Benchmarks & Definitions

The Chilli Startup Definitions™

The importance of defining your status before raising funds

By Bipin Parmar

The two most valuable things for an entrepreneur are time and money. At The Chilli, we pride ourselves in helping entrepreneurs, advisors and investors in making better use of their time by reducing the amount of time it takes for an entrepreneur to effectively communicate their status and requirements to potential investors and advisors. For potential investors, The Chilli aims to make their time more efficient by categorising startups into defined states, so that they can both filter and concentrate on companies that meet their current and future investment criteria.

1. Defining the different types of company

2. Startup stages

i.Chilli S1

ii. Chilli S2

iii. Chilli S3

iv. Chilli R1

v. Chilli R2

vi. Chilli R3

vii. Chilli Pre-Ex

3. The Chilli university spinout definitions

i. Chilli USO1

ii. Chilli USO2

iii. Chilli USO3

iv. Chilli USO4

1. Defining the different types of company

The Chilli definitions outlined below make it easier for advisors to position themselves in one or two distinct categories, where they can add the most value. For university spinouts (USO), we define the different stages so that external organisations can readily identify the level of progress a USO has made and where they can add the most value. The definitions were derived from research carried out by analysts at The Chilli, as well as feedback from many of our readers, who are entrepreneurs, advisors and potential angel, venture capital and corporate investors.

The aim of The Chilli definitions is to make communication between all parties more effective and succinct. We hope to remove much of the inordinate amount of wasted time, trips and expenses incurred due to misunderstanding the meaning of loosely defined terms like early stage startup, where each person's definition and understanding is different and sometimes contradictory. Loosely defined terms sometimes create huge problems for both entrepreneurs and potential investors. An extreme real-world example was where one investor's understanding of 'early stage' was a company with a product and one or two customers, while others understood it as meaning one with patents filed, but no customers, or one with a product but no revenue.

We do not expect all the companies to neatly fit into our pre-defined categories, but we hope they will be able to identify their status closest to our definitions.

The Chilli's experience has shown that the sector preferences, risk acceptance/aversion and readiness to sign term sheets of any potential investor are ever changing. Investors may hesitate to box themselves in any one category, but the lack of transparency is not only frustrating for the potential entrepreneur seeking new funds, but counter-productive for the investor in the long-term, as entrepreneurs and founders are going to use market networks and their own contacts to draw the wrong conclusions, thus depriving many investors of a lucrative investment opportunity.

Our aim is to define the current stage of the company and the rationale behind it seeking to raise new funds and their use.

2. Startup stages

Chilli S1 (seed stage 1)

A company or an individual who has developed a concept and carried out preliminary market research, which needs S1 funding to develop an effective business plan, and register the company.

Chilli S2 (seed stage 2)

A company that has researched and developed an initial business plan, and needs S2 funding to create a model or a demonstrator (but not a working prototype yet), validate the business plan with detailed financial analysis, identify the founding team (but not recruited yet), and research and prepare (but not file) key patents.

Chilli S3 (seed stage 3)

A company that has validated its business, product or service strategy with one or two prospective customers by successfully demonstrating a model and needs S3 funding to fully develop a working or functional prototype, recruit one or two additional team members or pay subcontractors, and file the initial paperwork for key patents. The company will have also started but not fully engaged external corporate finance and legal advisors in order to prepare for the first round VC funding.

Chilli R1 (round 1 - series A)

A company that has successfully demonstrated its model or prototype to potential customers, partners, and needs R1 funding (and issue series A preferred convertible shares in return) to fully develop the product or service, which can be delivered to pilot customers for sampling, evaluation and design-in. The R1 funding will pay for the required infrastructure like lab, capital equipment, tools and facilities including the personnel cost of the core team and sub-contractors. The R1 funding should be sufficient to pay for minimum sales, marketing and finance/admin personnel, to facilitate the agreed R1 milestones such as signed number of pilot customers, partners, number of staff and patents. The company may generate some nominal revenue from its pilot activities.

