🔥
Deals closing soon!
2 deals closing in  
1d 23h 14m 16s
 left to invest in
Logo of Robert Rodriguez's Brass Knuckle Films
Robert Rodriguez's Brass Knuckle Films
Logo of Pelican Air Services
Pelican Air Services
View closing soon
 
Republic Republic Republic
  • Log in
Oops! We couldn’t find any results...
Can’t find a deal? Try advanced search.
Is something missing? Add your suggestion here.
Primary market Live deals Secondary market Buy and sell Republic Note Own a piece of Republic's upside Investor Network Membership Receive exclusive discounts and benefits
Republic Venture Opportunities for accredited investors
Republic Capital Multi-stage venture firm Republic Digital Crypto hedge fund
Wallet Manage your digital assets Mobile app Available on iOS or Android Learning center Explore investor resources FAQ Get your questions answered
Capital fundraising Raise on Republic Tokenized assets Design, launch, manage tokenized assets Sharedrops Gift equity as a reward
Advisory Access veteran web3 advisors Infrastructure Stake your digital assets Tokenization Deploy your assets on-chain Asset management Explore digital asset funds
Republic Capital In-house Venture Capital fund Broker dealer Regulated capital services
Log in Sign up

Republic Republic Republic
Oops! We couldn’t find any results...
Can’t find a deal? Try advanced search.
Is something missing? Add your suggestion here.
  • US
  • Log in
  • Sign up
All investors
Primary market Live deals Secondary market Buy and sell Republic Note Own a piece of Republic's upside Investor Network Membership Receive exclusive discounts and benefits
Accredited only
Republic Venture Opportunities for accredited investors
Institutional
Republic Capital Multi-stage venture firm Republic Digital Crypto hedge fund
More
Wallet Manage your digital assets Mobile app Available on iOS or Android Learning center Explore investor resources FAQ Get your questions answered
Spotlight deal
Hamilton Lane Private Infrastructure Fund
Hamilton Lane Private Infrastructure Fund
Get unique access to the full spectrum of private markets with Hamilton Lane
Growth capital solutions
Capital fundraising Raise on Republic Tokenized assets Design, launch, manage tokenized assets
Sharedrops Gift equity as a reward
Web3 services
Advisory Access veteran web3 advisors Infrastructure Stake your digital assets Tokenization Deploy your assets on-chain Asset management Explore digital asset funds
Institutional services
Republic Capital In-house Venture Capital fund
Broker dealer Regulated capital services
Journal

Investor education

· August 27, 2018

Making sense of startup funding

  • Liked
    Like
    4

Understanding startup funding is critical for founders and investors alike, but fully grasping all the intricacies of funding rounds can be confusing for the novice investor. How, after multiple rounds of investing, do investors walk away with a profit? How much profit do they make? How is it all divided up?

Below is an overview of startup funding basics.



Most startups raise money in chunks—formally called rounds. When a startup initially kicks off, its founders aren’t approaching random angel investors or VCs. Instead, they’re typically looking closer to home, asking friends and families to open their checkbooks in support of their great business idea.

Right off the bat, founders incorporate their startup as a company. Then, they create shares of their company—stakes in ownership. The number of shares founders create is, for the most part, arbitrary, though they typically choose from 1M, 5M, or 10M shares.

To illustrate this, we’ll create a fictional startup called ChocoRush, an on-demand service that delivers chocolate products to your door in under 30 minutes. It has two founders—Anna and Barry, and they create 10M shares when they found their company. Each take 4M shares, so together, they own 80% of the total authorized shares, or 100% of the company's outstanding shares. They set aside 1MM shares as an options pool for potential employees and leave another 1MM authorized—but not outstanding—shares, possibly to sell their friends and family for seed funding. Options are contracts giving employees the right to buy shares at a predefined price in the future.  

