March 22, 2023 • 33 mins
How do tech entrepreneurs go from having an idea to turning it into a successful business? We look at the process of funding a tech startup and what might convince someone to invest in a long shot.
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Speaker 1 (00:04):
Welcome to Tech Stuff, a production from iHeartRadio. Hey there,
and welcome to tech Stuff. I'm your host, Jonathan Strickland.
I'm an executive producer with iHeartRadio. And how the tech
are yet? You know, there's been an awful lot of
talk about tech and money recently, whether we're talking about
(00:26):
cryptocurrencies or the collapse of Silicon Valley Bank a SVB.
Plus there's been talk about how the startup trend is
kind of in a bit of a slowdown right now
due to investors being a bit more cautious in order
to protect their money in a time of economic uncertainty. Plus,
you've got high interest rates on loans, which contribute to
(00:50):
a desire to wait for things to improve before investment
money starts flowing like wine once again. So I thought
I would actually do a Tech Stuff Tidbits episode about
the different types of funding in startups in general. But
we are of course interested in tech startups because honestly,
(01:13):
I find the stuff confusing at times, like how does
an idea for a business end up getting the support
it needs to actually become a thing? And I figure
we can take this episode by talking about the various
stages of funding that a startup will typically seek and
(01:33):
what each of these stages means. So let's say you've
got an idea for a new tech business. Maybe you
plan to make an app that detects which spots in
town are just on the verge of becoming trendy, so
that your users can jump in and be super cool
by going all Instagram on these spots before they blow
(01:56):
up as trendy spots. So you could be a tastemaker.
You know, you're really stylish, You're ahead of the curve,
and it's all because you have the spidy Sense app
that tells you win some place or object or thing
or fashion or whatever is about to really take off.
It's an idea, so dumb it can't fail anyway. You
(02:17):
got this idea, But how do you actually turn this
idea into a business. Well, you're gonna need some starting capital.
Maybe you are limiting costs by doing the classic Silicon
Valley story of launching out of a garage. Your initial
offering might be built on top of your own computers. Well,
(02:38):
that's not going to work for very long, because assuming
your idea actually does catch on, you're gonna need way
more computer power and storage in order to scale your business. So,
assuming you're not independently wealthy and willing to pour your
own money into this venture, what do you do? Well,
one thing you could do is apply at an incubator. So,
(03:03):
an incubator is an organization designed to provide resources to
fledgling startup businesses. There are different types of incubators out there.
Some require a little more established business than others. Some incubators,
if you come in with a great pitch, will bring
you in even if all you have is an idea.
(03:24):
Not many, but some will. And so you come in
with this idea and you pitch it to the incubator,
you go through the application process and they say, excellent,
you can be one of the businesses that we incubate.
So assuming that you do that, then you can get
access to resources that can include stuff from office space
(03:45):
to mentorship and classes, to networking as a building, connections
with potential partners and investors and team members, that kind
of networking. Usually the incubator takes some equity in your
business as a result, so they have some ownership of
your business, and the incubator often has input to some degree,
(04:08):
sometimes a lot of input on the evolution of your
business because the incubator is giving you access to these
resources and in return, you are expected to make something
out of your idea. But the only way you can
do that is if you put the work in. So
incubators are great resources for some types of startups because
(04:30):
you can easily have a situation where you have folks
who are really good at coming up with ideas right,
or maybe they're really good at coding, like they're good
at the building part, but maybe they have little to
know business experience or expertise. They don't know how to
start a business. They don't know how to run a
business and keep it successful. They don't know what it
(04:50):
takes in order to keep the lights on well. At
an incubator, startups can learn the ins and outs of
business itself. They can the foundation for what will be
a company further down the line, So startups can start
to learn how to do things like draft business plans
and to form a team, both a team of people
(05:14):
who are making the thing that you're offering and the
team that oversees that. They can start to make out
a hierarchy plan for their organization. All this kind of
stuff that is required for a business to have the
best chance to succeed. Now, it's not that every startup
has gone through this. There are some that have gone
(05:35):
through a very haphazard approach and through all logic should
have failed, but somehow didn't. But generally speaking, these are
the sort of things you need to do if you
want to have a good chance of being around for
more than a couple of years. There are a few
different kinds of incubators. As I mentioned, a lot of
(05:56):
colleges have incubator organizations, so you might have student and
or faculty taking on a really big part of running
those operations. There are also corporate incubators. Google had one
called Area one twenty, so once upon a time you
probably have heard this. At some point, Google had this
policy in place where employees were allowed to dedicate up
(06:19):
to twenty percent of their work week to their own projects,
with the one qualifier being that the projects should ideally
be something that could potentially benefit Google if it pans
out well. Area one twenty served as an incubator for
projects that had a lot of promise and gave employees
(06:39):
the resources they would need to further develop their ideas
and potentially see the mature into a business of their own,
so it wouldn't just become a Google product, it could
potentially become a Google spinoff. Google, by the way, abandon
the twenty percent time project back in twenty thirteen, so
that is not a standing at Google anymore. They still
(07:01):
do incubate businesses, but it's a slightly different approach now.
Now similar to an incubator is an accelerator. So incubators
help startups at the earliest stages of development, perhaps before
there's even a business idea that has formed around a
(07:23):
product or service idea, right, so it may be at
the earliest stages of germination for a business, whereas an
accelerator typically is for a startup that already has established
the business part, at least the rudimentary elements of a
business part. And so an accelerator takes a startup business and,
(07:44):
as the name suggests, accelerates it on its way to
scale up to becoming a larger business that it will
need to be in order to be a success. Incubator,
on the flip side, is a place to help develop
and earth of business, but both incubators and accelerators helped
startup companies find funding, and this kind of brings us
(08:08):
to the first real round of getting capital for your business,
which is called seed capital or seed funding. And this
could happen before you get into an incubator, probably before
you get into an accelerator, or it could be part
of that process. Part of what the incubator is trying
to help you do is to secure seed funding. This
(08:31):
is the initial round of funding the startup needs in
order to become a thing. It's what pays the bills
and helps the startup establish the basics and start to
do things like registered trademarks, you know, have an office space,
make payroll for the initial group of employees while they
(08:54):
further develop their idea. But it's the earliest, earliest stages.
