WHY SERIES FUNDING FOR START-UP IS MAKING FINANCIAL SENSE

It is common now for us to read the news about the Series funding that are received by start-up companies.

For example, GoJek, one of the most popular ride-hailing app in Indonesia, had even received up to Series F funding up to March 2019, as shown below.

 

Source: https://www.crunchbase.com/organization/go-jek/funding_rounds/funding_rounds_list#section-funding-rounds (accessed on 5 June 2019).

The purpose of Series A, Series B, etc. funding might be different, which for example,

Series A  ==> Optimize

Series B ==> Build

Series C ==> Scale

Source: https://www.investopedia.com/articles/personal-finance/102015/series-b-c-funding-what-it-all-means-and-how-it-works.asp (accessed on 5 June 2019).

These funding rounds provide outside investors the opportunity to invest cash in a growing company in exchange for equity, or partial ownership of that company.

Founder of the start-up company is an entrepreneur, and though he/she needs capital to build assets to generate as higher as possible the cash flows in the future, yet, he/she needs the capital at the lowest possible costs. The capital funding from the outside investors will translate, in most cases, to the equity or partial ownership of the company or venture. In other words, he/she, in exchange of the capital funding, sell the partial ownership of the venture to outsiders.

This Series Funding will provide a way for the entrepreneur to obtain the capital at lowest cost, while the business is growing its cash flows and its valuation.

It means, that the ownership cost that he/she has to sell, will go down, along with the higher valuation.

For example, if the percentage of ownership to sell will decrease compared to the funding needed, when the valuation is higher, as demonstrated below.

 

Knowing this relationship, then the entrepreneur could “TIMING” the funding needed, meaning that he/she does not have to raise the capital at one time, but could split it into some stages, while at the same time, he/she works with his/her team to grow the business and to bring more cash flows in the future or to reduce the uncertainty with regards to the business.

For example, if the business needs a total of USD 5 mio, then the funding could be broken into some Series.

If this US$ 5 mio is to be raised one time in the beginning while the valuation of the business might be not that high, for example, US$ 10 mio, then it means he/she has to sell an equity stake of 50%. Yet by timing the cash needed and funding raising, to 5 years, the equity ownership going out of the door to the outside investors could be much lower, depending the increase in the business valuation, as displayed below.

Under this simplified valuation example, it is shown that if the entrepreneur could “timing” the funding raising, then he/she will just have to release approximately 34% equity ownership instead of 60%.

Accordingly, this Series Funding is making financial sense for start-up entrepreneur.

 

Posted in ARTICLES & VIDEOS, VALUATION.

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