In our previous article, we talked about what investors do to minimize the chances of an unsuccessful venture. In today’s piece, we’ll be looking to go further in-depth on the more technical side of things, analyzing each phase of the funding process to better understand what each one entails.

Pre-Seed Funding

Pre-Seed Funding, also known as Bootstrapping, is the earliest stage of funding and represents the very beginning of the operational processes in a startup. Usually, the investors are the founders themselves, their families, friends, or close supporters.

Depending on where the founders are located and their need to hire additional help, the amount of bootstrap money would vary. A back-of-the-envelope calculation would be the money needed for the team to pay their bills while eating cheap food for as long as it takes until you create a product that a client would pay for. Sometimes this is called “noodle money”, as an allusion to the entrepreneurs surviving on noodle cups while preparing for the stage where they meet their first investors.

During this time, we would work on both the technical side of the solution and the business model under the guidance of our technical & business mentors.

Seed Funding

The name says a lot about what happens in this stage: this is when the “seed” is planted, after which the founders might expect to see the first results. It is when more sophisticated market research and further product development are done to grow the company’s value and attract even more funding.

There are many potential investors in this stage, but the most common ones are the so-called “angel investors”. For a startup to attract angel investors in the US nowadays, for example, it should be valued anywhere between $2 million to $6 million. The startup needs to show “traction”: one or more pilot projects already implemented, lots of adopters, or a high rate of growth month-to-month or year-to-year, etc.

The term “angel investor” is a bit misleading, for it suggests such investments are charitable acts. The actual origin of the term relates to such investments being miraculous, as it would be for an angel to show up in real life.

The critical aspect for entrepreneurs to grasp is that angel investors would only commit money if they were shown a credible plan about how such money could increase the value of the company 10x by the time the exit happens.

What does the exit mean?

All investors make their money when a startup is either purchased by another company or at the IPO (Initial Public Offering) when the startup becomes listed on the stock exchange. Since angel investors are the first to invest, they have the longest time to wait and face the highest risks.

Seed money offered by each angel investor can be between tens of thousands and several hundreds of thousands of dollars. However, a project will only get such money if it showcases a business that generates 10x returns. That is why joining a good accelerator program is essential.

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Series A Funding

In this round, the emphasis is placed on further developing our business model. The previous seed funding stage amplified the initial traction. We know more about our customers’ needs, what it takes to service them well, and how our technical solution should be developed to further grow our business. However, this is all knowledge and theory. We need something more palpable, which is why a new series of funding becomes necessary.

Series A rounds are expected to raise from $10 million to $30 million and are usually led by venture capital funds (VCs). A 2018 CB Insights report discovered that only 48% of seed-funded startups tend to make it to the next round.

Remember our earlier discussion about angel investors’ motivations? This particular report shows that more than half of their investments are spent on companies that cannot attract the next round. It even paints a more gruesome picture: 67% percent of the companies that attract seed funding either die or turn into regular companies, as they never truly take off.

Why turning into a regular company is gruesome for early investors?

Angel investors and VCs take huge risks when funding startups. The average dividend yield between 2008 and 2018 for US companies was 2%. Angels have a whole portfolio of investments, the majority of which will never be profitable. That dividend yield would require them to be right more than 98% of the time just to recover their losses.

This is why they need an IPO as an exit – IPOs are the only ones that sometimes bring them the 10x returns they want, and dividends cannot. A TechCrunch piece of research found out the actual return for angels in the US, and the UK is around 2.5x on average. This is why they must aim for 10x when looking at promising startups.

The same reasoning applies to the Series A VCs. The vital lesson for us, as startup founders, is if we want angels and VCs to invest, we should look to focus on creating a business that gives investors that type of return, the 10x kind. If our company only brings regular rates of return to early investors, as dividends do, then we should finance it through other means.