You're not necessarily doing business yet. You may not even
be a publicly known entity yet. You might still be
kind of a developing, in secret kind of company. Often
seed funding comes from people who are close to the
folks who are behind the startup, So this could include
friends and family, former or current employers, that kind of thing.
(09:17):
And in return for providing some of the seed capital
for the business, the investor receives some equity or percentage
of ownership of that business. So if the business succeeds,
there will be an eventual payout, But it's entirely possible
that seed capital investors are supporting a startup not because
they're hoping to get a big payoff down the line,
(09:38):
but rather they believe in the people behind the project
and they want to support them. So it's important because
a lot of these startups they fail. More than half
the vast majority of startups do not succeed. So often
we're talking about people who are taking on a financial
risk because they believe in the people behind it or
(09:59):
they want to s support them. Also, we're typically talking
about pretty modest amounts of money in the long term,
Like later on, when we're talking about Series ABC funding,
you're talking about the tens of millions of dollars or more.
Now we're talking about, you know, maybe hundreds of thousands
of dollars, which is still a lot of money, but
(10:20):
in the grand scheme of things, is much much smaller. Now.
Seat capital provides funding that otherwise would be off limits
to a startup. I've talked about in episodes that I
mentioned with Silicon Valley Bank that it's really hard for
startup businesses to secure like a business loan because they
might not have anything they can put up as collateral.
They might not have any track record they can point
(10:42):
to as showing their ability to make a successful business.
The business itself might not really exist yet. There might
not be an easy way to explain where revenue is
going to come from. They may not be able to
generate any revenue for a while, So the loan can
be seen as being too risky, and seed capital can
end up taking over that spot, because I mean, where
(11:05):
else are you going to get the money to get started?
And really it's usually just enough to establish the earliest
days of the business so that the founders can actually
seek additional investment. So you can almost think of it
as the money that a business needs in order to
get seen by the next level of investors. And we'll
talk about them after we come back from this quick break,
(11:36):
all right, Before I move on to venture capital funds,
because that's ultimately where we're headed for this next bit
of the discussion. There is one kind of special early
investor that I could mention at this stage. Investors who
typically can step in at the seed funding phase or
perhaps the next one, and that is the angel investor.
(11:58):
So an angel investor is usually a high net worth
individual h and WI. It's someone who has a lot
of liquid assets at their disposal. That's a way of saying,
if someone's got a whole lot of cash they can
throw around, or at least it's someone who could very
quickly get hold of a mountain of cash that they
could throw around. Angel investors sometimes provide seed money to startups.
(12:23):
If the amount is less than a million dollars, then
they may just loan the money to the startup and
the startup will pay back the angel investor with interest
on top of the loan at some later date, assuming
that you know they have the money to do that.
But if it's more than a million dollars, angel investors
typically will take a stake in the company. They will
(12:45):
take part ownership of that company, and then they know
they typically have a lot more say in how things
develop from there. So as a founder, you have to
start making these decisions of how much control do I
want to seed to the people who will give me
the money that lets me pursue my dream. And it's
(13:07):
a difficult question to answer. It's really up to the individual.
Angel investors take on a huge amount of risk. Like
I said, the majority of startups will fail within five years.
Only a few ever developed beyond being a small business
and reach a point where they can hold their own
initial public offering or IPO, or they get snapped up
(13:31):
by some bigger companies. So angel investors and other seed
capital investors are pouring money into something that statistically is
kind of a long shot. Some angel investors actually band
together to create angel networks. This spreads the risk out
across a group of people. It also allows them to
pool resources, so you're not pouring as much of your
(13:53):
money into individual investments. You know, it's part of a
pool of money that other people are contributing toward. It
also means that you're dividing up the equity you have
in that business. But you know, the lower risk means that, yeah,
maybe you are investing money into stuff you believe in,
but you're not going to see that money come back,
but maybe it'll be slightly less than if you were
(14:15):
just going in by yourself. All right, So the startup
receives the seed funding, maybe it's an incubator with the
founders learning how to structure and run a business. On
top of receiving the resources they need to develop their idea. Further,
whatever the case, they are now ready to attempt to
secure a loan, which they might also do later in
(14:38):
the structure. So like loans typically don't really become a
thing until you're past the seed funding stage at least,
and usually it's after you've done Series A or maybe
even Series B funding, or you instead of looking for
a loan, you face venture capital investors, or maybe you
do both. So Silicon Valley Bank would be an example
(15:01):
of a financial institution that used to take a chance
on tech startups before the bank collapsed, so they were
known to offer loans to businesses when other more established
banks wouldn't. And you know, tech investors would also turn
to SVB to take out loans in order to invest
money into startups. So SBB played a very important part
(15:22):
in the early stages of funding for tech startup companies.
Sometimes it would be actually after Series A, so we'll
get to that in a second. Let's talk about venture
capital investors. These are groups of private investors who you know,
it could be a single person, but it's usually a
company that has a bunch of people as their clients
(15:46):
who contribute money to the venture capital firm that then
uses that money to invest in various startups and jump
in after seed funding. The venture capital investors out there,
many of whom our long time players in the financial world,
are the ones who pour significant money into a startup.
(16:08):
We're talking about the tens of millions in some cases,
or you know, obviously you have things like unicorns where
you're talking about crazy amounts of money being poured into
a startup. The funding is intended to really accomplish two goals.
