A startup is a company in the early stages of development that is set up by one or several people to enter an existing market with unique products or services. Startup companies often face insufficient capital to fund their business operations to be at the same level as already established companies. As a result, the prime source of funding comes from the founders’ friends and families.
In their newness, startups usually focus on raising capital to further product development. Raising such funds is always a long and tedious process, and a startup needs to make a strong argument that supports the viability of its business idea. Some renowned startup companies include Airbnb, SpaceX, Avant, and Pinterest.
A startup refers to a new business venture that is either owned by one person or several people.
Startups generate most of their startup capital by using various private forms of funding, and they must prove the merit of their business ideas to attract these investors.
Technology-oriented startups own or develop intellectual property that can generate high levels of income for their investors and owners.
Understanding Startups: How They are Funded
One of the major challenges faced by startup companies is raising the required amount of capital to fund their development. Startup companies sometimes do not generate any revenues at their inception. Instead, they understand that they first need to grow, test, and market.
Doing so requires a considerable amount of funds, and startups can choose among several ways in which to get funding from investors. Some of the popular methods of raising startup capital include crowdfunding, angel investment, winning contests, venture capital, financial bootstrapping, applying for government capital, among others.
A new company is usually more successful if launched in a large and mature ecosystem. Different types of individuals and organizations form a strong startup ecosystem. Silicon Valley in California is a typical example of a strong startup ecosystem.
Some business sectors and locations are linked with newbie companies. The dot-com bubble in the late 1990s, for example, was linked to a significant number of new companies. A few of the startup companies provided internet access through technology, with Silicon Valley harboring a majority of them.
Investing in startup companies is risky since they are yet to make a profit and with a limited history. However, any business idea with merit and experienced advisors or management will attract investors who determine its value using any of the following approaches:
Discounted cash flow (DCF) method: The DCF method looks at the future cash flow of a company.
Cost to duplicate method: The cost to duplicate valuation is concerned with the newbie company’s incurred expenses due to the purchase of physical assets or product and service development. It does not capture future potential intangible assets.
Development stage method: Under the development stage approach, the new company is assigned a higher value as far as its potential to develop is concerned. A newborn company is assigned a high valuation if it maintains a website and some signs of traffic and profit, regardless of its current performance rate.
Market method: The market approach looks at the recent valuations of acquisitions for similar companies.
Prospective investors are attracted to startups that are distinguished by their management team’s wealth of experience and unique ideas. Investors are careful to invest money that they are not willing to lose. Company owners should seek intellectual property protection if the value of a company is based on its technology.
According to The Economist, intellectual property accounts for 75% of the value of most startup companies in the United States. Today, most technology-based startup companies formulate sound strategies to protect their intellectual property. A large number of tech startups with innovative ideas generate high revenues for their owners and investors. Examples of such companies include Facebook, Twitter, Amazon, and Google Inc., with their founders and investors earning huge returns in the form of stock appreciation over time.
Taxation of Startup Companies
Various tax incentives and benefits are available to startup companies at their inception. For example, homegrown U.S. startups are entitled to a lower tax rate compared to already established companies. Their total income is calculated without including certain incentive provisions, such as deduction and depreciation. However, there are taxation laws that are considered unfriendly to startup companies in different states in the U.S.
Startup companies are exposed to external attacks. The attacks are related to a company’s long-term prospects and the possibility of shutting down for various reasons such as inadequate resources, lack of proper planning, or competition. In their fragile state, startup ventures need to be mentored properly and nurtured lest they succumb to external pressures.
Entrepreneurs tend to become overconfident and sometimes underestimate the potential of flawed analysis and stiff competition, which are essential parameters that define success. Other newbie companies enter the market with the eagerness to prove the merits of their innovative products or services. Successful new companies adopt a clear strategy before joining the market to ensure that they have a sustainable competitive edge.
CFI offers the Capital Markets & Securities Analyst (CMSA)® certification program for those looking to take their careers to the next level. To keep learning and advance your career, the following resources will be helpful:
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