Now that you have finally received funding, it seems you have reached the finish line, but getting funding is not the end of your startup journey. It’s time to go to the drawing board again. The journey may still be tough, but at least, you now have some desperately needed resources.
When you are raising money for your startup, it helps to also understand how the investors you are pitching will make money for themselves. The formula for paying investors is often not as simple as taking their return on investment and allocating it equally among the key players.
For angel funds, venture capital funds and other investment partnerships, there are often complex formulas for how the individuals involved in managing investments make money. Ultimately, you should remember that all the investors want in return for their money is pretty simple: more money.
[READ MORE: To become a millionaire, set these benchmarks]
What is the implication of raising funding?
By seeking funding rather than taking out a loan, startups can raise money that they are under no obligation to repay. However, the potential cost of accepting that money is higher – while traditional loans have fixed interest rates, startup equity investors are buying a percentage of the company from the founders.
This means that the founders are giving investors rights to a percentage of the company profits in perpetuity, which could amount to a lot of money. Big-name companies like Amazon, Facebook, and Google were once venture-backed startups.
4 ways startup investors can make money from their investment
- The startup is acquired by another company: For an investor in a startup, this is frequently the quickest way to make money on your original investment. When a startup is acquired, an investor may receive cash or new stock (or a combination of the two) from the acquiring company. So, how much an investor would see back on a merger or acquisition of this kind depends on his share of the startup and the valuation the company was being acquired at (Example here is Instagram).
- The startup goes public (IPO): If you had invested just $10,000 in Amazon, Dell, Apple, or Microsoft, when they went IPO, you’d be a million dollars richer just from that investment according to the IPO Playbook. Apple kicked that 100x ‘Franklin Multiple’ to the curb with a 4,581.7% rise in stock value between 2002 and 2012 alone.
- The company begins paying dividends: Some companies decide not to get bought or IPO. Their founders have a vision of running large, standalone businesses. To repay investors, they can pay out part of their cash flow in the form of ongoing dividends or if the cash buildup on their balance sheet is large enough, they may decide to dividend out a chunk of that cash in a one-time, special dividend.
- Investors sell their shares to other investors: Investors in startups typically have the ability to sell their shares to another buyer for a profit if they can find one.
What is Equity?
Equity essentially means ownership. Equity represents one’s percentage of ownership interest in a given company. For startup investors, this means the percentage of the company’s shares that a startup is willing to sell to investors for a specific amount of money.
As a company makes business progress, new investors are typically willing to pay a larger price per share in subsequent rounds of funding, as the startup has already demonstrated its potential for success. If the company turns a profit, investors make returns proportionate to their amount of equity in the startup. If the startup fails, the investors lose the money they have invested.
Returning Money to Investors: How to calculate their actual return
Often you know how much you want investors to invest, and they are demanding a certain rate of return. What cash flows do you need to provide to give them that rate of return?
If they provide $100,000 and demand a 40% rate of return per year, that means you’ll have to pay them $40,000 each year. If you agree that they get their money in a lump sum when the company goes public, then the 40% compounds.
The calculation is easy — the total due each year is the previous year’s total plus the interest (40%). If you estimate the company will be worth $5,000,000 at the end of the fifth year, then the investors will need to own 10.8% of the company ($537,824 / $5,000,000) in order for them to get their 40% return.
[READ FURTHER: What Is A Share Reconstruction and How It Affects You]
Splitting the Pie
Every time you get funding, you give up a piece of your company. The more funding you get, the more company you give up. That ‘piece of company’ is ‘equity.’ Everyone you give it to becomes a co-owner of your company.
The basic idea behind equity is the splitting of a pie. When you start something, your pie is really small. You have 100% of a really small pie. When you take outside investment and your company grows, your pie becomes bigger. Your slice of the bigger pie will be bigger than your initial bite-size pie. When Google went public, Larry and Sergey had about 15% of the pie, each. That 15% was, however, a small slice of a really big pie.
Let’s look at how a hypothetical startup splits its equity from idea stage till it gets external investment:
Idea stage: At first, it is just you. You own 100% of it now and you are the only person in your company, you are not even thinking about equity yet.
