Even though it’s much cheaper to create companies nowadays — especially those based on the Internet and mobile platforms such as Apple’s (NASDAQ:AAPL) iOS and Google’s (NASDAQ:GOOG) Android — those companies still a need to raise capital. And that process has changed little over the years.
There are essentially four major steps. The first three happen when a company is private: seed, angel and venture rounds. The final type of financing is the IPO.
How does each one work? Let’s use Facebook as an example:
This is the initial capital for a company, and it is usually a small amount, say, $1,000 to $50,000. As the old saying goes, this money comes from three sources: friends, family and fools!
When Mark Zuckerberg started Facebook in his dorm, he needed capital to pay for the hosting costs. A month after the site launched, he got $15,000 in seed funding from a classmate, Eduardo Saverin.
However, the relationship deteriorated and Eduardo froze the bank account. To keep Facebook afloat, Mark and his father had to invest an additional $85,000. Yes, there is usually lots of drama in a company’s early days.
An angel investor is a wealthy person who invests in early-stage companies. There are some who are known as “super angels” because they have tremendous experience in a particular industry and are often extremely wealthy. A typical angel round will be $100,000 to $1 million.
Facebook raised $600,000 from super angels. Peter Thiel invested $500,000 (he was the co-founder and CEO of PayPal). Mark Pincus, co-founder of Zynga (NASDAQ:ZNGA), and Reid Hoffman, co-founder of LinkedIn (NYSE:LNKD), invested $40,000 each. Several other employees invested in this round as well.
Zuckerberg had to deal with complex securities laws, such as not advertising the funding and soliciting only sophisticated investors. However, with the recently passed JOBS Act, the process is much easier. Now a company can raise money using a website, which is known as “crowdfunding.”
A venture capital (VC) fund has various managers who invest a large pool of money across a portfolio of companies. In the first round, the amount is usually $5 million to $10 million.
In April 2005, Facebook raised its first round of venture capital from Accel Partners (there was also participation by Pincus and Hoffman). In all, the company raised $12.7 million.
In some cases, a company will look for a strategic investor. This is basically a large company that may provide benefits such as distribution for the product. Facebook received $240 million from Microsoft (NASDAQ:MSFT), which was to to help the social network move into global markets.
This is when a company sells shares to the public. In an initial public offering, a company will raise anywhere from $100 million to $200 million.
But some companies may have huge offerings: Zynga raised $1 billion.
While Facebook has yet to come public, the deal is expected hit the markets within a month or so. The buzz is that it will raise over $10 billion.
Tom Taulli runs the InvestorPlace blog IPO Playbook, a site dedicated to the hottest news and rumors about initial public offerings. He also is the author of “The Complete M&A Handbook”, “All About Short Selling” and “All About Commodities.” Follow him on Twitter at @ttaulli or reach him via email. As of this writing, he did not own a position in any of the aforementioned securities.