We often hear about early-stage startups securing their first batch of seed funding, or Aussie success stories scoring millions in their Series B or C rounds. But what we see less of in Australia is startups making their way a little further along the alphabet.
In the US, Reddit recently raised $150 million in Series D funding. But that pales in comparison to Uber’s 2016 $3.5 billion Series G round, or Space X’s $273.2 million Series J, closed in January 2019.
These are companies often considered tech giants — barely still in the startup category. So why are they still raising, and do they really need the cash?
Speaking to StartupSmart, Benjamin Chong, partner at Right Click Capital, says ever since the global financial crisis of 2008, and especially in the US, “tech companies have been going public much later”.
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In order to stay private, they may have had to issue new shares, facilitate secondary shares, or allow purchase and sale of existing shares.
Early investors who may have had their funds tied up in a startup for 10 years or more can sell their equity on to free up their personal liquidity, Chong says.
In any raise of Series D or beyond, “it’s common for there to be a percentage of the round being used to mop up, or purchase secondary shares”, he adds.
“Not all of that is going into the company.”
Also, not going public allows potentially controversial companies to continue running, without the scrutiny a listing brings.
Even just a couple of years ago, startups such as Uber and Airbnb “in some jurisdictions were the subject of lots of questions”, Chong says.
“When you have a backdrop or environment that is potentially volatile, and that is really difficult to predict, staying private allows you to do things public companies can’t,” he adds.
“You don’t have that type of microscope.”
This is particularly relevant to startups, who are more likely to be disrupting the status quo and inventing new business models. In some jurisdictions, Airbnb is still illegal, Chong points out. But, according to Crunchbase, it has raised $4.4 billion over 13 rounds.
“If you’re going to be a challenger and a disruptor, that’s going to be the case,” Chong says.
Alan Jones, Aussie angel investor and founder of M8 Ventures, tells StartupSmart VC funding is often about “validating or invalidating variations of a hypothesis”.
While startups can do this without funding, at any stage, additional funding “allows you to validate or invalidate that much more quickly”.
If a startup is trying to build a critical mass of users in order to test a new way of doing things, spending money on marketing to acquire those customers can make it happen much more quickly.
“You can do it by yourself and hope word of mouth kicks off … or you can borrow someone else’s money and spend it,” Jones says.
Fuelling the fire
For any startup, there are three possible funding routes to take. Bootstrapping, bootstrapping for as long as possible and then raising when you have a better valuation, or raising funds right from the start.
If a startup goes down the funding route from the off, “it’s likely those existing investors will want a pathway to exit at some point in the future”, Chong says.
According to Jones, in Australia there’s something of a “local startup orthodoxy” that VC funding is bad in general. And if you’re a startup in a good position, avoiding funding “puts you in a good bargaining position”, he says.
However, to achieve growth, often a cash injection is required.
“Acquiring customers, and recruiting and retaining top talent costs money,” Jones says.
“Most people don’t have a couple of hundred grand at home.”
Either way, the most difficult thing, Jones says, is choosing which path to take.
“The real pain is in trying to switch from one of those to another,” Jones says.
According to Chong, the startups raising early funding and the startups that end up raising silly amounts of money are all doing it for the same reasons: to fuel growth.
“If you’re going to be building a business that’s likely disruptive, that will have lots of customers and will be international in its approach, you’re probably going to need capital to accelerate that growth,” Chong says.
If a startup can demonstrate that it has taken funding and used it “in a judicious way”, then both existing and new investors will want to double down on that.
Capital is like fuel, Chong says.
“When you put it on a big fire, can make it much larger and brighter, and it will spread,” he adds.