Series B and beyond

If we have understood that an IPO is what any early investors want from a startup, it is also easy to understand why there might be other rounds of financing after Series A. The purpose of subsequent rounds is to build the business until the IPO happens. Any further round past B would only occur depending on how convincing the possibility of the IPO is.

This is why it is great fun to run a startup. We get into something that will grow huge and can potentially offer us an experience like none other. We learn and expand our horizons beyond just our technical creativity. We learn to connect to our customers and angel investors & VCs. We begin envisioning how to create 10x returns for our early investors, which entices us to start thinking big, changing our worldview forever.

Often, people confuse startups with small businesses. However, one crucial aspect to remember when differentiating the two is that startups aim to bring significant change to the world we live in. They are constructed with one main idea in mind: to become big and impactful.

For our startup to get there, there are a few challenges we need to overcome. The first, and maybe the most important, is understanding how funding works. Following that, we need to understand the type of investors and the difference between them, especially between angel investors and venture capital funds (VCs), since these are the primary funding sources for accelerated growth.

With that said, before getting into the specifics of funding, we must focus our attention on a few facts worth knowing before diving into that topic.

Helping investors help us

As the old saying goes, “the best way to get what we want is to help others get what they want”. Angel investors and VCs are in it for the money they make when the startup’s value grows, and they sell their shares.

Statistics show around 80% of investments in startups end in loss, regardless of how experienced the investors and the startup founders may be. To mitigate the risks, investors do a few things:

1. They only fund startups that look capable of generating 10x the return on investment.

Four out of five startups would generate zero returns, so the successful ones need to cover these losses. Aiming just for 5x would mean the investors would still lose money on their total portfolio.

Therefore, investors aim for startups that look capable of generating 10x the returns. We should apply for funding only after developing our business model to make such returns possible.

2. Funding happens in stages or rounds.

We get to the next round of funding only after we have reached certain milestones. It is important to realize that these milestones have more to do with increasing the startup’s value than achieving some technical results.

Investors are there to witness the value growth. Technology is only relevant in so much as it helps achieve that. Improving the technical quality of the solution must result in the growth of sales, the number of users, or the lifetime value of a customer, just to name some of the more important metrics to keep track of.

3. VCs tend to specialize in certain stages, meaning they know how to best help startups at certain maturity levels.

As the need for financing grows, new VCs must be brought in. Successfully convincing them to invest depends a lot on the quality of assistance received from the existing investors. Therefore, a startup must choose the first investors wisely to help keep the startup on track to achieving those 10x returns.

Most entrepreneurs are tech-savvy. That means that from their perspectives, superior technology would make customers come knocking at their doors. If we want funds from investors, we need to develop a plan to reach the 10x return threshold other than by relying on popularity.

It goes without saying that it’s always an advantage to pursue projects that are in the social limelight, for all the right reasons. However, simply going for a popular project without much to back it up won’t get you very far in an entrepreneur’s eyes.

That is where a good accelerator comes into play – to help guide you through all the hoops that you have to jump in order to make the cut.

While the startup is accelerated, a significant part of the mentoring process focuses on improving the business model and tweaking the technical solution to support the business plan.

A good acceleration program has mentors who boast a significant amount of business experience in the startup’s sectors. They know what it takes for a solution to be successful & popular, and they know what kind of sales effort it takes to get things going with your customers.

Once you’ve considered all of these pre-funding aspects, we can focus on the financial part of the process, which will be covered in our next article.

How it started – a historical brief

When looking to gauge the Romanian investment, funding, and start-up environment, you’ll find that the country has only experienced real, genuine growth in the past two years. After the fall of communism over three decades ago, the country experienced a lukewarm economic development process at best.

Around 1995, the first semblance of a professional rebirthed industry materialized in IT. By 1999 and early 2000s, we saw the rise of a few ISP providers, such as RCS-RDS or Romtelecom, which became long-standing household names.