One for the investors. Ideally it will represent a return
(16:29):
on investment at some point where you will make more
money than what you put in at some point further
down the line, assuming that things go well. But the
other thing it's meant to do is to provide the
startup the support it needs to get on a path
toward that success, to further establish the business, to allow
(16:53):
it to grow and to scale so that it can
start to really become a success, to attract the talent
it needs, to produce whatever the product or services at
a level that is sustainable and profitable, and hopefully reach
a point where the company can have a big payout
(17:15):
to its investors, which could come in the form of
an initial public offering that is the company goes from
privately held to a publicly traded company, or it gets
acquired or merged with another company, and in that process
there's a transfer of money that ends up being a
big payout to the early investors. In either case, the
(17:37):
investors end up getting back their investment plus a healthy
return on top of it. It may not be in
the form of cash with initial public offerings, it might
be in the form of additional shares of the company.
Venture capital companies are also betting on long shots, but
the general ideas that while most startups do ultimately fail,
some will succeed, and if you're really wise with your
(18:01):
investments and you have a wide enough spread of those investments,
then hopefully the successes will more than make up for
the failures. If you lose a million dollars on startups
that ultimately fizzle out, but you make ten million dollars
on the one that went to the moon, well you
could say that it all paid for itself at the end, right,
(18:22):
like you made a huge profit. That's not how it
always works out, but that's how the game is played now.
Startups might seek multiple rounds of venture capital funding. They
typically do. It is typically required before a business can
really establish itself to a point where it can really
become a success. So the first round, usually called Series
(18:45):
A funding might happen when the startup is still kind
of figuring out its place in the world. Part of
what determines the funding rounds is that venture capitalists try
to figure out a valuation for the company. Valuation essentially
means how much is that company really worth? And worth
is It's a subjective thing. There are actually different ways
(19:07):
that you can come at a valuation for a company,
and it's not necessarily that one way is better or
more legitimate than another. It all depends upon your perspective
and the point that you take, the approach you take,
But it typically involves things like figuring out like how
experienced is the team in charge. If it's a team
(19:28):
that has a series of wins in its past, that's
going to add to the value the perceived value at
least of the company. How good is its business plan?
What assets does the company have at its disposal? These
are all different questions that kind of contribute to it,
and then ultimately the investment community figures out, well, we
(19:53):
estimate that the value of this company is x amount
so that's what the investments kind of reflect. The investments
reflect the perceived value, like what is the future of
this company, what could it be worth five years down
the road, And that ends up informing investors. It's not
(20:14):
always right. There are a lot of companies that end up,
in hindsight, having been highly overvalued and investors board way
too much money in that. Again, with hindsight, you could say, man,
there was just never any chance that that business was
going to realize the value that was poured into it.
(20:36):
Like if someone's poured a billion dollars into a company
and there's just no way that that company is ever
going to be a true billion dollar company in the
sense of it it's really worth a billion dollars, Well,
that's a big loss. It also means that you're inflating
a economic bubble, and if that bubble ever deflates or pops,
(20:56):
then you're going to see a huge collapse. We saw
this with the dot com bubble, and you know, you
could argue that we've saw it or we're seeing it now,
like we're seeing the deflating part now, But that's more
complicated because it involves other economic issues as well. Anyway,
when you're going through Series A funding. As a business,
(21:19):
you might actually still be trying to figure out things
like basic stuff like, Yeah, I've come up with a
product or service, but is there a market for that? Right?
What is the market for this thing I'm creating? Is?
Does one exist? If not, can I create that market?
You know, if you have something that addresses a challenge
(21:41):
or a problem, then that's one thing. Right. You could say, Hey,
this thing I've created, it solves this problem you have,
and it does it better than anything else out there. Well,
then you say, okay, there is a market for this.
The question then is how big is that market? But
it might be a case where you say, the thing
I have of solves a problem you didn't know you had,
(22:04):
and maybe it really is a problem. Maybe it's just
that you're doing something differently than you had before. Maybe
the way you're doing it differently is better, or maybe
it's not. Here's the crazy thing. The success for the
business doesn't necessarily matter on whether or not the projects
or service really is better than existing stuff. A company
(22:28):
might succeed or fail completely independently of that. Because life
is not fair. Okay, we're going to take another quick
break when we come back, I'm going to wrap this
up and talk a little bit more about the process
of funding. Okay, So we were still talking about series
(22:54):
A funding, where venture capital companies come in. So typically
you might have a single venture capital company acting as
an anchor here, and maybe a few other venture capitalists
come in and also invest in a Series A round.
Series A rounds typically are not ginormous. They can be
(23:17):
in rare occasions. For a while it seemed like that
was just going to be the trend, but that was
when people were getting real loosey goosey with their money.
But often there it's not small because we're still talking
in the tens of millions of dollars, but small lur
Then subsequent rounds of funding would be so you hold
(23:39):
your Series A funding and you typically have maybe one
or two anchors that hold that down. And this is
you usually don't see a lot of other like larger
financial institutions jumping in at this stage. It typically is
still venture capitalists because we're still talking about a pretty
risky kind of investment. Some of those investments will have
like a set amount of time on them when they're
(24:01):
supposed to be paid off, and the startup will have
to pay back that investment with whatever return on top
of it was promised. But then there's usually more than
one round of funding. Series A helps establish things, but
it's not unusual to see a Series B round of funding.
(24:25):
This is where you might see a couple more venture
capitalist companies get involved. You still may not see that
much from larger financial institutions at this stage, but it's
if a company seems to have promise that it's on
a forward momentum, then you might get a little bit
more in the investment community pouring money into Series B.
(24:48):
This typically is really focusing on scaling up a business
and making sure that it can meet a global demand.
