This story will help you understand the different aspects of StartUp development, funding and growth.
But first, is there such thing as an African Dream? This fictitious story of how [insert your name here] made it in Africa, could become a reality.
It often starts with a problem, leads to a potential solution and culminates in a vision, a startup that solves the issue once and for all.
Africa is full of needs and who is better placed to solve them than a young African like yourself?
In a smoke veiled moment of enlightening, you find the one you’re able to solve, you have your product idea clearly and carefully laid out in your mind, it’s something you’ve been talking about with your best friend and potential business partner for a long time. To convince her to join the venture you say:
It seems this problem was made to get us rich by solving it!
The time is right for financial, insurance and health-tech in Africa, the middle class is growing, and in your city, the young workforce is totally open to innovative solutions.
You are excited and ready to put all your energy and time into it, so you decide to make the jump.
Here comes the entrepreneur, the CEO…
…and as “cliché” as it may sound, you are convinced that you will leave your mark on this planet.
You come up with a name, a mission statement, you tap into your network to find a designer for a slick logo and you acquire that unique domain. Dot com, dot net, dot Africa, you just take them all.
Things start to get serious, and you call it a startup.
You decide to incorporate, you register an LLC, costs can be higher or lower depending on the country you establishing your Startup.
You need servers, a frontend developer, a workplace… but you’re smart enough to go into an incubator space. Soon the expenses start to pile and surpass your expectations.
After using up your savings… you sell your PlayStation, your collection of games, even your car. But who cares, you really believe in your concept and you’re willing to make sacrifices in order to succeed.
After all, it is a great product idea, those local pitching sessions and hackathons prove to be very helpful in defining your scope and focus. That is when you realize it is time to raise money and venture further into the startup world…
But who on earth will give you money at such an early stage?
I mean… your product isn’t market-ready yet.
Most probably you’ll get it from friends, family or crowdsourcing.
As things start to take shape, your co-founder and yourself need liquidity… cash… hela…
Luckily your grandfather has it and is willing to invest. He gives you 20,000 dollars for a percentage of your business, no strings attached…
You realize at this point, your co-founder and yourself have never talked about business ownership.
Things are getting a little messy here. Who owns what and who owes who?
Here’s the plan:
To regulate things you go the usual route. You divide your company into 100,000 equal chunks or pieces of ownership.
In industry terms: You issue 100,000 Shares.
You decide “who” will get “how many” of those shares.
After agreeing to disagree and finally finding a middle ground that ends the argument, your co-founder and yourself decide to take 40,000 shares each and leave the remaining 20,000 for that wealthy grandpa of yours who buys them for $20,000. That’s 40% of the business for yourself, another 40% for Miss Co-Founder and 20% available for the first investment round which is called a Seed Investment.
The money you raised by selling those shares now belongs to your company.
So what if your company fails?
Well, Grandpa Wealthy will never see his money again.
It’s a risky thing to do… But your grandfather always liked you, he sees it as an advance on your future heritage.
Let’s stop here for a minute, it’s a pretty big deal, you just sold 20% of your business for 20,000 dollars. That means your 40% stake is worth 40k. and it puts the value of your business at 100,000 dollars.
In industry terms:
It’s a $100,000 valuation.
Your grandpa’s retired lawyer friend says: “Sign here, here and here…” and a handshake later, the check is yours to cash…
Voila!!! You just finished your first round of investment…
Now you’re ready to launch that M.V.P. .
What is an MVP you ask?
A Minimum Viable Product is an early version of your core product with just the right amount of features to test with customers in a so-called beta phase. It is just good enough to get valuable user feedback, gain traction and attention but stripped down to a minimum so that you can launch quickly and cost-effectively.
After all, you gotta be strategic about those 20,000 dollars.
A year later things are working quite well… early adopters are really happy with your product, so happy that they recommend it to others… Growth is steady and organic, so your co-founder and yourself decide to quit your day jobs.
Now you need a serious office space, you’re ready to move your infrastructure to the cloud and hire some full-time workforce.
The 20,000 dollars are long gone and you’re bootstrapping and hustling your way to the next stage.
The so-called Series A.