Why is this important for the topic of our article? Well, that’s because Romania’s modern-day investment environment centers chiefly around IT & software development, which starts making a lot of sense if you happen to know the aforementioned historical tidbit.

Fast forward a few years, and we’re in 2014 and 2015. This period is when we see the first venture capital (VC) organizations take form. Investment phases began being a thing, but the processes of pre-seeding, seeding, or series A seeding were not adequately developed, so investment was very much a wild, wild west area. The sheer volume of investments wasn’t the largest, with approximately 15 investments/year for seeding and around five investments/year for series A or B seeding.

Additionally, since nobody really knew or trusted the system yet, many Romanian start-ups began going abroad for investors. For example, between 2013 and 2015, 6 start-ups from Cluj and Bucharest raised investment funds from Bulgaria.

Moreover, since we’re on the topic of start-up numbers, if we were to further analyze the environment back then, we’d find that the number of start-ups being created was between 300 and 500, with only 100 or maybe 200 of them being considered investment-worthy.

How it’s going – current developments

Slowly but surely, starting with 2017, we began seeing more and more players come into the investment environment, with 2019 and 2020 witnessing an incredible surge, despite the extremely unfortunate Covid-19 outburst.

The major investment hubs align with Romania’s major cities, with the biggest one being Bucharest, followed by Cluj-Napoca, Timișoara, and Iași.

In terms of figures, on the one hand, the number of start-ups receiving investment doubled in 2019 (30 start-ups) and more than tripled in 2020 (54 start-ups).

On the other hand, the number of funding sources has seen unprecedented growth. There are over 14 business angel networks – encompassing over 3,000 business angels and 23 venture capital funds. In addition to this, crowdfunding and bank loans have become staples for start-ups wanting to get their business off the ground.

Now that we’ve caught up to modern times, let us see how the funding landscape looks in Romania by going over the investment phases, what they mean, and some of the average sums floating around.

Pre-seeding

Pre-seeding is the funding phase that occurs before any big investors come into the picture. Traditionally, this phase usually sees a company investing either its founders’ savings or any loans they might have contracted, in addition to any finances received from family, friends, acquaintances, or supporters wanting to help one’s cause.

However, in modern times, we also see several other entities chipping in to help promising start-ups take flight. These entities are either the above-mentioned business angels (e.g., Business Angels Romania, VentureConnect, TechAngels, AngelConnect, Growceanu, RocaX) or business accelerators (e.g., Techcelerator, Spherik, Seed for Tech, Risky Business, Orange Fab, Startarium, Innovation Labs), whose goal is in the name – to accelerate your business.

In Romania, we had 21 pre-seed transactions in 2019 and 2020, with an investment volume of €2.57 – 3.30 million euros and an average investment per transaction of between €122k – 157k euros. A large portion of these sums came from angels, accelerators, or support programs offered by similar organizations, like 0-Day Capital, whose business model seeks partnership within a start-up right from its infancy, offering financial and managerial assistance.

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Seeding

Seeding is the first phase where we begin equity funding, meaning a startup attracts its first big investors, who elect to finance its services/products in exchange for equity. This is also the phase where we begin seeing funding from VC organizations like Gapminder, Gecad, Early Game, 3TS Capital Partners, or Earlybird Venture Capital.

In Romania, 2019 saw approximately 16 seeding transactions, while 2020 experienced a boom, registering 37 transactions. The investment volume for this phase was between €11.37 – 21.87 million euros, with an average investment per transaction of between €591k and 1.1 million.

Other potential funding sources for the seeding phase are equity crowdfunding and private equity funds. The former enables large groups of investors to fund startups in exchange for equity. The latter are investment management companies that provide financial backing and make investments in the private equity of startups or operating companies through various loosely affiliated investment strategies.

It should be noted that private equity groups providing funds for startups is more of an exception than a rule since such groups do not typically invest in startups; however, it can happen!

For example, the Roca group has developed RocaX, a business angel subsidiary that helps out startups.

