Hypothetical path of financing

Hypothetical path of financing

The venture capital model assumes that a young company with a promising product, process or service may develop faster if it obtains an investor who will provide substantive and financial support. In exchange the investor is offered the company’s shares. Obtaining consecutive investors is colloquially called a ‘series’.

The investor’s aim is to ‘exit’, i.e. selling his shares with a profit. It can be achieved in two ways: 1/ through acquisition of the whole company by a corporate investor or 2/ through taking the company public, i.e. through an Initial Public Offering, IPO.

Usually companies need between three to five rounds of financing before the ‘exit’, i.e. selling the company, may take place.

One extremely important aspect of the process is the way in which the estimated value and cap table of the company changes. The diagram shows a sample path of financing in the venture capital model.

1. Own capital investment /business angel

When deciding to start your own company it is essential to have experience in the sector and a sound knowledge about the target market. Thanks to this we are able to develop a product that will bring value to our clients. Usually this phase does not require vast financing and many founders cover it from their own capital. It is also possible to involve a business angel who will provide initial financial support in turn for a slight volume of shares in the company.

Allocating funds to:

1/ confirming the existence of a market need,

2/ verifying how the technology works in laboratory conditions.

2. Seed

At this phase the investor usually turns attention to these three factors: confirming the real demand for the product, process or service in the indicated target group of consumers, how well the business model is developed, and the competences of the founders, which are necessary to succeed in the project.

Allocating funds to:

1/ running research and development works,

2/ developing the target version of the product (Minimum Viable Product – MVP),

3/ obtaining first clients.

3. Series A round

In order to receive financing in series A round it is particularly important to confirm the ‘product/market fit’, that is the degree to which the product, process or service matches the needs of the clients. (The idea is still shrouded in some myths. When trying to define the product/market fit of the solution that is being developed it is worth reading the article entitled The Illusion of Product/Market Fit for SaaS Companies). Moreover, the investor will probably be interested in the scalability of the business model, expecting to receive a confirmation that the company can grow quickly without the need to introduce profound changes in the business model.

Allocating funds to:

1/ preparing the company for scaling,

2/ building the team,

2/ refining the product, process or service,

2/ refining the business model.

4. Series B round

In order to receive financing in series B round all the elements that were in place in series A round are significant, including reaching the milestones. Moreover, it is also necessary to prove that further scaling of the company is possible.

In the case of a venture capital model often the companies are not profitable at the stage of scaling because they allocate almost all financial resources to development the client base. For investors it is important that a given business model presents a potential for making revenues after the scaling phase. It is best to verify this on basis of figures representing an average client, that is in terms of ‘unit economics’ – a summary which presents e.g. the total income of the company made on an average consumer; this includes the total amount necessary to win the client, the amount we receive from the client for the solution we offered, as well as the time required to get a return on the money invested in winning the client.

Allocating funds to:

1/ scaling,

2/ further development of the product – continuing the scaling process, expanding the functionality of the product, upgrading the existing product, internal improvements in the company,

2/ international development.

5. An exit (being acquired by the corporate investor or an Initial Public Offering (IPO)

An exit is possible when the company meets the sector investor’s benchmarks and once the appropriate scale of operations and potential for increase in revenues are ensured.