Really important for tech companies, right, because a lot of
tech companies digital company needs. They're not limited by geography, right.
It's not like they're making a physical thing that they
(25:08):
can only ship to certain places. They're making a digital
product that at least in theory, could be accessed pretty
much anywhere where you have a connection. You want to
be able to scale your business so that you can
meet the global demand, which means you've got to have
access to all that compute power, storage power, all that
kind of stuff in order to do that not have
(25:29):
your service just crash whenever there's a spike in demand.
So Series B is really typically focused on scaling a
business up, but you can also have a third round,
a Series C round of funding. At this stage you
might start to see some larger financial institutions start to
come on board if again the company looks like it's
(25:50):
on the right track, that there is high hope that
this is a company that is going to firmly establish itself.
You can even have further rounds. You can have Series D,
series etc. There's no real limit to how many rounds
of funding a company could hold, except the limit being,
you know, whatever the investment community is willing to do.
(26:11):
If you're getting to a point where you're seeking, you know,
the tenth round of funding, you might have investors saying,
I don't think I'm ever going to get my money
back if I pour it into here, because if you've
taken this long to try and establish a business, it
may just be there's no business to establish. So this
is also a round Series B Series C where you
(26:33):
start to see banks take a slightly more acceptable risk
in loaning out money to these companies. So Silicon Valley
bank might be more involved in something that's going through
a Series B or Series C round. So then you
have to talk about what these investors actually own. They
(26:56):
might own debt, so in other words, they hold the
debt that the startup has, and the startup needs to
pay that debt back. So what you hold is an
IOU and eventually the company is going to pay that
IOU out to you, or you own equity in the
company you own, you have some sort of ownership of
(27:18):
the company itself. Now, with debt, you can actually buy
and sell debt, right, you can sell your debt off
to someone else. Maybe you sell it off at cost
or maybe at slightly above cost, and the person who's
buying it is hoping that the debt in fact does
get paid out ultimately with whatever return there might be.
(27:40):
And meanwhile you can walk away. You have sold off
your debt that you held for this startup, and you've
got your cash, and you can then invest it in
something else if you like. But this gets outside the
experience of the business itself, Like this sort of activity
can happen around the business and it doesn't necessarily directly
affect the business. So that's almost its own episode But
(28:04):
then you're talking about what is the end goal of
all of this, Well, I mean a couple. One is
that the business actually becomes a revenue generating entity. But
investors typically want to see one of two things happen.
They want to see a privately held company become a
publicly traded one through an IPO or initial public offering.
(28:27):
This is when you go through the extensive process of
having your company scrutinized to determine what the value is,
you set a price for the shares and the number
of shares that you're going to put out on the market,
and you start selling shares to the general public. Investors
(28:49):
at that point may get a big payout as a
company goes public, or they, like I said before, maybe
awarded with shares on top of whatever percentage they owned
in the company as part of the equity they held,
and that's like the big payout for investors, or one
of them. The other, of course being when a bigger
(29:12):
fish comes along and buys up a private company and
as part of the acquisition price, there's a payout to
all the investors, which again includes a return on top
of the investment. Those are the two goals for the investors.
And that's kind of why I get real cynical about
the startup and investment communities, because I've seen a lot
(29:35):
of startups that appear to exist only for the purpose
of getting snapped up by some other company, and that
strikes me as unsustainable in the long run, like it's
not providing actual benefit. It might provide employment to people,
which is good, right, but if no one ever figures
(29:57):
out how to take the central premise of this business
and make it into something meaningful beyond employing people, it
starts to look like it's just hollow. To me. There
are people who are really well known for being serial
entrepreneurs who will come up with a business idea. They'll
(30:18):
go through those early stages of getting seed funding and
venture capital funding, grow the business to a certain point.
Then they just want to bail and do it all
over again. And the cynical part of me thinks that
it might be because it's one thing to come up
with an interesting idea and to get people excited enough
(30:39):
in it to give you money, but it's another thing
to grow that into a stable business that can continue
to grow and to profit, and that the skill set
for the person who's great at creating that initial germ
of an idea and the person who's leading the big
(31:01):
company and providing that stability. Those are two different skill sets,
and not everyone has them, so I guess it's not
necessarily a bad thing to be a serial entrepreneur. I mean,
there can be some really great companies that grow out
of that. But I don't know. There's something about Henry
(31:23):
Higgins music man huckster stuff going on in that world.
Not everyone is a huckster, obviously, but it feels a
bit like the fast talking salesman who is setting up
a big sale and then bailing out of the town
before having to pay the piper. I'm using a lot
of different metaphors here and then doing it all over again.
(31:48):
I don't know. Maybe I'm just thinking like music man
slash Doc Terminus from the original Pete s Dragon or whatever.
In my head, that's what every single startup founder is like.
They're they're dressed in a equated outfits and doing fast
talking pattern songs. Probably not how it actually pans out,
but I'm okay living in that fantasy anyway. I thought
(32:09):
it would be interesting to talk about this because the
way that this world works is important. It has has
shaped the tech industry significantly since the nineteen eighties at least,
and I think it helps us understand where we are
now and how the products that come to us, how
(32:32):
those were able to exist, how they were able to
get to a point where we could actually see and
use them in the startup world obviously, I mean, it's
a totally different story for long established companies that are
you know, their own foundational pillars in the tech industry,
like your intels and your ibms and your you know,
(32:53):
AT and ts and whatnot. But yeah, I kind of
wanted to to look this over. I think it's an
interesting way to get some insight into this and understand
some of the issues going on within the tech sector.
All Right, that's it for this Tech Stuff Tidbits episode.
Hope you are all well, and I'll talk to you
again really soon. Tech Stuff is an iHeartRadio production. For
(33:24):
more podcasts from iHeartRadio, visit the iHeartRadio app, Apple Podcasts,
or wherever you listen to your favorite shows.