The amount of shares the friends and family receive depends on how much each share is valued. If Anna and Barry raised $1M for their entire personal network and decide to value each share at $1, then the friends and family receive 1MM shares. This means Anna and Barry will own 8MM of 10M outstanding shares, of 80% of the company's voting stock, and their friends and family and potential future employees own the rest.



After Anna and Barry raise some money through friends and family, they’re ready to have a seed round of investment from either angel investors or through equity crowdfunding. At this stage, a beta version of their product or service might be up and running, and it may have even hit the market.  

Angel investors are people who invest their own money into a startup, as opposed to VCs who invest other people’s money. Before the passage of Title III of the Jumpstart Our Business Startups Act, an angel investor had be accredited, meaning they needed to have a net worth of at least $1M or an annual income of at least $200K for the last two consecutive years. With the passage of Regulation CF under the JOBS Act, there’s an exemption that allows anyone, despite their income or net worth, to invest within certain parameters.

Let’s say during a seed round an angel investor comes along and invests $1M. Now, Anna and Barry have to create 1M new shares to sell to the angel investor, so ChocoRush has 11M shares after the angel investor invests $1M.

The founders, their friends and family, and future employees owned 100% of the company together until the angel investor came along. The percentage of the company owned by the above parties will shrink slightly after the angel investor gets her shares. This process is called dilution. With each funding round, ownership by founders, employees, and investors shrinks.

With 11M shares, the founders own roughly 73% of the company, and the angel, friends and family, and future employees now own roughly 9%.

Though the dilution decreases both founders’ and investors’ percentage of ownership during each round, if the company has a large exit this won’t affect the size of their returns. For example, if founders start off owning 80% of a company with a $10M valuation but after multiple funding rounds only own 10% of the company at a $200M valuation, their returns increase from $8M to $20M.


There are three different instruments that are used in an unpriced round for simplicity, timeliness, and cost—the SAFE, the Crowd Safe, and the convertible note.

Safe stands for Simple Agreement for Future Equity. So when you invest in an early-stage startup on a Safe, you aren’t purchasing shares or equity. Instead, you’re purchasing a promise of future equity. It’s similar to the employee options in that Safes are contracts that give an investor rights to shares in the future. Let’s say an angel investor comes along and purchases $1M on a Safe in a seed round. Those shares do not convert to equity until the next fundraising round.

Investments on Republic are made through the Crowd Safe, which is similar to the Safe, except shares do not have to turn into equity until there is a trigger event—either an acquisition, a change of control or an IPO. The Crowd Safe shares convert into common stock at a trigger event.

Convertible notes are are a type of debt instrument that convert into equity. This means that convertible notes accrue interest and have a maturity date, which comes with much more tax-related paperwork. They are typically used in the early-funding stage, before priced or series rounds, but because of their complexities, more and more founders are raising money on Safes, even in the seed stage.

An investor’s convertible note converts into equity at a discount or with a valuation cap (which we’ll explain in further detail below),  in the rounds following their investment, similar to the safe.


There are two types of shares someone can purchase when investing—preferred shares and common shares. Preferred shares can come with many different rights, such as voting rights and liquidity preferences. Voting rights allow investors to have a say in the company’s business decisions, and liquidity preferences allow investors to receive returns before those with common stock.

Those with common stock don’t have liquidity preferences or voting rights—service providers and employees in an option pool typically have common stock.


After the initial seed rounds of funding, startups begin to go through further rounds, and these are typically priced rounds, meaning investors are purchasing equity in the company by purchasing either preferred or common stock. They start with a Series A round, then move onto B, C, D, and so forth. Once a startup enters formal raising rounds, many different types of entities will often invest, from VCs to corporations, and sometimes even nonprofits and universities.

During priced rounds, founders and investors agree on a company’s valuation. Let’s say a VC firm invests $5M into ChocoRush. They agree with investors that the pre-money valuation of the company is $15M. The pre-money valuation of the company would be $15M, and the post-money valuation would be $20M.

