Mio, a startup, helps enterprise teams collaborate across messaging services like Zoom Chat, Microsoft Teams, Slack, and Cisco’s Webex. On December 9, 2021, Mio announced that it has raised an \$8.7 million Series A funding, led by Zoom and Cisco Investments. In total, Austin-based Mio has now raised $17 million. Other investors include Goldcrest Capital, Eniac Ventures, Two Sigma Ventures, Khosla Ventures, Y Combinator, and Capital Factory1. At this point, you might be wondering what’s Series A funding. Let me decode it for you with the help of a hypothetical startup.
Meet Rohan Agarwal, a budding entrepreneur from India with a brilliant business idea – to manufacture highly fashionable, organic cotton t-shirts. The designs are stylish. Pricing is attractive. Cotton to be used will be of premium quality. He is pumped with confidence that the business will be up-and-running, and is all avid to turn the idea into a profitable business. Like every typical entrepreneur, he encounters the problem of funding – where would he get the funding from? Though he hails from a rich family, he has no business experience. He finds it hard to appeal to any thoughtful investor at the early stage. He approaches his family and friends to pitch the idea for funding. It clicks, he pools in his own money, thanks to his father and close relatives, worth INR 45 million, and also gets two of his good friends convinced to put in INR 2.5 million each in his business. Finally, his dream comes true and he floats the company named Trendy Textile Private Limited and gets it registered with an authorized capital of INR 100 million having 10 million shares of INR 10 each. As his two friends are investing at the pre-revenue stage and taking a chance on a novice entrepreneur, they are called Angel investors. The point to note here is that the money from the angels is not treated as a loan, rather treated as an equity investment.
Rohan, the promoter, along with the angels raise INR 50 million in the capital. This initial money that he gets to kick start his business is called the ‘Seed Fund’. It is important to note that the seed fund does not hit the promoter’s bank account instead hits the company’s bank account. Once the seed capital hits the company’s bank account, the money will be referred to as the initial share capital of the company. In return for the initial seed investment, the original three investors i.e., the promoter and two angels, will be issued share certificates of the company which furnish them with ownership in the company. The only asset that the company has at this stage is a bank balance of INR 50 million. Hence, the company’s value is also INR 50 million. Out of the total of 10 million authorized shares, Rohan gets 4.5 million shares and the two angels get 0.25 million shares each and the balance of 5 million shares remains unissued. The initial shareholding pattern is as follows:
|Shareholders||No. of Shares held||Holding %|
Now backed by a good company structure and a healthy seed fund, Rohan kickstarts his business operations. He moves cautiously and decides to open just one small manufacturing unit and one store for retailing his product. His hard work pays off, and the business begins to pick up. At the end of the first two years of operations, the company is on the verge of breaking even. Rohan is now no longer a novice business owner; instead, he is more knowledgeable about his own business and more confident. Afloat with confidence, Rohan now aims to expand his business by adding one more manufacturing unit and a few additional retail stores in the city. He chalks out the plan and figures out that the new investment needed for expansion is INR 75 million. He is now in a better situation compared to what he was two years ago in terms of attracting investors to his business. The big difference is the fact that his company is generating revenues. A healthy inflow of revenues validates the efficacy of the business model and offerings. He is now in a situation where he can attract reasonably savvy investors into his business. He meets one such professional investor who agrees to invest INR 75 million against 0.75 million shares. The investor who typically invests in such an early stage of business is called a Venture Capitalist (VC), and the money that the business gets at this stage is called Series A funding. The shareholding pattern after Series A funding is as follows:
|Shareholders||No. of Shares held||Holding %|
With the VC’s money coming into the business, an exciting development has taken place. See how it works as a perfect recipe for wealth creation for the initial investors. However, wealth creation happens at the cost of dilution in the ownership of the initial investors. For example, the promoter’s initial holding was 90% but is now reduced to 78.26% after the Series A funding.
|Shareholders||Initial Shareholding||Initial Valuation||Shareholding after 2 years||Valuation after 2 years||Wealth Created|
|Promoter||90%||INR 45 million||78.26%||INR 450 million||10 times|
|Angel 1||5%||INR 2.5 million||4.35%||INR 25 million||10 times|
|Angel 2||5%||INR 2.5 million||4.35%||INR 25 million||10 times|
|Venture Capitalist (VC)||0%||0||13.04%||INR 75 million||NA|
|Total||100%||INR 50 million||100%||INR 575 million|
Now that we have understood the meaning of Series A funding let’s have a quick look at the pros and cons of Series A funding.
- Recall, Series A funding can be a perfect recipe for wealth creation for the initial investors. Moreover, Series A funding is an equity contribution that can be used to grow a company, and the company is under no obligation to pay it back to the VCs.
- When a company receives Series A funding, its business will likely benefit from the professional connections of the VCs. And, the right connections paired with an influx of money can just be the perfect combination that a startup might need to scale up.
- When a VC agrees to invest in a business with Series A funding, it implies that the VC sees high growth potential in the company. Thus, Series A funding can do a world of good to the confidence of the promoter of a startup.
- When a company accepts Series A funding, it gives the VC a stake in the company. Recall, this leads to dilution in the ownership of the initial investors, including the promoter.
- While Series A funding can help a startup scale up, premature scaling up can be disastrous if the revenue fails to catch up commensurately. This is one of the main reasons most startups get nipped in the bud.