Welcome to Tech Stuff, a production from iHeartRadio. Hey there,
and welcome to tech Stuff. I'm your host, Jonathan Strickland.
I'm an executive producer with iHeartRadio. And how the tech
are yet? You know, there's been an awful lot of
talk about tech and money recently, whether we're talking about
(00:26):
cryptocurrencies or the collapse of Silicon Valley Bank a SVB.
Plus there's been talk about how the startup trend is
kind of in a bit of a slowdown right now
due to investors being a bit more cautious in order
to protect their money in a time of economic uncertainty. Plus,
you've got high interest rates on loans, which contribute to
(00:50):
a desire to wait for things to improve before investment
money starts flowing like wine once again. So I thought
I would actually do a Tech Stuff Tidbits episode about
the different types of funding in startups in general. But
we are of course interested in tech startups because honestly,
(01:13):
I find the stuff confusing at times, like how does
an idea for a business end up getting the support
it needs to actually become a thing? And I figure
we can take this episode by talking about the various
stages of funding that a startup will typically seek and
(01:33):
what each of these stages means. So let's say you've
got an idea for a new tech business. Maybe you
plan to make an app that detects which spots in
town are just on the verge of becoming trendy, so
that your users can jump in and be super cool
by going all Instagram on these spots before they blow
(01:56):
up as trendy spots. So you could be a tastemaker.
You know, you're really stylish, You're ahead of the curve,
and it's all because you have the spidy Sense app
that tells you win some place or object or thing
or fashion or whatever is about to really take off.
It's an idea, so dumb it can't fail anyway. You
(02:17):
got this idea, But how do you actually turn this
idea into a business. Well, you're gonna need some starting capital.
Maybe you are limiting costs by doing the classic Silicon
Valley story of launching out of a garage. Your initial
offering might be built on top of your own computers. Well,
(02:38):
that's not going to work for very long, because assuming
your idea actually does catch on, you're gonna need way
more computer power and storage in order to scale your business. So,
assuming you're not independently wealthy and willing to pour your
own money into this venture, what do you do? Well,
one thing you could do is apply at an incubator. So,
(03:03):
an incubator is an organization designed to provide resources to
fledgling startup businesses. There are different types of incubators out there.
Some require a little more established business than others. Some incubators,
if you come in with a great pitch, will bring
you in even if all you have is an idea.
(03:24):
Not many, but some will. And so you come in
with this idea and you pitch it to the incubator,
you go through the application process and they say, excellent,
you can be one of the businesses that we incubate.
So assuming that you do that, then you can get
access to resources that can include stuff from office space
(03:45):
to mentorship and classes, to networking as a building, connections
with potential partners and investors and team members, that kind
of networking. Usually the incubator takes some equity in your
business as a result, so they have some ownership of
your business, and the incubator often has input to some degree,
(04:08):
sometimes a lot of input on the evolution of your
business because the incubator is giving you access to these
resources and in return, you are expected to make something
out of your idea. But the only way you can
do that is if you put the work in. So
incubators are great resources for some types of startups because
(04:30):
you can easily have a situation where you have folks
who are really good at coming up with ideas right,
or maybe they're really good at coding, like they're good
at the building part, but maybe they have little to
know business experience or expertise. They don't know how to
start a business. They don't know how to run a
business and keep it successful. They don't know what it
(04:50):
takes in order to keep the lights on well. At
an incubator, startups can learn the ins and outs of
business itself. They can the foundation for what will be
a company further down the line, So startups can start
to learn how to do things like draft business plans
and to form a team, both a team of people
(05:14):
who are making the thing that you're offering and the
team that oversees that. They can start to make out
a hierarchy plan for their organization. All this kind of
stuff that is required for a business to have the
best chance to succeed. Now, it's not that every startup
has gone through this. There are some that have gone
(05:35):
through a very haphazard approach and through all logic should
have failed, but somehow didn't. But generally speaking, these are
the sort of things you need to do if you
want to have a good chance of being around for
more than a couple of years. There are a few
different kinds of incubators. As I mentioned, a lot of
(05:56):
colleges have incubator organizations, so you might have student and
or faculty taking on a really big part of running
those operations. There are also corporate incubators. Google had one
called Area one twenty, so once upon a time you
probably have heard this. At some point, Google had this
policy in place where employees were allowed to dedicate up
(06:19):
to twenty percent of their work week to their own projects,
with the one qualifier being that the projects should ideally
be something that could potentially benefit Google if it pans
out well. Area one twenty served as an incubator for
projects that had a lot of promise and gave employees
(06:39):
the resources they would need to further develop their ideas
and potentially see the mature into a business of their own,
so it wouldn't just become a Google product, it could
potentially become a Google spinoff. Google, by the way, abandon
the twenty percent time project back in twenty thirteen, so
that is not a standing at Google anymore. They still
(07:01):
do incubate businesses, but it's a slightly different approach now.
Now similar to an incubator is an accelerator. So incubators
help startups at the earliest stages of development, perhaps before
there's even a business idea that has formed around a
(07:23):
product or service idea, right, so it may be at
the earliest stages of germination for a business, whereas an
accelerator typically is for a startup that already has established
the business part, at least the rudimentary elements of a
business part. And so an accelerator takes a startup business and,
(07:44):
as the name suggests, accelerates it on its way to
scale up to becoming a larger business that it will
need to be in order to be a success. Incubator,
on the flip side, is a place to help develop
and earth of business, but both incubators and accelerators helped
startup companies find funding, and this kind of brings us
(08:08):
to the first real round of getting capital for your business,
which is called seed capital or seed funding. And this
could happen before you get into an incubator, probably before
you get into an accelerator, or it could be part
of that process. Part of what the incubator is trying
to help you do is to secure seed funding. This
(08:31):
is the initial round of funding the startup needs in
order to become a thing. It's what pays the bills
and helps the startup establish the basics and start to
do things like registered trademarks, you know, have an office space,
make payroll for the initial group of employees while they
(08:54):
further develop their idea. But it's the earliest, earliest stages.