Again, the founders have to continue to create new shares, which dilutes their percentage of ownership in the company.


When following funding rounds, one thing you may spot is reference to pre-money and post-money valuations. A pre-money valuation is the valuation determined prior to the amount raised. This is not the same thing as the valuation that follows funding of a previous round.

For example, if ChocoRush raised $2M in a Series A round at a pre-money valuation of $8M, the post-money valuation would be $10M. In the Series B round, the pre-money valuation will not necessary be $10M. Instead, investors and founders will agree on a new valuation. For example, they may agree to a $15M pre-money valuation in Series B. If Anna and Barry raise  $5M in this round, the post-money valuation will be $20M.


Valuation caps are put on investment rounds to protect the investors in the case of a negative scenario, like a startup folding or getting acquired for a low valuation. In the case of ChocoRush, the valuation cap of $20MM could be placed on the Series A round. This means that if the subsequent rounds of funding has a post-money valuation of $30MM (which is greater than 20MM, the shares or equity from the previous round convert at the $20MM valuation, not the $30M valuation, leaving investors with a greater percentage of the company.

A discount means that when shares are converted in the next round the investor receives shares for a lower price than the investors in that round. If each share in the Series A round costs $1 and an investor invests $1M, in the next round those shares will convert at $.80 each. So the 1M shares becomes 1,200,000M shares.

In subsequent rounds of funding, investors’ shares convert at either the valuation cap or the discount, depending on what conversion is most valuable to the investor.

Exits are the whole reason people invest in startups. An exit is also called a trigger event, and it comes as either an acquisition or an IPO.  When an exit occurs, investors are hoping their investment yields a very high return. If an investor put money into a unicorn — a startup that exists at $1B or higher — during its early stage, they'd receive a very high return. Still, some exits take the form of a liquidation or a dissolution—it's important to remember that startup investing is risky.

There’s even more lingo and complexity that we can dive into when discussing startup funding. This is just a primer on the basics. The most important thing to remember is that everyone wants to keep their cut of the pie as large as possible, and discounts, valuation caps, and purchasing preferred stock are some means that investors can do this. Most importantly, everyone wants a large exit.


This educational article is provided by Republic to help its users understand this area of the market, it should not be construed as investment advice as it is impersonal, disinterested and was produced by Republic for Republic’s users, without remuneration received or expected. 

Share this story

Read next

The #1 Place Where Private Wealth Allocations are Moving

Investor education

The #1 Place Where Private Wealth Allocations are Moving

76% of private wealth professionals and advisors say their clients view private markets as returning higher rewards than stocks and bonds.1  A new survey finds that one investment category sits at the top of private wealth managers’ plans for new all...

Timeworx.io: Transforming AI Development Through Decentralized Data Labeling

Crypto

Timeworx.io: Transforming AI Development Through Decentralized Data Labeling

-

Republic Joins Injective as a Validator

Crypto

Republic Joins Injective as a Validator

Powering Institutional-Grade DeFi and Tokenization

Get notified about new posts

Not a valid email address
Republic

Giving everyone access to early-stage startup investing

For investors
  • Why invest
  • How it works
  • FAQ
  • Risks
  • Privacy policy
  • Accessibility
  • Cookie Preferences
  • Form CRS
For startups
  • Why raise
  • Learn
  • FAQ
  • Instruments
  • Crowd SAFE
  • Tokenized assets
Company
  • About
  • Journal
  • Events
  • Contact
  • We're hiring!
Dollar Refer a startup, get $2,500
Dollar Refer a startup, get $2,500

Invest in the app

Android app iOS app

Invest in the app

Android app iOS app

This site (the "Site") is owned and maintained by OpenDeal Inc., which is not a registered broker-dealer. OpenDeal Inc. does not give investment advice, endorsement, analysis or recommendations with respect to any securities. All securities listed here are being offered by, and all information included on this Site is the responsibility of, the applicable issuer of such securities. The intermediary facilitating the offering will be identified in such offering’s documentation.

