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Things Internet Startups should know before seeking Investment

Things Internet Startups should know before seeking Investment

For those who want to take their hobbies and interest based projects further and seek a cash injection to turn their projects into a business, you might like to start learning how investors talk and think.

Below this paragraph I have included a list of references that the investment community use to negotiate deals and fund new startups.

So when you want to take your idea for the next Angry Birds game to market, or spin out the next Twitter app, you need to know these things before you ever think about approaching investors.

I myself have started 3 on-line businesses before, 2 which received 4 rounds of funding, 1 from a corporate stakeholders and 3 rounds from Angel investors.

Startups

A startup is a brand new business, usually started by a group of like minded, yet multi talented individuals who have an idea for developing a business, based on an idea for a product or service.

Financials Parameters

There are many different types of financial parameter in a business, but from an investment point of view the following formula determines whether a business is healthy or not, from an investors perspective.

Assets = Liabilities + Equity

Assets

The assets of a business can be perceived as what a business venture is worth, after all debts and incomes are taken into account. The assets of a business include both tangible and intangible properties.

A tangible asset would be something like, cash in the bank, real estate or perhaps the value of machines you own.

An intangible asset would be something like, the value of an idea, the value of the skills in the business, the value of a customer database, the relationship with clients and the intellectual property value.

When a business first starts, it usually has only two assets, “the idea” and “the talents of the people”.

This is called the Pre-Money stage.

After a while the business starts to make profit or gains capital from investors.

This is called the Post-Money stage.

Liabilities

These are the debts of the business and the obligations to pay suppliers, banks and tax man.

Equity

Equity is the value placed on a business.

The equity value of a business can be determined by the value of the Shares issued.

Typically, when a business first starts, it has only ideas and talented people.

A valuation for the whole business can be made, based on these two intangible assets.

eg. A startup has a team of 5.

Each of the team owns one fifth of the business. They own 20% Equity of the business.

After deliberation, the Equity value of the business, based on the idea and talent committed, is said to be $100k.

A decision is made to issue each team member 2000 shares each, making 10000 shares issued in total.

Each share is therefore valued at 10000 / $100k = $10 per share.

With each team member owning $20k worth of equity and 2000 shares out of the total 10000 in issue.

Bear in mind this is only the valuation of the business as the originators of the company see it. Other people outside the startup might think the value of your business is much less, or perhaps even greater.

It all depends who you are talking to.

 

Angel Investors

It may be that a startup decides that it needs to seek a cash injection to pay for the development of a product, or perhaps for marketing a completed product.

A startup business will approach one or a number of individuals or groups, seeking the required investment.

Angel Investors are unlike venture capitalists and banks, because they typically comprise wealthy individuals who are looking to increase their wealth by investing in new ideas and/or businesses they believe in and expect to get a return on investment from.

They are called Angel Investors, because they not only supply investment monies, but will typically get more involved by sharing their experience, expertise and contacts to help your business grow and to become successful.

An Angel investor would typically invest any where from $1K to several million dollars.

In return for their investment they would expect a share of the Equity in the business, which is typically realised by issuing more shares in the business.

So, taking the example above.

If your startup business was valued at $100K, before any money was invested and the Angel Investor was willing to invest $100K,  the equity value of the business would be then said to be worth $100k + $100k = $200k.

So $100K was the equity value of the business before investment and it is now worth $100K more with the investors money.

So if 10000 shares issued to the start-up team were valued at $100K, the Angel investor investing $100K cash, would also expect a 10000 shares to be issued to him., taking the business to 200000 shares issued valued at $200k.

This would mean that the Angel investor would now own  50% of the equity of the business and the original team 50%.

In other words, the startup team originally owned 100% of the business (20% each), before the capital investment from the Angel investor and after the $100k cash injection, they now own 50% (10% each).

Yet, the 50% they own, is still worth the same, because now their business is effectively valued as $200k.

Venture Capitalists

It may be that a start-up will receive many rounds of investment from different Angel investors over its lifetime.

But for those mature or more ambitious businesses, the next source of funding will be through venture capital.

Venture Capital is usually for those who are looking to raise $1million upward.

A Venture Capitalist is usually an investment management business, employing Fund Managers, to maintain a portfolio of investment properties for clients. Unlike Angel investors, Venture Capitalists are usually only interested in supplying the money and expect you the business owner to supply all the resources and know-how to make your business success.

 

Return on Investment (ROI)

A Return on Investment or ROI, is what an investor will expect from their investment.

If an investor gives your $100K investment, they will hope that this money will go some way to giving them a healthy return.

Eg. If i gave $100K worth of investment to a business, I might expect a 300% return on investment over 3 years, making my original $100K, now worth $300K.

An investor will calculate how much ROI they might get, based on what they learn about your business, prior to investing any money in your business.

Where to go first?

One of the places you might want to get started is http://www.kickstarter.com.  Most people know about this site. Essentially you post your idea/project and people will pledge money in return for some sort of reward.

That’s it for today.

Good luck with your ventures and if you want to ask questions on where to find investment, have your say in our forum at www.youngwebbuilder.com/forum.

Written by Stephen

Steve Ryan is the co-founder of Young Web Builder with Oliver Neely.