Let's imagine you have an amazing business idea of producing high-quality food products. You have found a source to procure ingredients to make it and have a few reliable people who will help you run the business. You are passionate about this idea and are eagerly looking forward to launching the business.
But you suddenly realize that you do not know how you will fund this business idea. You have no business background and there are chances that not many will take your idea seriously.
The Angel Investors
At the initial stage, your best source for funding is your family, friends and your own little savings. These are known as 'Angel Investors', as they have decided to blindly invest in your idea.
Since you are also investing your money and you are the founder of the company, you will be called the 'promoter' where as your friends will be 'angel investors'.
Initial Share Capital
Let us assume that you and the angel investors have managed to accumulate Rs 2 Crores in the business. You will now get your business registered with that money also known as the "seed fund" and this amount will rest in your company's account and not your personal account. Let's call this fictional company as ABC Foods, and assume the following contribution:
- Rs 1 Crore (50%): Promoter
- Rs 25 lakhs (12.5%): Angel Investor 1
- Rs 75 lakhs (37.5%): Angel Investor 2
The money that now belongs to your company is its initial share capital and at this stage, it is all in the form of cash. This is also your company's valuation at that stage.
Issue of Shares
On registration, you can decide any amount to be the face value of shares. Suppose you decided Rs 10 to be your face value, a total of 50 lakh shares will be your authorized shares. The authorized share capital is the maximum amount a company can raise from selling its shares.
Usually, the company does not issue shares to the full amount of authorized capital. It will keep some reserved under the company's name for future use.
Now let us assume you decided to keep 40% of the shares as the promoter and give 5% and 15% to your investors. So now the allotted shares are:
- 8 lakh shares (40%): Promoter
- 1 lakh shares (5%): Angel 1
- 3 lakh shares (15%): Angel 2
The remaining 40% are not allotted but reserved by the company for now.
Expansion of Business
Now that you have money, you open one retail outlet of 'ABC Foods' with one manufacturing unit and work really hard to make it a successful business in the next 2 years.
You start making substantial profits and are more confident about its future prospects.
At this stage, you decide to start few more retail outlets in your city with an additional manufacturing unit and some employees to support it. You set up a plan and make an estimate of 5 crores to make it possible.
With a plan, you can now look for people who are looking to invest in a growing business like yours and say you find such a person who is willing to invest Rs 5 crores for a 10% stake in your business.
This kind of investor is typically known as a Venture capitalist as he/she invests at an early stage where you have just started making reasonable profits from your business and this is known as Series A Funding.
Increase in Company Valuation
Now that the company has agreed to give the Venture Capitalist 10% of the stake, it changes its valuation. If Rs 5 crores is 10%, that means that the VC has valued your company for Rs 50 Crores (5 crore x 10/100).
This will significantly increase the value of the shares you and your angel investors hold.
No. of Shares
Valuation of Shares
|Promoter (you)||8 lakhs||40%||80 lakhs|
|Angel Investor 1||1 lakh||5%||10 lakhs|
|Angel Investor 2||3 lakhs||15%||30 lakhs|
Valuation after 2 years
Your company's worth in this scenario is worth more than 20 times in 2 years, thanks to Series A funding.
No. of Shares
Valuation of Shares
Increase in wealth
|Promoter (you)||8 lakhs||40%||20 crores||19.92 Crores|
|Angel Investor 1||1 lakh||5%||2.5 crores||2.49 Crores|
|Angel Investor 2||3 lakhs||15%||7.5 crores||7.47 Crores|
|Venture Capitalist||5 lakhs||10%||5 crores||-|
The increased valuation is also a sign that the venture capitalist believes in your business and expects ABC Foods to grow.
With the funding, you can now purchase additional manufacturing units and retail outlets to expand the business. Your business will start growing and gain popularity with improved market presence.
You can also hire professionals to deal with new marketing or other business related problems come with an increased customer base and new markets. You need a better management team as you can increase your profits mainly through operational efficiency.
Series B Funding
As your business grows and you plan on entering new territories with new products, you will need additional capital that you can choose to raise from another Venture Capitalist and this shall be your 'Series B' Funding.