Co-Founder Stage: As you start to transform your idea into a physical prototype, you realise that you could really use another person’s skills. So you look for a co-founder. You also realise that since she will do half of the work, so you give your co-founder 50%.
Soon you realise that you need funding. You would prefer to go straight to a VC, but so far you don’t think you have enough of a working product to show, so you start looking at other options. The Family and Friends Round, then The Angel Round. And then more options:
Incubators and accelerators: These places often provide cash, working space, and advisors. The cash is tight – about $25,000 (for 5 to 10% of the company.)
Angels: Let’s say it is still early days for you, and your working prototype is not that far along. You find an angel who looks at what you have and thinks that it is worth $1 million. He agrees to invest $200,000.
Now let’s calculate what percentage of the company you will give to the angel. We have to add the ‘pre-money valuation’ (how much the company is worth before new money comes in) and the investment:
$1,000,000 + $200,000 = $1,200,000 post-money valuation
Now divide the investment by the post-money valuation $200,000/$1,200,000 = 1/6 = 16.7%
The angel gets 16.7% of the company, or 1/6.
What about you, your co-founder and the family member that invested? How much do you have left? All of your stakes will be diluted by 1/6. Is dilution bad? No, because your pie is getting bigger with each investment. But, yes, dilution is bad, because you are losing control of your company. So what should you do? Take investment only when it is necessary.
Venture Capital Round
Finally, you have built your first version and you have traction with users. You approach VCs. How much can VCs give you? Let’s say the VC values what you have now at $4 million. Again, that is your pre-money valuation. He says he wants to invest $2 Million. The math is the same as in the angel round. The VC gets 33.3% of your company. Now it’s his company, too, though.
Your first VC round is your series A. Now you can go on to have series B, C – at some points either of the three things will happen to you. Either you will run out of funding and no one will want to invest, so you die. Or, you get enough funding to build something a bigger company wants to buy, and they acquire you. Or, you do so well that, after many rounds of funding, you decide to go public.
Why Companies Go Public?
There are two basic reasons. Technically an IPO is just another way to raise money, but this time from millions of regular people. Through an IPO, a company can sell stocks on the stock market and anyone can buy them. Since anyone can buy, you can likely sell a lot of stock right away rather than go to individual investors and ask them to invest. So it sounds like an easier way to get money.
There is another reason to IPO. All those people who have invested in your company so far, including you, are holding the so-called ‘restricted stock’. The people who have invested so far want to finally convert or sell their restricted stock and get cash or unrestricted stock, which is almost as good as cash. This is a liquidity event – when what you have becomes easily convertible into cash.
A prime example is Google, which launched as a startup in 1997 with $1 million in seed money. In 1999, the company was growing rapidly and attracted $25 million in venture capital funding, with two VC firms acquiring around 10% each of the company. In August 2004, Google went public, raising over $1.2 billion for the company and almost half a billion dollars for those original investors, a return of almost 1,700%.
[READ ALSO: Determining the Best Savings Account for You]
The term sheet
In the context of startups, a term sheet is the first formal document between a startup founder and an investor. A term sheet lays out the terms and conditions for investment. It is used to negotiate the final terms, which are then written up in a contract.
The downside of receiving funding
- After the investment, it’s not entirely yours anymore. That dream you had of building your own business ends when you take on outside startup investors. You have partners now. You have people who have a claim to ownership, shares, and having a voice in key decisions. You no longer set your own goals, strategy, milestones, and pace.
- Investors aren’t generic. Some become collaborative partners and even mentors, some are nagging insensitive critics. Some help, some don’t.
- Investors can be bosses. You are not your own person when you have investors; you’re part of a team. You can’t decide everything by yourself.
- Investors don’t make money until there’s a liquidity event. That’s why we always talk about exit strategies. You can be the world’s happiest, healthiest, most cash-independent company, but your investors won’t be happy until you get them cash back. The win is getting money back out of the company.
Founders should raise money when they have figured out what the market opportunity is and who the customer is, and when they have delivered a product that matches their needs and is being adopted at an interestingly rapid rate.