Chilli R2 (round 2 - series B)

A company that has successfully developed its first product and/or service and acquired the first few pilot customers and partners. R2 funding is required to convince more potential customers, that sufficient capital is available to fulfill the terms of the orders or contracts. R2 funding will also allow the company to expand its sales, marketing, customer support, finance and admin personnel, as well as expand its markets, products and services. R2 funding is intended to allow the company to reach a break-even position and achieve a critical mass of customers and market presence.

Chilli R3 (round 3 - series C)

A company that has reached a critical stage with its products, services, customers, and market presence and needs R3 funding to consolidate its resources and market presence. R3 funding will allow a company to make a potential acquisition and/or seek merger with a bigger organisation, or alternatively position itself for a successful exit via trade sale or initial public offering (IPO) via listing on a recognised share exchange such as the LSE or NASDAQ.

Chilli Pre-Ex

A company that has successfully attained the pre-requisites for a successful IPO or trade sale. Pre-ex status can coexist with any one of the R1, R2 or R3 phases, depending on market sentiment.

3. The Chilli university spinout definitions

In order to provide a better understanding and a draw a fine line between academia and the commercial world, we have characterised university spinouts into specific categories. It may come as a relief to the academic world to know that 70 to 80% of a commercial company's own research never gets commercialised or exploited. As in the academic world, the commercial company's research department competes for scarce resources and only a few ideas (or those closest to realisable profit) get the necessary funding and support to take ideas out of the labs and through the development department for transformation into commercial products. As a reflection of the commercial world in the academic world, all ideas go through a series of defined stages. For background to this definition see article 'University Spinouts - an Alternative View'.

Chilli USO1 (stage 1 - science project status)

A concept, piece of research, or a laboratory project, which is under the supervision of academic staff and needs articulating such that it can be presented to the university's technology transfer staff or external parties to support further preparation for USO2 (stage 2). The USO1 activity will mostly be supported internally.

Chilli USO2 (stage 2 - technology project status)

An initial patent filing and/or the protected publication of a paper in a relevant journal. Documentation, papers, or presentations in a language that could easily be understood by the non-academic community, such as r & d, marketing and business development managers at commercial organisations. A clearly defined market space or sector, in which the idea or assertion can be exploited. USO2 activities will be mostly funded by internal university resources or Government grants.

Chilli USO3 (stage 3 - commercial feasibility or service)

A feasibility study to check the potential for converting the technology project into a commercial product or service, identifying its business potential, providing a detailed business plan, including financials, headcount and capital resources required, skills, milestones and roadmap of how the technology can be converted and exploited in the form of product or services to successfully reach USO4.

A USO3 company will also have identified potential external partners that may co-fund and/or license the technology. The final result of a USO 3 company would be similar to a Chilli S3 company, which can secure external Chilli R1 funding to fully develop the product or service. A USO3 company would have been set up as a separate legal entity, with the rights to exploit the technology, patents and ability to seek external relationship for both funding and commercial contracts.

Chilli USO4 (stage 4 - profitable and sustainable advantage)

A successful USO4 company would have secured external Chilli R1 funding, developed first IP, product or service, which can be sold or licensed to commercial organisations. It would be fully independent from the university, although the university would have a sizeable share of the equity and may elect to have board representation.

A USO4 organisation will be run on a purely commercial basis, and would be open to merger and acquisition activity, perhaps partnering with other universities if required to meet objectives. At this point, the majority of the staff will be domain experts from the private sector, and some academic staff will have to decide whether to exit the company to return to academia, or stay on and be measured on a commercial basis. The USO4 organisation will have its own facilities, and there will be some revenue generated.

The vast majority - more than 90% - of university ideas will start as USO1, namely science projects, that can be demonstrated externally in USO2 and converted into working prototype in USO3. The secret to building a sustainable endowment fund is to increase the number of projects in the USO2 category, such that they have a higher chance of reaching USO3 and USO4 positions. In most cases the university will need relevant, external domain expertise to assist USO2 companies to move to USO3 status, and external Chilli R1 funding to reach USO4 status.

Comments on this benchmark/definition? Send an e-mail to Bipin@theChilli.com.

© Chilli Publishing Ltd 2003

07MAY2003