the start-up has really grown bigger and the entrepreneur looks for investors that can provide the firm with adequate capital so that the business can grow further and expand without the need to list itself on a public bourse. After the funding by Private Equity capitalists, Venture capitalists exit the business by selling their share in the business at a favourable valuation. This is the last stage before which a company gets listed.
4) Initial Public Offering: When the capital requirements of the business get too high & risky to be funded by PE capitalists, they exit the business by roping in Investment banks and offer the shares of the company to the public. And that's how we get hold of 'risky' investments.
So, that was a short insight of the way funding of startups change as they grow from disruptors into mature companies.
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