Investment Rounds: From Bootstrapping to Big Exits

Welcome Sir.

Hey Joe.

We’ve talked a lot this far about the startup ecosystem in Florida and the Angel investing, but let’s dig into how do the funding of these companies actually takes place.

Since this is an entry-level podcast, I’m going to start really with the basics. There are various rounds of funding that take place when an entrepreneur has an idea or has a company that they want to get funded. First is, what we call a concept stage. That’s when maybe it’s only an idea or a concept that an entrepreneur has, but not much else. And nothing to actually look at. Typically, at this stage, the funding comes from what’s called bootstrapping which the entrepreneur themselves or herself is actually doing the funding, or funding that comes from what’s called friends and family. And these are exactly what it sounds like. These are friends and family of the entrepreneur. Sometimes called friends, family and fools.

These are people that provide the original funding for the company; the first 25, 50, $100,000 typically. So, the company then has something. They have a product; do they have something they could take to other investors? They may have an individual angel in some of these funding rounds if they have the connections, but typically you’re not having professional Angel groups or other professionals involved in this. It’s basically friends, family, maybe individual Angel or two if there’s connections with the family. These rounds as I said, can be from the $10,000 to $100,000 in Florida. I’ve rarely seen them higher, but typically it’s $25 to $50,000, but they can be higher but not in Florida. I haven’t seen much higher than $100,000 coming in the friends and family route.

Got it. So, all the uncles and aunts are tapped out, who’s next?

What comes next really after the friends and family is, when a company enters the seed stage, and these stages have got larger over the years. And I’ll talk about that in a little bit of depth here. Now, there’s even what’s called a pre-seed stage. And three years ago, when I started SeedFunders, we were investing and still investing about 150,000-dollar average. Just three years ago, that was in Florida called the seed stage. And now it’s actually called a pre-seed stage. It’s actually before the seed rounds that happen. So, it’s a pre-seed stage or a seed stage as the stage that happens after the friends and family are out. These basically rounds can be from $500,000 to $1 million and still be called a seed stage. I’ve even seen seed one and seed two rounds.

This is the part where some Angel groups now get involved in looking at, once there’s an MVP or minimal viable product, it’s no longer just an idea. The friends and family round, money was used to develop this minimum viable product that would include a website, a product that could be a demo or some kind of a product. Obviously, they need to have a pitch deck to propose to investors. Those things all take place during the friends and family round, but when the seed stage round comes, the professional investors get involved. These companies are still probably pre-revenue in the early seed or pre-seed stage. Although, later seed stages may actually start to generate a bit of revenue. These lines are getting more blurred between pre-seed, seed, seed two – as I mentioned, Series A. I’ll talk a little bit more about that.

In fact, recently just this week, I heard of an entrepreneur who was presenting to a venture capital firm. Decided he didn’t want to put a label on the round that they were seeking. Basically, saying well, if the venture capital firm said, “Is this is a seed stage or a pre-seed?” they said, “Well, we don’t want to put a label on it,” because they were afraid they would be thrown into a bucket or they would be thrown into an expectation of how much money they should be raising of what valuation. That’s the first I heard, but it just shows how fluid things are between these definitions of these various rounds of funding.

And I heard in there a series A. What’s a Series A round?

As I said, there is no hard line between a seed and a series A, but the series A round is typically the next round after the company has got proof of concept and traction. They’ve got paying customers. They’ve got revenue that investors can talk to the customers about, “Why did you buy these products? Are you going to renew your contract?” those type of things. So, the company has now got – as I said – some traction, some proof of concept. This is the point where Angel groups and smaller funds and even venture capitalists get involved in this A round.

Typically, what may happen on any round is called syndication. That is where a lead investor – say a venture capital firm or even an Angel investment firm – leads a round, comes up with the deal, comes up with the terms, the term sheet. And we’ll talk about term sheets in a future podcast, comes up with the terms of the deal. Once that’s established and the company is raising say $1 million, they invite other investors to participate in that same round, in what’s called Pari-passu of the same terms. I did one stat recently that said that actually less than 10% of companies that raise a seed round, actually reach a Series A round. So, Series A shows traction, customers are progressing.

The goal of Series A round is to give the company a couple of years of runway. What that means is they should have enough capital to survive a couple of years, before having to go out for other financing if they need to at that time. Nationally, by the way in 2020 there were 650 series A deals across the country. Many were led by companies that probably mostly everybody knows. California companies, investors such as Andreessen Horowitz, Sequoia Capital, Intel Capital, Google Ventures. In Florida, none of those companies are highly active. Although, some of them invested some in Florida, but in Florida really the investment firms that are leading those rounds and investing in Series A deals include Florida Funders, Ballast Point, Stonehenge which I believe now is rebranded to be called Topmark Partners and DeepWork Capital out of Orlando.