You're not necessarily doing business yet. You may not even
be a publicly known entity yet. You might still be
kind of a developing, in secret kind of company. Often
seed funding comes from people who are close to the
folks who are behind the startup, So this could include
friends and family, former or current employers, that kind of thing.
(09:17):
And in return for providing some of the seed capital
for the business, the investor receives some equity or percentage
of ownership of that business. So if the business succeeds,
there will be an eventual payout, But it's entirely possible
that seed capital investors are supporting a startup not because
they're hoping to get a big payoff down the line,
(09:38):
but rather they believe in the people behind the project
and they want to support them. So it's important because
a lot of these startups they fail. More than half
the vast majority of startups do not succeed. So often
we're talking about people who are taking on a financial
risk because they believe in the people behind it or
(09:59):
they want to s support them. Also, we're typically talking
about pretty modest amounts of money in the long term,
Like later on, when we're talking about Series ABC funding,
you're talking about the tens of millions of dollars or more.
Now we're talking about, you know, maybe hundreds of thousands
of dollars, which is still a lot of money, but
(10:20):
in the grand scheme of things, is much much smaller. Now.
Seat capital provides funding that otherwise would be off limits
to a startup. I've talked about in episodes that I
mentioned with Silicon Valley Bank that it's really hard for
startup businesses to secure like a business loan because they
might not have anything they can put up as collateral.
They might not have any track record they can point
(10:42):
to as showing their ability to make a successful business.
The business itself might not really exist yet. There might
not be an easy way to explain where revenue is
going to come from. They may not be able to
generate any revenue for a while, So the loan can
be seen as being too risky, and seed capital can
end up taking over that spot, because I mean, where
(11:05):
else are you going to get the money to get started?
And really it's usually just enough to establish the earliest
days of the business so that the founders can actually
seek additional investment. So you can almost think of it
as the money that a business needs in order to
get seen by the next level of investors. And we'll
talk about them after we come back from this quick break,
(11:36):
all right, Before I move on to venture capital funds,
because that's ultimately where we're headed for this next bit
of the discussion. There is one kind of special early
investor that I could mention at this stage. Investors who
typically can step in at the seed funding phase or
perhaps the next one, and that is the angel investor.
(11:58):
So an angel investor is usually a high net worth
individual h and WI. It's someone who has a lot
of liquid assets at their disposal. That's a way of saying,
if someone's got a whole lot of cash they can
throw around, or at least it's someone who could very
quickly get hold of a mountain of cash that they
could throw around. Angel investors sometimes provide seed money to startups.
(12:23):
If the amount is less than a million dollars, then
they may just loan the money to the startup and
the startup will pay back the angel investor with interest
on top of the loan at some later date, assuming
that you know they have the money to do that.
But if it's more than a million dollars, angel investors
typically will take a stake in the company. They will
(12:45):
take part ownership of that company, and then they know
they typically have a lot more say in how things
develop from there. So as a founder, you have to
start making these decisions of how much control do I
want to seed to the people who will give me
the money that lets me pursue my dream. And it's
(13:07):
a difficult question to answer. It's really up to the individual.
Angel investors take on a huge amount of risk. Like
I said, the majority of startups will fail within five years.
Only a few ever developed beyond being a small business
and reach a point where they can hold their own
initial public offering or IPO, or they get snapped up
(13:31):
by some bigger companies. So angel investors and other seed
capital investors are pouring money into something that statistically is
kind of a long shot. Some angel investors actually band
together to create angel networks. This spreads the risk out
across a group of people. It also allows them to
pool resources, so you're not pouring as much of your
(13:53):
money into individual investments. You know, it's part of a
pool of money that other people are contributing toward. It
also means that you're dividing up the equity you have
in that business. But you know, the lower risk means that, yeah,
maybe you are investing money into stuff you believe in,
but you're not going to see that money come back,
but maybe it'll be slightly less than if you were
(14:15):
just going in by yourself. All right, So the startup
receives the seed funding, maybe it's an incubator with the
founders learning how to structure and run a business. On
top of receiving the resources they need to develop their idea. Further,
whatever the case, they are now ready to attempt to
secure a loan, which they might also do later in
(14:38):
the structure. So like loans typically don't really become a
thing until you're past the seed funding stage at least,
and usually it's after you've done Series A or maybe
even Series B funding, or you instead of looking for
a loan, you face venture capital investors, or maybe you
do both. So Silicon Valley Bank would be an example
(15:01):
of a financial institution that used to take a chance
on tech startups before the bank collapsed, so they were
known to offer loans to businesses when other more established
banks wouldn't. And you know, tech investors would also turn
to SVB to take out loans in order to invest
money into startups. So SBB played a very important part
(15:22):
in the early stages of funding for tech startup companies.
Sometimes it would be actually after Series A, so we'll
get to that in a second. Let's talk about venture
capital investors. These are groups of private investors who you know,
it could be a single person, but it's usually a
company that has a bunch of people as their clients
(15:46):
who contribute money to the venture capital firm that then
uses that money to invest in various startups and jump
in after seed funding. The venture capital investors out there,
many of whom our long time players in the financial world,
are the ones who pour significant money into a startup.
(16:08):
We're talking about the tens of millions in some cases,
or you know, obviously you have things like unicorns where
you're talking about crazy amounts of money being poured into
a startup. The funding is intended to really accomplish two goals.