Look for ways to keep the amount of equity or percentages as low as possible when negotiating with an investor. For instance, ask for a smaller amount of money initially, rather than a sum you feel you’ll need over a few years. This allows you to give away a smaller slice of your business in exchange for the capital, leaving you with more as the owner of the company.
What are the Alternatives?
If it’s the advice you need more than the financing, another option is to take on a partner willing to offer working capital and expertise to your company. Your partner gets a cut of all profits, depending on your operating agreement, but you may have more options for terminating this arrangement.
Your partner can agree to sell his portion of the partnership to you, for example. Then you own his share and do not have to pay a percentage of the profits to him anymore.
[READ FURTHER: Top eight investment destinations for Nigerians]
7 common money mistakes I made and why you should avoid them
Don’t plan your wedding with the hope that your uncle will foot the bill. It is setting yourself up for frustration. Uncle also has his money issues that you have no clue about.
On Sunday, March 17th, 2020, Nairametrics Founder, Ugodre Obi-Chukwu, tweeted a question that has over time garnered more than seven hundred interesting responses. His question was about debt and it was straight to the point —”What was the most amount you lent out to someone and never got paid back?”
What’s the most amount you lent out to someone and never got paid back?
Mine is N550k and it’s still paining me till today.
— Ugodre (@ugodre) May 17, 2020
As you can expect with this type of question, the responses were varied and highly personal. The Twitter thread also proved one thing, and that is the fact that banks are not alone when it comes to bad debts. One of those whose responses stood out for this author is Gabriel Omin, a personal finance enthusiast. Interestingly, Mr Omin had earlier written extensively about the 7 money mistakes he made in the past, and lending is atop his list. See below.
Never Ever Lend Money Kept In Your Custody.
There is a reason you were chosen to keep the money. People do not joke with their money and so they carefully choose who keeps corporate funds. Even thieves chose trusted people to keep their money.
When you betray the trust of people for whatsoever reason, you’ve soiled your name. You will lose social capital, which is a very important capital (this is one of those, not everything that counts that can be counted). That is very hard to undo. Whatsoever happened, it’ll be hard for people to forget. My dad will not touch the original money that is given to him to keep. If you numbered your money, you will get it back the same way. Basically, you will get the same notes you gave him to keep except he took the money to the bank.
I learned this the hard way. A friend of a friend came with a need. He told me he had funds in the bank but it did not clear and the next day was a public holiday (this was pre-online banking). I loaned him money that someone gave me to keep. The person who gave me the money to keep, trusted me to the extent that he refused to sign a contract with me because he trusted me. I was supposed to get the money on the next working day, from the friend of a friend. Till today the next working day nefa reach. I had to go to the guy who gave me the money to keep for him, spoke a lot of English and paid back though I missed the day we earlier agreed. It was sad but I learned the hard way.
Avoid Impulse & Unplanned Expenses.
No budget, no spend. Spending without a budget is misappropriation. It doesn’t apply only to politicians. Have a budget & stay on it. This is the epitome of discipline. People will say what they want to say but instilling financial discipline is more important. A budget creates boundaries. Without a budget, you are on the speed lane to debt and debt…s/he is cruel. Plan plan plan. There might be surprises but a plan keeps you in order. It helps you know where you have detoured. You must not buy every AsoEbi. ATM cards are sweet to swipe but hard on the balance.
One of the ways to avoid impulse buying is to hold cash. Yes. It sounds not- so-tech in a tech age but believes me it works. When the cash is finished, it is finished. Sitting down in one place also helps. Yes o. The more the outing, the more the expense. I can feel the envy I am generating with this but na so e bi.
The Money Will Come.
You are old enough now to know that the money will not always come. Things happen. Have a buffer for emergencies. The difference between politicians & business people is that politicians do not understand why the money should not come. Business people work for money. They know that you have to make it happen. Stop planning your expense based on the generosity of strangers.
Spending Based On Other People’s Purse.
Don’t plan your wedding with the hope that your uncle will foot the bill. It is setting yourself up for frustration. Uncle also has his money issues that you have no clue about. Don’t plan to fly business class with the hope that someone else will pay. You are not on welfare. Even if you are on welfare, please bring something to the table. That something is humility.