All related securities activity is conducted by OpenDeal Broker LLC a registered broker-dealer, Member of FINRA and SiPC, an affiliate of OpenDeal Inc. and OpenDeal Portal LLC, located at 149 5th Avenue, 10th Floor, New York, NY 10010. Please check our background on FINRA’s BrokerCheck.

Certain pages discussing the mechanics and providing educational materials regarding regulation crowdfunding offerings may refer to OpenDeal Broker LLC and OpenDeal Portal LLC collectively as “Republic”, solely for explanatory purposes.

Neither OpenDeal Inc., OpenDeal Portal LLC nor OpenDeal Broker LLC make investment recommendations and no communication, through this Site, or in any other medium, should be construed as a recommendation for any security offered on or off this investment platform. Investment opportunities posted on this Site are private placements of securities that are not publicly traded, involve a high degree of risk, may lose value including the total loss of invested capital, are subject to holding period requirements and are intended for investors who do not need a liquid investment. Past performance is not indicative of future results. Investors must be able to afford the loss of their entire investment. Only qualified investors, who understand the risks of early-stage investment and who meet the Republic's investment criteria may invest. Investors may be restricted to only Accredited Investors or non-U.S. persons, to invest in offerings hosted by OpenDeal Broker. Neither OpenDeal Inc., OpenDeal Portal LLC nor OpenDeal Broker LLC, nor any of their officers, directors, agents and employees make any warranty, express or implied, of any kind whatsoever related to the adequacy, accuracy or completeness of any information on this Site or the use of information on this site. Offers to sell securities can only be made through official offering documents that contain important information about the investment and the issuers, including risks. Investors should carefully read the offering documents. Investors should conduct their own due diligence and are encouraged to consult with their tax, legal and financial advisors.

By accessing the Site and any pages thereof, you agree to be bound by the Terms of Use and Privacy Policy. Please also see OpenDeal Broker’s Business Continuity Plan and Additional Risk Disclosures. All issuers offering securities under regulation crowdfunding as hosted by OpenDeal Portal LLC are listed on the All Companies Page. The inclusion or exclusion of an issuer on the Platform Page and/or Republic’s Homepage, which includes offerings conducted under regulation crowdfunding as well as other exemptions from registration, is not based upon any endorsement or recommendation by OpenDeal Inc, OpenDeal Portal LLC, or OpenDeal Broker LLC, nor any of their affiliates, officers, directors, agents, and employees. Rather, issuers of securities may, in their sole discretion, opt-out of being listed on the Platform Page and Homepage.

Investors should verify any issuer information they consider important before making an investment.

Investments in private companies are particularly risky and may result in total loss of invested capital. Past performance of a security or a company does not guarantee future results or returns. Only investors who understand the risks of early stage investment and who meet the Republic's investment criteria may invest.

Neither OpenDeal Inc., OpenDeal Portal LLC nor OpenDeal Broker LLC verify information provided by companies on this Site and makes no assurance as to the completeness or accuracy of any such information. Additional information about companies fundraising on the Site can be found by searching the EDGAR database, or the offering documentation located on the Site when the offering does not require an EDGAR filing.

To help the government fight the funding of terrorism and money laundering activities, Federal law requires all financial institutions to obtain, verify, and record information that identifies each person who opens an account. Therefore, when you use the Services we will ask for your name, address, date of birth, and other information that will allow us to identify you. We may also ask to see your driver's license, passport or other identifying documents.

Republic and its affiliates are not and do not operate or act as a bank. Certain banking services are provided by BankProv, member FDIC / member DIF. FDIC coverage only applies in the event of bank failure. Digital (crypto) assets and investment products are not insured by the FDIC, may lose value, and are not deposits or other obligations of BankProv and are not guaranteed by BankProv. Terms and conditions apply.

Invest in startups using your credit card
You can invest using your credit card

Made in SF/NYC