Equiliant Capital, another group, created by the Dedeman founders, seeks to invest in any industry of any kind, making no exclusions for startups; however, it does exclude the tech industry. While this is a bit odd, it still bodes well for startups in other fields that have what it takes to convince such an organization to invest in them.

When it comes to equity crowdfunding, SeedBlink is Romania’s most prominent source, financing over 26 campaigns worth €8 million euros, out of which more than half came from individual investors.

Series A financing

This phase of the funding process represents the first truly major investments. This is where a start-up has a clean-cut operational framework, has managed to posit itself comfortably on the market, and is making waves among consumers on a large scale, generating a growing stream of revenue and income.

The goals of investors looking to finance start-ups that reach this threshold are the identification and assessment of progress made by a company using its seed capital and the efficiency of its management team. Additionally, investors will also inspect how an organization manages its currently-available resources to generate profits in the future.

Basically, this is the part of the financing process where a VC company goes, ”Yeah, you could probably go global and blast competitors out of the water. We’re on board with that!”.

In Romania, not many start-ups have reached this phase. In 2017, UiPath – a robotic process automation (RPA) company, became the first Romanian start-up to get series A funding. In 2019, FintechOS – an open-source financial technology firm, also achieved the same status. In 2020, TypingDNA – an AI-based solution for risk-based authentication and fraud prevention, was the third Romanian start-up to reach series A, raising €6.2 million euros.

In 2021, UiPath managed to reach series F funding, raising $750 million dollars.

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Success stories

Investment doesn’t usually stop at series A. Typically, especially in larger environments, such as the US, many start-ups enter series B, C, D, and so on. How well a company handles its newly-found influx of income determines whether it will manage to go to the next step or stagnate.

Now, stagnating isn’t a bad thing in this case. Many start-ups want to reach a stage where they can comfortably service a specific number of customers. While this may come as a surprise, not every company wants to go global. Many want to stay local or regional while maintaining good ROI numbers.

• Blugento is an e-commerce platform that has managed to raise €1 million euros from the Polish IT group R22 in exchange for a 31% equity stake. It aims to expand into central Europe, after having grown its revenue ten times in 3 years and is valued at around €4 million euros.
  

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• Questo is a Bucharest-based start-up that created a mobile city exploration game, which features over 40 European cities. Questo is currently valued at $1.5 million dollars and plans to expand its game to include some of the largest cities in Europe, including London, Paris, Berlin, Amsterdam, and Barcelona.
  

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• Jobful is a gamification-based recruitment platform that has completed its first angel investment round, receiving €100k euros. Jobful represents an intelligent middleman between young professionals and companies who want an efficient recruitment process that provides them with an initial test sheet of a candidate’s skill setup and interests. This initial investment will be used to launch a mobile app for the platform and further develop its capabilities.
  

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• Beez, a cashback service company, received a €1.2 million euros investment from RocaX and Gapminder to facilitate growth and expansion beyond their current cashback service.
  

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• Flip, a second-hand verified smartphone marketplace, received €250k euros investment from Gapminder, V7 Capital, and a group of private investors. This is the second round of investments that Flip raises. The first one raised €120k.
  

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• Telios, a telemedicine start-up, received $200k dollars investment from Transylvania Angels Network, Growceanu, and TechAngels.
  

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Final thoughts

Raising funds for your start-up has become more accessible and more difficult at the same time. On the one hand, companies now have access to an ocean of funds available to them compared to previous years. Money is no longer a stopping point.

On the other hand, you only get access to the funds you want if you have a well-laid-out plan for your ideas.

The Romanian investment environment has much of the same characteristics as any other investment environment. You follow the same steps, and you generally have access to the same funding sources, whether we’re talking business angels, accelerators, support groups, or VCs.

The actual difficult part is finding those people who possess both the funds and the knowledge to help you grow sustainably, enabling you to reach seeding easily and potentially even series A funding.