Understanding Terms in Startup Funding

In the startup world, there are many terms that may be foreign to some people – sometimes even the startups themselves. While the definitions and concepts of the terminology are important to understand, especially if you have the intention to grow big and connect with various parties, including venture capital or global business partners.

In order to provide education to founder startup startups and the public who enjoy the dynamics of the startup ecosystem in Indonesia, DailySocial trying to review various popular terms that are often raised in discussions about startup funding.

Fundraising

Etymologically it can be interpreted as fundraising process. These funds are needed by startups to increase resources to accelerate business – increase the number of users, sales figures, or presence in new territories. Generally done after startup gains traction (traction) convincing.

Traction takes various forms, but basically it is a customer who uses the product repeatedly. For example, for a food delivery application, traction can be represented by the number of active member and partners merchant; for online media applications, traction can be measured by the number of daily and monthly unique visits; and others.

Startup funding is carried out in stages, therefore if you listen news in DailySocial, there is often the term “initial funding”, “series A”, “pre-series B” and so on. The following is a brief explanation for each stage:

• bootstrapping; venture capital carried out independently by startup founders. So the most popular mechanism when a new startup is launched. Fundraising from grant –for example winning a competition or an award--is also included here.
• Initial funding(seed funding); is the first or initial investment round that is obtained from an external investor, which means it will get a certain share in return. External funding is done after the startup (and investors) agree on the company value (valuation).
• Advanced funding; if after initial funding the startup still opens a new round of investment rounds, it will enter the advanced stage. The first advanced stage is commonly referred to as “series a”, followed by “series b”, “series c” and so on according to startup needs.
• Pre-Funding; other terms put the word pre-funding, for example pre-seed funding/ pre-funding initial, pre-series a/pre series a, and so on; as an accompanying round of funding which will be continued at a later date until the closing of the round at a certain stage – pending the involvement of new investors.

The term "round" is also attached to funding, this is to illustrate that at every stage of funding, startups open up opportunities for anyone to join as an investor. Each round of startup funding has certain achievement targets. For example series f funding Gojek targeting $3 billion.

In addition, there is also the term funding round which is based on the type of investor. Some can also be correlated with funding categories based on stages. Here's the review:

• Angel round; This round of funding is provided by individual investors, groups of individual investors, partners, or families in small amounts at the start of the startup's establishment – ​​most of which can be equated with pre-seed funding.
• corporate rounds; funding is provided by a company to a startup. It can be done at any stage, the goal is to build strategic partnerships. For example, an insurance company invests in an online motorcycle taxi startup, so that the startup uses its insurance product as the main option in the application.
• Venture rounds; funding provided by venture capitalists (venture capital) at an advanced stage. This term is also commonly used if startups and investors have not found an investment agreement that is included in series a, b, c, or others. Capital Venture raise funds from limited partners, which consists of companies, private equity, and others.
• Private equity rounds; funding obtained from private equity –namely an investment company that collects funds from certain companies or parties. Generally enter into advanced stages with very large values.
• Debt Funding or Debt Financing; is a loan of capital funds granted in convertible notes for startups that are already at an advanced level. In a certain period of time the funds can be returned with the agreed interest agreement, or it can also be converted into share ownership.
• Growth Fund; advanced stage funding provided by investors to accelerate an established business, usually in series A and above. Not infrequently investments are made through joint fund initiatives that involve more than one person venture capital. Example of a joint fund: Vision Fund initiated by Softbank.

Funding instrument

Investors provide investment to startups through several instruments. In Indonesia, there are two of the most popular, namely debt and equity. First, debt, the model is different from capital loans provided by financial institutions such as banks, because the repayments do not come with money and interest on loans. In Indonesia the most popular mechanism is through convertible notes (some call it convertible loans).

Convertible notes contains a debt repayment agreement, either with money or equity options as a conversion of the given investment funds. Some have specific timeframes, some are more flexible in terms of deadlines. There are many factors behind the issuance of this agreement. Most often, for early-stage startups, because they haven't found a bright spot on valuation – while they are considered debt until one day when the valuation has been calculated it will be converted into a percentage of equity or shares.

The second instrument is equity. This is clear, for a startup that is already established and has a clear calculation of valuation. Investors provide funds, then the startup will allocate a percentage of shares to each investor. There is no definite formula, because it depends more on the agreement between founder and investors.

Startup valuation

“If you sell your startup, how much will it cost?”, that statement is an easy definition of valuation. The value of a company is important to know, especially when you want to open investment gates to outsiders. These calculations will also be useful for founder to determine how much equity will be given to potential investors in the offering. The challenge is that digital startups tend to be different from conventional companies in calculating valuations.

In conventional business the variables are clear, usually consisting of the sum of the market capitalization value (for those who have IPO), company turnover (from transactions), cash (from profits), company shares (if the company is incorporated in private equity or invest in other businesses); then reduced by debt. The startup approach is unique, in that the valuation has to be calculated even before the business turns a profit.

For self-starting, valuation calculation usually divided into two models, pre-money (before getting funding) and post-money (after getting funding). Before getting funding, the determining variables include many things, for example the value of business transaction turnover, traction or service users, products developed, existing teams, even to external factors such as market potential and competitors.

Converting this variable into a nominal currency is indeed a difficult task, because it cannot be in the same direction – for example founder only determines. Investors will also see and make calculations. So they rely more on agreement to reach a certain number. Different from post-money, which is equipped with a valuation value before funding, the calculation becomes easier. The agreement will focus on discussing the value of the shares to be awarded.

Along with its development, several methods of calculating valuation are now becoming popular, such as Discounted Cash Flow, Comparable, Venture Capital Method, and others.