One for the investors. Ideally it will represent a return
(16:29):
on investment at some point where you will make more
money than what you put in at some point further
down the line, assuming that things go well. But the
other thing it's meant to do is to provide the
startup the support it needs to get on a path
toward that success, to further establish the business, to allow
(16:53):
it to grow and to scale so that it can
start to really become a success, to attract the talent
it needs, to produce whatever the product or services at
a level that is sustainable and profitable, and hopefully reach
a point where the company can have a big payout
(17:15):
to its investors, which could come in the form of
an initial public offering that is the company goes from
privately held to a publicly traded company, or it gets
acquired or merged with another company, and in that process
there's a transfer of money that ends up being a
big payout to the early investors. In either case, the
(17:37):
investors end up getting back their investment plus a healthy
return on top of it. It may not be in
the form of cash with initial public offerings, it might
be in the form of additional shares of the company.
Venture capital companies are also betting on long shots, but
the general ideas that while most startups do ultimately fail,
some will succeed, and if you're really wise with your
(18:01):
investments and you have a wide enough spread of those investments,
then hopefully the successes will more than make up for
the failures. If you lose a million dollars on startups
that ultimately fizzle out, but you make ten million dollars
on the one that went to the moon, well you
could say that it all paid for itself at the end, right,
(18:22):
like you made a huge profit. That's not how it
always works out, but that's how the game is played now.
Startups might seek multiple rounds of venture capital funding. They
typically do. It is typically required before a business can
really establish itself to a point where it can really
become a success. So the first round, usually called Series
(18:45):
A funding might happen when the startup is still kind
of figuring out its place in the world. Part of
what determines the funding rounds is that venture capitalists try
to figure out a valuation for the company. Valuation essentially
means how much is that company really worth? And worth
is It's a subjective thing. There are actually different ways
(19:07):
that you can come at a valuation for a company,
and it's not necessarily that one way is better or
more legitimate than another. It all depends upon your perspective
and the point that you take, the approach you take,
But it typically involves things like figuring out like how
experienced is the team in charge. If it's a team
(19:28):
that has a series of wins in its past, that's
going to add to the value the perceived value at
least of the company. How good is its business plan?
What assets does the company have at its disposal? These
are all different questions that kind of contribute to it,
and then ultimately the investment community figures out, well, we
(19:53):
estimate that the value of this company is x amount
so that's what the investments kind of reflect. The investments
reflect the perceived value, like what is the future of
this company, what could it be worth five years down
the road, And that ends up informing investors. It's not
(20:14):
always right. There are a lot of companies that end up,
in hindsight, having been highly overvalued and investors board way
too much money in that. Again, with hindsight, you could say, man,
there was just never any chance that that business was
going to realize the value that was poured into it.
(20:36):
Like if someone's poured a billion dollars into a company
and there's just no way that that company is ever
going to be a true billion dollar company in the
sense of it it's really worth a billion dollars, Well,
that's a big loss. It also means that you're inflating
a economic bubble, and if that bubble ever deflates or pops,
(20:56):
then you're going to see a huge collapse. We saw
this with the dot com bubble, and you know, you
could argue that we've saw it or we're seeing it now,
like we're seeing the deflating part now, But that's more
complicated because it involves other economic issues as well. Anyway,
when you're going through Series A funding. As a business,
(21:19):
you might actually still be trying to figure out things
like basic stuff like, Yeah, I've come up with a
product or service, but is there a market for that? Right?
What is the market for this thing I'm creating? Is?
Does one exist? If not, can I create that market?
You know, if you have something that addresses a challenge
(21:41):
or a problem, then that's one thing. Right. You could say, Hey,
this thing I've created, it solves this problem you have,
and it does it better than anything else out there. Well,
then you say, okay, there is a market for this.
The question then is how big is that market? But
it might be a case where you say, the thing
I have of solves a problem you didn't know you had,
(22:04):
and maybe it really is a problem. Maybe it's just
that you're doing something differently than you had before. Maybe
the way you're doing it differently is better, or maybe
it's not. Here's the crazy thing. The success for the
business doesn't necessarily matter on whether or not the projects
or service really is better than existing stuff. A company
(22:28):
might succeed or fail completely independently of that. Because life
is not fair. Okay, we're going to take another quick
break when we come back, I'm going to wrap this
up and talk a little bit more about the process
of funding. Okay, So we were still talking about series
(22:54):
A funding, where venture capital companies come in. So typically
you might have a single venture capital company acting as
an anchor here, and maybe a few other venture capitalists
come in and also invest in a Series A round.
Series A rounds typically are not ginormous. They can be
(23:17):
in rare occasions. For a while it seemed like that
was just going to be the trend, but that was
when people were getting real loosey goosey with their money.
But often there it's not small because we're still talking
in the tens of millions of dollars, but small lur
Then subsequent rounds of funding would be so you hold
(23:39):
your Series A funding and you typically have maybe one
or two anchors that hold that down. And this is
you usually don't see a lot of other like larger
financial institutions jumping in at this stage. It typically is
still venture capitalists because we're still talking about a pretty
risky kind of investment. Some of those investments will have
like a set amount of time on them when they're
(24:01):
supposed to be paid off, and the startup will have
to pay back that investment with whatever return on top
of it was promised. But then there's usually more than
one round of funding. Series A helps establish things, but
it's not unusual to see a Series B round of funding.
(24:25):
This is where you might see a couple more venture
capitalist companies get involved. You still may not see that
much from larger financial institutions at this stage, but it's
if a company seems to have promise that it's on
a forward momentum, then you might get a little bit
more in the investment community pouring money into Series B.
(24:48):
This typically is really focusing on scaling up a business
and making sure that it can meet a global demand.
Really important for tech companies, right, because a lot of
tech companies digital company needs. They're not limited by geography, right.