Responsible people spend within their means. They may not have Rolexes or iPhones but they hardly ask for help on predictable things like house rent, school fees, etc. It takes 9 months to have a baby. It is not an emergency; plan for it. I take God beg you; plan.
Your kids should be in schools that you can afford. People have come to me for fees of school that my kids cannot even attend. I once headed a scholarship board and we set our requirements from day one. But parents kept coming for help in schools that they cannot afford. I mean households that both parents were not earning any income. You see what I mean by the fact that you have to contribute humility when you come to the welfare board?
Don’t buy with the hope that someone else will pick the bill. Try and agree upfront for a joint transaction. For the fact that someone paid upfront might mean that s/he expects repayment. Don’t think s/he is wicked when repayment is expected and asked for. In joint transactions, always think of going Dutch except you are advised otherwise. Err on the side of caution.
Spending Money Before It Gets To You.
Things happen. Until money enters your account, don’t go & pick something with the hope that you will pay when you get the money. That habit will lead you into the red. How about if that money does not come at the end of the day? I try not to make promises to people based on expected money. I see people start piling up debt just because they got a new job. It will distort your balance sheet if you start that way. It never ends well.
Money Sent Me On Errand.
I have seen people who were given a raise, upgrade their lifestyle in a heartbeat. Fly business class by the next day. Buy an expensive toy they never planned for. This is what happens to lottery winners. They pursue the appearance of wealth. The appearance of wealth is demonstrated when you get those things that make it look like you’ve arrived. It is the reason people take pictures sitting on cars; same reason musicians record videos in mansions and nice cars and private jets. Gang stars wear fur coats. Same when people buy TV/stereo set/gadgets with their first salary. Always allow the money to cool down. Take out time to plan what to do afterward. I have a one month rule for windfalls. They stay in the account until such a time that I have decided the way forward.
Depending on the Generosity of Strangers.
This is living life with the hope that somehow someone else will show up in the nick of time to pick your bills. It leads to living in debt and hoping that those you are indebted to will forget the money. These people can come to you with their family to thank you for the debt forgiveness you have rendered them. Meanwhile, you have said nothing of such. They always convert their debt into forgiven loans by themselves without your consent. They are experts at this. They quarrel and get contentious if you do not forgive. Money problems abound.
So, next time you think of doing any of these, have a rethink.
A New Wave: Where to Invest in H2 2020
Some of the industries that are expected to succeed given the changing times are not your usual kinds of investments.
There are two kinds of people in the world: The ‘glass-half-empty’ kind, and the ‘glass-half-full’ people. Where some see problems, others see the opportunities – same glass, but different perspectives. 2020 might have left very little hope to hang on to, but the world is still in motion.
Amidst the chaos, many have found their diamonds in the rubble – and many more will. These people, however, will be those who are willing to adapt to the changing times by repositioning themselves to leverage the opportunities that arise.
The Covid-19 pandemic has proven to be a holistic challenge, bringing to the fore a myriad of issues. It has caused a dent in the revenue/ disposable income of many businesses and individuals alike, shaken the very balance of the economy with many countries heading for unprecedented recessions, and left everyone with so much uncertainty.
Yet, we are at the cusp of a new dawn. Processes are changing, new industries are emerging, and money is changing hands. Flexibility, automation, and sustainability are just some of the words that will make all the difference in the world of business.
Dr. Ola Orekunrin Brown, the founder of Flying Doctors – a healthcare investment company – had, at the Quarterly Economic Outlook Webinar hosted by Nairametrics, offered insights into some of the industries that are expected to succeed given the changing times, and they have been outlined below. But be warned, a lot of them are not your usual kinds of investments.
Investment opportunities to leverage in H2 2020
One of the many trends that emerged in recent times, as a result of the Covid-19 pandemic induced lockdown in many parts of the world, is a huge dependence on internet technology and digital media. Everybody went indoors – and online. The entertainment sector found its home on social media through Instagram Live parties, Tik Tok, and the Houseparty App.
