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2.1 Startup

The term “startup” is used generically as a synonym for entrepreneurial activities across many forms of businesses and especially to describe young, new businesses ever since the dot-com-bubble in 2000 (Recke 2015). In recent years, startups have been attributed with being a driving force behind economic growth and job creation by many policy makers and industry advocates around the world (Reynolds et al. 2000, Shane 2009, Kane 2010). Therefore a differentiated approach to classify entrepreneurial activities is necessary.

To distinguish between regular entrepreneurial activities and those that might in fact entail a potential for the creation of economic wealth, a startup can be defined as an innovative company, trying to develop a scalable business model that can be replicated repeatedly (Blank 2012). In addition these startups can be characterised by being young businesses (Brettel et al. 2008), having low initial capital funds and taking high risks to establish their innovative business ideas (Graham 2005).

Most importantly, these businesses are growth oriented (Warmer & Weber 2014) and are often called high-growth ventures (Shane 2009, Morris et al. 2015, Mason & Brown 2013). High-growth ventures are very different from any other kind of newly founded firm, since their chance of failing is about 75% even if its business idea, team and product are good enough to secure venture capital financing (Blank 2013).

Therefore a scalable business model is the most relevant aspect for growth oriented startups and needs to be verified in regards to its potential for success at the lowest financial expense (Kollmann 2011). This is a challenging process during which the startup, its structure and financial needs change dramatically and repeatedly. During its lifetime a startup requires very different types of funding, ranging from initial seed capital funding to high volume venture capital financing (Ripsas 1997).

Startup Stages

Startups may evolve very dynamically and can be categorised in 5 distinct stages of development according to “Deutscher Startup Monitor”, initiated by the Bundesverband Deutsche Startups (e.V.). These stages are “seed stage”, “startup stage”, “growth stage”, “later stage” and “steady stage” (Ripsas & Tröger 2014).

The “seed stage” is a conceptional stage in which the startup is experimenting with its product and business model to reach a market fit. Within the “startup stage” the company has a working product and generates first revenues or signs up users. In the “growth stage” the company is characterised by a matured product and high growth (also known as scaling). During the “later stage” the business might plan to sell or aim for a stock exchange IPO whereas the “steady stage” is a phase of stagnation (Kohlmann 2011, Ripsas 1997). Additionally there are an “idea stage” and a “co-founder stage” (see fig. 1) described by Vital (2013), which are important to note in order to understand concepts behind startup funding (Recke 2015).

Figure 1: How Startup Funding Works

Startup Funding

During its distinct stages of development, a startup requires different types of funding, which can ruffly be divided in “seed round”, “angel round” and “series A round” (Graham 2005). There are other terms used for these stages, e.g. by Vital (2013) and there might be additional rounds of funding, still they all fit into one of the above categories.

Smallest rounds of funding before an actual “seed sound” might be called “pre-seed investment” or something similar. Although they might have impact on equity shares within the business and are of relevance for startup formation, they are not that different from a “seed round” in regards to requirements in terms of scope, size and volume of the investment. Therefore, Graham (2005) does not distinguish between different types of “seed round” funding and considers them structurally comparable.

A “seed round“ can be attributed to the “seed stage” of a startup and might come from the entrepreneurs’ private funds or investors such as family & friends, public subsidies or as part of an accelerator program. The investment usually ranges between a 5-digit and small 6-digit sum and involves giving small equity shares to the investors (Recke 2015). Accelerator programs are the most professional forms of investments at this stage. They provide initial funding during a timed program of usually 3-6 months to prepare the startup for the next round of financing in exchange for 3-10% in equity. In addition they provide access to office space, coaching, industry insights and workshops for the founding team. Lastly they expect the startup to leave the accelerator after finishing the program, hopefully with prospects of additional funding (Altman 2014, Springer 2015, NMA 2016).

An other alternative is receiving subsidies or investments from public funds. These can be divided in grants, aids, investments and non-cash benefits and are available on regional, national and international levels (FÜR-GRÜNDER.DE 2015). These types of funding will be discussed in greater detail later on.

If a startup manages to obtain a “seed round”, it leaves the “idea stage” and “co-founder stage” mentioned by Vital (2013) and evolves into the “seed stage” in terms of the “Deutsche Startup Monitor” (Ripsas & Tröger 2014).

An “angel round” is typically linked to the “startup stage” and is usually done with business angels (also called angel investors), who invest their own money, or seed funding companies, often called incubators or company builders. It involves higher investment sums in the 6-digit to low 7-digit range and larger equity shares for the investors (Recke 2015). Incubators can be compared with accelerators but in addition to higher investments and larger equity shares, they also provide more operational support in building up the company, e.g. with dedicated development or marketing teams. Startups remain within an incubator for longer periods of time, ranging from 1 to 5 years (Cohen 2013).

Additional means of financing during this stage might be crowd-funding and crowd-investing through various national or international platforms which became quite popular over the past years (Recke 2015).

If a startup manages to obtain an “angel round”, it evolves to the “startup stage” in terms of the “Deutsche Startup Monitor” (Ripsas & Tröger 2014).

A “series A round” or any subsequent investment round after that (called “series B round”, “series C round” etc.) is meant for the “growth stage” during which the startup scales towards an potential acquisition or an IPO. It is typically done by specialised venture capital investors, investing large amounts of money through their managed funds and acquiring equity shares of usually more than 33% to accelerate the growth of the business (Recke 2015).

If growth criteria are met, subsequent rounds of funding might be attributed to the “later stage” and can involve large private equity firms or investment banks in addition to venture capital investors. The ultimate goal in terms of funding is an acquisition or an IPO, often referred to as an Exit, during which the shareholders can liquidate their equity shares at an ideally lucrative price (Graham 2005).

The “steady stage” as a stage of stagnation is not discussed in more detail since it does not entail firm growth and usually no substantial additional rounds of funding.

Startup Lifecycle

The lifecycle of a startup with high-growth potential can be described as a process of continuously changing shareholder structure (see fig. 2). This is necessary to facilitate the distinct kinds of investments at different levels of risk to achieve the exponential growth (scaling) characteristic for a high-growth startup (Recke 2015).

Figure 2: Startup funding at different stages of development

Taking all these aspects into consideration, startups - or more specifically high-growth ventures - are characterized as follows in regards to this thesis:

- newly established businesses with high-growth potential

- trying to establish an innovative, scalable business model

- having low initial capital, requiring high risk financing to scale