It's not like they're making a physical thing that they
(25:08):
can only ship to certain places. They're making a digital
product that at least in theory, could be accessed pretty
much anywhere where you have a connection. You want to
be able to scale your business so that you can
meet the global demand, which means you've got to have
access to all that compute power, storage power, all that
kind of stuff in order to do that not have
(25:29):
your service just crash whenever there's a spike in demand.
So Series B is really typically focused on scaling a
business up, but you can also have a third round,
a Series C round of funding. At this stage you
might start to see some larger financial institutions start to
come on board if again the company looks like it's
(25:50):
on the right track, that there is high hope that
this is a company that is going to firmly establish itself.
You can even have further rounds. You can have Series D,
series etc. There's no real limit to how many rounds
of funding a company could hold, except the limit being,
you know, whatever the investment community is willing to do.
(26:11):
If you're getting to a point where you're seeking, you know,
the tenth round of funding, you might have investors saying,
I don't think I'm ever going to get my money
back if I pour it into here, because if you've
taken this long to try and establish a business, it
may just be there's no business to establish. So this
is also a round Series B Series C where you
(26:33):
start to see banks take a slightly more acceptable risk
in loaning out money to these companies. So Silicon Valley
bank might be more involved in something that's going through
a Series B or Series C round. So then you
have to talk about what these investors actually own. They
(26:56):
might own debt, so in other words, they hold the
debt that the startup has, and the startup needs to
pay that debt back. So what you hold is an
IOU and eventually the company is going to pay that
IOU out to you, or you own equity in the
company you own, you have some sort of ownership of
(27:18):
the company itself. Now, with debt, you can actually buy
and sell debt, right, you can sell your debt off
to someone else. Maybe you sell it off at cost
or maybe at slightly above cost, and the person who's
buying it is hoping that the debt in fact does
get paid out ultimately with whatever return there might be.
(27:40):
And meanwhile you can walk away. You have sold off
your debt that you held for this startup, and you've
got your cash, and you can then invest it in
something else if you like. But this gets outside the
experience of the business itself, Like this sort of activity
can happen around the business and it doesn't necessarily directly
affect the business. So that's almost its own episode But
(28:04):
then you're talking about what is the end goal of
all of this, Well, I mean a couple. One is
that the business actually becomes a revenue generating entity. But
investors typically want to see one of two things happen.
They want to see a privately held company become a
publicly traded one through an IPO or initial public offering.
(28:27):
This is when you go through the extensive process of
having your company scrutinized to determine what the value is,
you set a price for the shares and the number
of shares that you're going to put out on the market,
and you start selling shares to the general public. Investors
(28:49):
at that point may get a big payout as a
company goes public, or they, like I said before, maybe
awarded with shares on top of whatever percentage they owned
in the company as part of the equity they held,
and that's like the big payout for investors, or one
of them. The other, of course being when a bigger
(29:12):
fish comes along and buys up a private company and
as part of the acquisition price, there's a payout to
all the investors, which again includes a return on top
of the investment. Those are the two goals for the investors.
And that's kind of why I get real cynical about
the startup and investment communities, because I've seen a lot
(29:35):
of startups that appear to exist only for the purpose
of getting snapped up by some other company, and that
strikes me as unsustainable in the long run, like it's
not providing actual benefit. It might provide employment to people,
which is good, right, but if no one ever figures
(29:57):
out how to take the central premise of this business
and make it into something meaningful beyond employing people, it
starts to look like it's just hollow. To me. There
are people who are really well known for being serial
entrepreneurs who will come up with a business idea. They'll
(30:18):
go through those early stages of getting seed funding and
venture capital funding, grow the business to a certain point.
Then they just want to bail and do it all
over again. And the cynical part of me thinks that
it might be because it's one thing to come up
with an interesting idea and to get people excited enough
(30:39):
in it to give you money, but it's another thing
to grow that into a stable business that can continue
to grow and to profit, and that the skill set
for the person who's great at creating that initial germ
of an idea and the person who's leading the big
(31:01):
company and providing that stability. Those are two different skill sets,
and not everyone has them, so I guess it's not
necessarily a bad thing to be a serial entrepreneur. I mean,
there can be some really great companies that grow out
of that. But I don't know. There's something about Henry
(31:23):
Higgins music man huckster stuff going on in that world.
Not everyone is a huckster, obviously, but it feels a
bit like the fast talking salesman who is setting up
a big sale and then bailing out of the town
before having to pay the piper. I'm using a lot
of different metaphors here and then doing it all over again.
(31:48):
I don't know. Maybe I'm just thinking like music man
slash Doc Terminus from the original Pete s Dragon or whatever.
In my head, that's what every single startup founder is like.
They're they're dressed in a equated outfits and doing fast
talking pattern songs. Probably not how it actually pans out,
but I'm okay living in that fantasy anyway. I thought
(32:09):
it would be interesting to talk about this because the
way that this world works is important. It has has
shaped the tech industry significantly since the nineteen eighties at least,
and I think it helps us understand where we are
now and how the products that come to us, how
(32:32):
those were able to exist, how they were able to
get to a point where we could actually see and
use them in the startup world obviously, I mean, it's
a totally different story for long established companies that are
you know, their own foundational pillars in the tech industry,
like your intels and your ibms and your you know,
(32:53):
AT and ts and whatnot. But yeah, I kind of
wanted to to look this over. I think it's an
interesting way to get some insight into this and understand
some of the issues going on within the tech sector.
All Right, that's it for this Tech Stuff Tidbits episode.
Hope you are all well, and I'll talk to you
again really soon. Tech Stuff is an iHeartRadio production. For
(33:24):
more podcasts from iHeartRadio, visit the iHeartRadio app, Apple Podcasts,
or wherever you listen to your favorite shows.
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