Finance for Start-Ups 101 (Part 1)

One thing that a lot of start-ups and entrepreneurs often lack in understanding are things related to the financial realm. Company capitalization, equity compensation, valuation and fundraising sounds like a lot of very technical terms with complicated definitions.  It is true that these terms are not exactly the most straightforward concepts, but a high level understanding of some basic financial concepts empower start-up founders to be in a better position during negotiations and key business decision making points.

Equity

Equity represents the ownership interest in the company.  The boundaries are set by 0% on the bottom and 100% on the top end with the specific percentage someone holds representing the ownership interest in the  company.  For start-up, equity is often provided in return for labor and work (sweat equity) or capital (cash) contributions.  Founders should typically retain a large portion in order to retain control of the company during the growing phase and ensure that future dilution doesn’t result in loss of this control.  We will talk about dilution as well.

Debt

There are some start-ups that will borrow money in order to start a business, but is a rare form of capital for early stage businesses as there is no business model to be analyzed as a credit risk.  Without cash flow and or clear projections on revenues, lending institutions will most likely be hesitant in lending funds.  Money that is borrowed is not given ownership in exchange, which is one of the benefits of debt.  Borrowed money must be repaid, while equity takes full risk and has no promise of any sort of return.

Capitalization

Capitalization represents how the company is funded in terms of equity and debt.  A company’s capitalization = equity $$ + debt $$. Most start-ups’ capitalization will be 100% equity funded and make this equation much easier to comprehend.

 

 

email
Loading Facebook Comments ...
Loading Disqus Comments ...

One Response to “Finance for Start-Ups 101 (Part 1)” Subscribe

  1. Washington 07/04/2012 at 2:42 pm #

    Hi Kimberly. That’s a good question. The padrgiam under which Kickstarter and others operate is one of donations, sometimes in return for services or perks of some kind. Kickstarter is actually limited to creative “projects” only and they state that it is “not about investment or lending.” While there are target amounts and deadlines, best practices in raising funds for a project in this way seems to be to not shoot too high in your target amount because if you don’t reach your target, no money changes hands. With Indiegogo, the money changes hands regardless of amount, but the fee is higher if the target is not reached and people are encouraged to run multiple, smaller campaigns. The bill before the Senate does not specifically address the issue of over funding, however it does require “a description of the stated purpose and intended use of the proceeds sought,” and “a target offering amount, the deadline to reach the target offering amount, and regular updates regarding the progress …” This will probably be addressed in the rules that will be promulgated after the bill is signed into law, but bearing in mind that this will concern offerings for the sale of securities, in some specific amount, for a specific intended purpose, and with a finite deadline, once the target is met and all the securities offered have been sold, that will be the end of that particular offering; there will not be any more shares for sale and thus no over-funding. There may ultimately be a provision for the release of funds to the issuer once a certain percentage of the target amount is reached, as provided for in the House bill. In a case like that, presumably the offering would remain open after funds were released until the stated deadline has been reached or it was fully funded.

Leave a Reply