Companies went online as well, leveraging digital technology like Zoom, Microsoft Teams, and Slack. Even the lifestyle industry went online with online gym classes, yoga classes, and even karate classes. Not only have they provided much-needed solutions, they have also come with the additional benefit of convenience.
A good example of this is Eric Yuan, the founder of Zoom, who joined Forbes’ billionaires’ list for the first time as a result of the increased use of Zoom for work meetings. Apptopia, an App tracking firm, reveals that Zoom was downloaded 2.13 million times around the world on 23 March, the day the lockdown was announced in the UK– up from 56,000 a day and two months earlier.
Another feature of the digital economy lies in the education sector. With schools forcefully closed, classes have had to go online. Online courses, training workshops, and even full degrees will become more normal as those who work from home will see these online education courses as an opportunity to develop themselves with little effort.
Investments here will be even more fostered by access to international markets, thereby increasing the market size. ResearchAndMarkets predicts that the online education market is poised to grow by $247.46 billion during 2020-2024, progressing at a CAGR of 18% during the forecast period.
Institutions that are too big to fail
The stock market is expected to be even more volatile, given the overall unfavourable economic terrain and a high level of uncertainty – especially with all the talks of a recession coming. In H1 2020, the more favourable companies to invest in are those that have stood the test of time – the stocks that are too big to fail.
Many of these stocks have been in existence for decades and have been able to attain a level of stability as a result of their large market share and stable structures. You want financially strong companies and the reason is not far-fetched; the goal is to put your money behind the companies that are strong enough to withstand the storm to a good extent.
Another by-product of the Covid-19 induced lockdown is the increased need for internet services. Dr. Ola explains that the use of the internet as well as the move to work-from-home, are some of the megatrends of the times.
Good internet connectivity has proven to be the lifeblood that keeps digital entertainment trends, digital work trends, digital lifestyle trends, digital entertainment trends, and a huge chunk of the communication we have today. As a result of this, companies in the telecommunication industry have begun experiencing growth in revenue and earnings. Investments in this sector will most probably be worth your while.
Distribution & E-commerce
When the Okada ban took place, several motorcycle companies that were affected were forced to pivot from transporting people to moving items as full-scale delivery businesses. While many might have thought that a bad idea, the lockdown has undoubtedly contributed to the development of this industry.
The e-commerce industry is also expected to thrive with trade moving predominantly to the internet. Investments in distribution companies and e-commerce businesses are also expected to be worth your while.
One of the major hits of the pandemic is the Nigerian foreign exchange market which has now become highly volatile. The demand for the dollar far outweighs the available supply and this has forced importers and speculators alike to scramble for what is available in circulation.
Given the challenges with the FX market, international spending on foreign denominated expenses like tuition fees or international loans will come at an increased cost. To mitigate foreign exchange loss challenges, investments in USD denominated equities, and Eurobond funds will help you withstand the storm. While gains here could have you betting against the Naira, having foreign investments in your investment portfolio will come in handy.
The Agricultural industry is an expected gainer. One of the reasons for this is that local supply chains will expand, given the restrictions on the global supply chain as a result of the lockdown and the border closure. While this will also thrive, Dr. Ola Brown, explains that jobs will only be created in the short term.
This is because fewer hands will be required as productivity, better processes, and mechanization systems increase. An example of this is the new trend of robot herders in the United States. This is even more so as we compete with the rest of the world in production. Needless to say, Agriculture will always exist, given the need for food, as well as the rising global population.
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While the Covid-19 pandemic has a direct impact on the healthcare industry, the industry is a complex one. The first reason for this is that, with the healthcare infrastructure deficit in Nigeria, the government will need to invest in it to provide wide access.
With subsidies on healthcare, the free market in terms of investments might not be as lucrative with more people opting for government healthcare. However, given increased investments in the sector and the move to preventive health practices, the industry remains attractive.
For more detailed investment opportunities with specific stocks in the Nigerian Stock Market, sign up for the Nairametrics Stock Select Newsletter.
Analysis: Airtel Nigeria is winning where it matters
Airtel has left no stones unturned in ensuring that its provisions are top-shelf – subscribers to the network, of course will have their own ideas.