So, this is the stage where there’s a lot more funding capabilities from these types of companies than Angel groups. As far as SeedFunders go, as I said that’s our name, SeedFunders. We do seed investment only, and we have not participated in any Series A investments generally in the state or out of the state of Florida.

Now, I heard you mention $1 million in there. So, where do Series A rounds typically end up?

Well, there are a lot of stats on that. Nationally, in 2021 the mean for Series A investors in somewhere between five and $8 million. That’s five and $8 million invested into the company. The average evaluation of those companies is pretty staggering, $24 million pre-money evaluation. And I’ll talk a little about the difference between pre-money and post-money valuation, but the average valuation is $24 million, but that’s not in Florida, not even close in Florida. In Florida, the cluster we can get – there’s a study done by the Halo Report – studied the whole southeast from Atlanta down to Florida, and basically said that the average investment for a Series A deal is $1.4 million. And the valuation on a Series A deal in Florida is typically around $9 million.

So, what you’re looking at is in Florida, a company is valued at $9 million in a Series A, but in California primarily and in New York and others is basically valued at $24 million. So, what you’re going to see is obviously Florida has much lower valuations on these companies. That is actually obviously good for investors. We are an investor-friendly State. Because these companies, if you think about it they have to perform. If a company is valued at $24 million, it’s pretty difficult to raise additional funds unless they become really, really successful. As a result, they can go under if they can’t raise additional funds. Where in Florida, if a company is valued at $9 million and they start to see some traction, some success, it’s pretty easy to then go out and raise follow on capital, because you’re starting at nine. So, there are huge advantages to investing in Florida, and to entrepreneurs in Florida. It’s not all about the valuation. It’s a lot of other factors that take place.

So, Dave, I’m going to put my college education to use here and see if I can predict what comes after a Series A round. I’m going to go with Series B, how did I do?

You did it. There is Series B. Then there is C and D etcetera. I’ve seen some companies run up to series J or K. These are obviously companies that are not well past the startup status. They’re in what’s called the growth phase. So, these companies have not only proof of concept and revenue, but some of them might even be making profits and growing, and looking for additional capital to grow. Some points, one of four things happen to these companies. First of all, they can go out of business, and we talked a lot about that previously. If the company doesn’t succeed and they can’t raise additional capital and they can’t fund operations, they’ll go out of business. So, that’s one thing that can happen during this cycle of series A, B and past.

Second thing that could happen is, they become what we call a zombie company. A zombie company is a company that really can’t raise any more capital, but has enough revenue to survive, but basically is not fundable any more. Doesn’t see a lot of growth. Investors don’t see a lot of growth. They don’t see any reason in putting additional funds into the company. Nobody might lose all their money, but nobody is really gaining a lot of money. The company really functions and survives but is pretty much a zombie company to future investment.

The third thing that happens is what’s called M&A – Mergers and Acquisitions. A company can get bought out. This is where a private equity company comes in, and really takes control of the company. They invest enough funds to take control and either roll that company up into other companies, combine them with other things. So, basically that’s the private equity phase. That is typically a success story for the company and for previous investors, because these private equity companies want to come in and have controlling interests, they need to buy out a lot of the previous, if not all off the previous investors.

These things just recently happened, something happened in Orlando with a company basically where a private equity company came in, brought in controlling interests. And the original investors, some of the original investors got a 10 to 12x return on their investment in three years or so. That’s a huge success story. That really is the goal of these early investors. They have an M&A come through of a private equity firm, buy them out and make essentially a good return on their funds.

Same thing happened with a company I started. A company called Red Vector. We started with a seed investment from Angel investors. We went to a Series A where a Tampa venture capitalist invested funds. We did a Series B where the venture capitalists did additional funding. Then few years after that, a private equity firm came in, bought out controlling interests and basically venture capitalists and everybody made decent return on their investment.

Finally, the fourth thing that can happen in situations like this with these startups is an IPO or initial public offering. That is pretty rare. We see, not a few types of entrepreneurs who on their application that are funding request who say they plan on having an IPO. I haven’t seen it. It’s really rare for a company to have an IPO particularly in Florida. Really, as far as investors are looking for, we’re looking for a company that’s going to go the M&A route and have private equity come in and take over controlling interests and everybody will make a decent profit.