This is your first serious round of cash, and for that, you need to reach out to Venture Capitalists and Angel Investors…
The goal? Raising 1 million dollars from VC’s and Angels in the next 3 months, or probably close down shop.
VC’s are people who manage so-called “venture capital funds”, they take other people’s money, invest it into risky startups like yours and try to make a profit at a later stage.
Angel Investors are professional “wealthy grandpas” who probably made a stack of cash by selling their own startup and are now feeling adventurous and willing to invest in others in memory of those hustling times.
It’s tough… that VC who gave you his business card a few months ago never replies to your emails… The Angels you’re interested in working with don’t seem to be the right fit after all… But after some network juggling and contact fishing, you have some serious meetings.
Soon you realize, these investors are more interested in your team, your charisma and dedication as a future CEO, you’re Co-Founders operational skills and the company culture you created with her. That’s actually a good thing.
So you pivot some aspects of the product, rewrite the business plan a little, shift some resources and after some back and forth, it’s time to talk valuation.
Pre-money valuation, post-money valuation… What does all this jargon mean?
Your friend, the rich serial founder that has been giving you advice tells you in front of a beer:
Pre-money valuation is how much you currently value your company. Post Money Valuation equals to Pre Money Valuation plus the money you are trying to raise.
Post Money is the term and value you should be throwing around at this point because the investment you’re trying to raise divided by the Post Money valuation equals to the investor’s share.
But careful here.
Investors want a low post-money valuation so that they can get more shares for their money.
And you should be looking for a high post-money valuation to maintain a larger share of your Startup.
So you boldly say:
6 million post-money.
The Kenyan investor quickly calculates how much equity he would get for that amount, gives you a defying look, and says:
That’s not enough bang for the buck, or like they say in Kenya, bang for the bob.
They make a first counter offer and the negotiation round starts, everybody puts his offer on the table.
The one you end up going for:
1 million dollars for a 5 million dollars post-money valuation.
In other words: You get 1 million dollars for 25% of your company.
Some offers were higher in valuation, some VC’s offered more cash, however this Angel is a Startup Super Star… A tech-guru who understands the African Corporate landscape better than no other, and being smart, you go for it.
Mr. Tech-Guru Angel adds value to the deal, this is called Smart Money.
So now… What about the shares?
It’s time to split the cake again since the investor is a new partial owner of your business. In the middle of the negotiations, somebody throws out another fancy word: Dilution.
So what is Dilution?
We will get into that, but first let’s look at the 100,000 shares of which 40,000 are yours, will you have to give some away?
Since the new investor will get shares too, those shares have to come from somewhere, right?
Well… Your company can simply issue new shares.
You create them out of thin air but in proportion to the amount of money you are raising.
In this case, instead of redistributing the 100,000 existing once, you add another 25% to the pile. That’s 25,000 new shares that will go to the Angel investor.
Your Startup now has a total of 125,000 shares. 5 million dollars divided by 125,000 means every single share of your company is worth 40 dollars. Your grandpa keeps his 20,000, your co-founder has 40,000…
And you? Your 40,000 are now worth 1.6 million dollars.
But back to the dilution…
Since now the total pile of shares has increased but the number of shares you own stayed the same, your percentage of ownership of the startup is lower…
40,000 of 125000 is 32% instead of the 40% you owned after the Seed Investment. That’s what you call dilution.
You now have enough cash to grow into a real company, two years later your product is mature and selling well… The company is still growing steadily.
Now you are thinking of going into a series B, in order to expand into new African markets. Your proprietary software solution combines insurance, fin- and health-tech innovatively and turns out to be the ultimate provider in sub-Saharan Africa.
It was a smart move when you decided to never disclose your numbers publicly, speculations create a hype. Now the media and experts are talking about the “African Unicorn” worth 150 million dollars. And that’s pre-money…
In this fundraising round, you replicate the cycle of the series A, add whatever you learned about negotiation into the game, and boom! You raise another 300 million to cover the whole of sub-Saharan Africa.
The rest is history… math… or whatever…
Can you guess the post-money valuation after this round?
At this point, looking at the speed at which your company is growing now…
We can confidently say well done [insert your name here] !!
You created yourself a billion dollar company.