Airtel might have won our hearts over with internet-war adverts starring our favourite tribal in-laws, but its fundamentals are what will make us the bucks that keep us happy. Airtel Africa Ltd is a subsidiary of Indian telecoms group, Bharti Airtel Ltd; the group has left no stones unturned in ensuring that its provision of prepaid plans, credit transfers, mobile internet services, messaging, roaming facilities and more, are top-shelf – subscribers to the network, of course, will have their own ideas.
Since last year when Airtel Nigeria became the second telecommunication company in Nigeria listed on the NSE, the company has experienced a steady level of growth. With a presence in 14 African countries, the group’s strength lies in its diversity with stronger companies mitigating the poor performances of others.
Performance Overview: Airtel Africa
Airtel Africa’s report for the year ended March 2020, revenue jumped by 10.9% from $3.1 billion at the year ended 2019 to $3.4 billion in 2020. The consolidated profit before tax also jumped by 71.8% from $348 million in 2019 to $598 million in 2020. However, profit for the period dropped by 4.23% with earnings of $408 million in 2020 from the $426 million it had earned in 2019. A reason for this is the tax figure that moved from a credit of $78 million in 2019 to tax payments as high as $190 million in 2020. Total assets also jumped by 2.41% from 2019’s value of $9.1 billion to $9.3 billion in 2020 primarily as a result of their acquisition of more property, plant, and equipment (PPE). The total customer base grew by 9.3% to 99.7 million for the year ended.
Full Report here.
Revenue growth of 10.9% was driven by double-digit growth in Nigeria and East Africa. However, the rest of its African operations experienced a decline in revenue. Its success in Nigeria is especially commendable, considering the fact that the company lost more than 100,000 subscribers in Nigeria between December 2019 and January 2020. Raghunath Mandava, Chief Executive Officer, remarked that the results which were in line with the group’s expectations, “are clear evidence of the effectiveness of our strategy across Voice, Data and Mobile Money.”
Behind The Numbers – Nigeria
Airtel Nigeria’s performance indicates the company is making the right calls in a very competitive industry. Nigerians are fickle when it comes to data and voice but will spend if the service is right. The company grew its data revenue by a whopping 58% to $435 million a sign that its strategy to focus on data is working. Voice Revenues for the year was up 15% to $850 million. In total, Airtel Nigeria’s revenue was up 24.4% to $1.37 billion. Ebitda margin, a number closely watched by foreign investors 54.2% from 49% a year earlier. Operating profit for the year ended also jumped by 52.6% for the year from 2019 and 32.4% from Q1 2019. Total customer base in Nigeria also grew by 12.5%.
Nigeria is surely critical to Airtel Africa’s future seeing that it contributes about one-third of its revenue. Recent results thus indicate it is winning where it matters most and it must continue to stay this way if it desires to survive a brutal post-COVID-19 2020. Telcos are expected to be among the winners as Nigerians rely more on data to work remotely but there are other players in this game. Concerning the impact of the pandemic, he explained that at the time of the approval of the Group Financial Statements, the group has not experienced any material impact arising from the impact of COVID-19 on its business.
On cash flows…
The group has also taken measures to enhance its liquidity. The CEO explained that it is moving its focus to enhance liquidity towards meeting possible contingencies.
“Having considered business performance, free cash flows, liquidity expectation for the next 12 months together with its other existing drawn and undrawn facilities, the group cancelled the remaining USD 1.2 billion New Airtel Africa Facility. As part of this evaluation, the group has further considered committed facilities of USD 814 million as of date authorisation of financial statements, which should take care of the group’s cash flow requirement under both base and reasonable worst-case scenarios.”
To this end, they have put in the required strategies to preserve its cash as its cash and cash equivalents, consequently, jumped by 19.1%.
Investors looking at this impressive result will be wondering if this portends a buying opportunity. Airtel Nigeria closed at N298 on Friday and has remained at this price for about a month. The stock is quite illiquid and is not readily available to buy.
It’s the price to earnings ratio of 4.56x makes it quite attractive. Further highlighting this opportunity is its price-to-book ratio which is as low as 0.5273, suggesting that the stock could be undervalued. Whether it is available to be bought, is anyone’s guess.