Every business person knows that apart from having a good business idea, finding the perfect office location, building a customer base, and so on, you need money to sustain and grow a business. Even if you had a lump sum of money cached somewhere, the costs of running and scaling a business will deplete it. In order to continue to scale and grow, the business might periodically need an infusion of funds from external sources. These periods are called funding rounds.
In the past, entrepreneurs had limited options when trying to raise capital for their businesses. They either took bank loans, patronized the so-called ‘loan sharks’ or attempted to reach out to a small circle of well-placed individuals in the society. Fortunately, in more recent times, there has been an increase in available funding for startups at different stages. They are the Pre-seed, Seed, Series A, Series B, Series C, Series D and IPO stages of funding.
Each round is designed to give entrepreneurs or founders enough capital to take their business to the next level of growth. Founders give equity in their company in exchange for capital from investors. At every stage, the founder must evaluate where his startup stands and how much capital he needs to raise from external sources.
Stages of Startup Funding
As earlier said, there are 7 common funding rounds/stages for startups. They are briefly discussed below:
This is also known as the bootstrapping stage. Technically, it is not a startup funding stage because it is the primary capital base on which the company begins. During this stage, the startup is still in its infancy and the business rules and strategies are still being determined. The founder(s) may already have a working prototype of the product and are in search of enough capital to launch full time operations.
Funding at this stage is generated internally from the FF&FS (Family, Friends and Founder/Co-founder). Jonathan Patrick, a startup investment expert, says it is good practise to treat your initial investors (well-meaning relatives and friends) as you would outside investors. Prepare a pitch/projection, do a presentation for them, give them equity in the company or a promissory note, go through due diligence, etc.
During this developmental stage, the founder might have to work overtime or take a second job to raise more money to invest in the startup. He also seeks advice from more established startup founders on what to expect and how to go about it.
This is the product development stage and the first stage of actual external funding. Mark Suster, an entrepreneur-turned-investor says the single biggest mistake founders make is waiting until they have too little cash in the bank before fundraising.
Seed funding allows the startup to fund the costs of launching the product, doing market research, hiring employees, and achieving a product-market fit. Sources of Seed funding include family members, friends, angel investors, early stage venture funds and crowdfunding.
This is the first round of venture capital financing. By now, the startup should have a well-developed product, a refined working business model and a substantial customer base, with consistency in income flow. This is the ideal time for the startup to scale themselves in the larger commercial market. It means it is ready to optimize its value offerings and go for a Series A round of funding.
At this stage, it is very important that the founder has a plan that will generate long p-term profits. Investors and traditional venture capital firms are not quite as interested in your business idea, as they are in profits they hope to make on their investments. If the founder follows the 30-10-2 rule, he must find 30 willing, potential investors and out of that number, 10 might show interest in the business proposal and at least 2 will give out the needed funds. Potential Series A investors include Accelerators, Super Angel Investors and Venture Capitalists.
After passing through the first two stages of funding, it is expected that the startup has already developed a substantial user base and a steady stream of revenue. It has now to the last-stage investors that it can achieve success at a larger scale.
The series B funding stage allows the startup to grow enough to meet the various demands of their customers and also compete favorably in a stiff market. Investors at this stage assist startups to expand their horizons by funding their market reach activities, increasing their market share, funding operational teams such as marketing, boosting business development and customer success.
While Series A and Series B look similar in terms of key players and the processes involved, Series B focuses on attracting the attention of a new flock of Venture Capitalists that specialize in investing in well-established startups so that they can achieve further scalability.
Startups at this stage are already on the path to established growth and are in search of more funding to help them build new products, reach new markets and perhaps buy underperforming startups in the same or similar industry. At this stage, investors happily dish out the money and are hopeful to receive a profit that is higher than the money they invested. This stage focuses on scaling the startup as rapidly as possible.
The risks of investing in the startup at this stage are greatly reduced as it has already proven itself to be an operating success. New investors are eager to jump in by investing a significant amount of money into thriving startups to secure their own positions as leading investors. Potential investors at this stage are late stage venture capitalists, private equity firms, hedge funds and banks.
Most startups do not need to go to this stage. The stage allows entrepreneurs raise funds for a special situation like when contemplating a merger or going public. Also, if a startup was unable to achieve landmark growth with Series C funds, it will need more funds through series D funding to keep afloat.
IPO (INITIAL PUBLIC OFFERING)
IPO is the process of offering corporate shares to the general public for the first time. Growing startups that need more funding often use this process to generate it, while more established organizations use it to allow startup owners relinquish some or all of their ownership by selling the shares to the general public.
Apart from raising funds for the startup, IPO helps the organization raise additional funds through secondary offerings, since it already has access to public markets. Also, many public organizations compensate its executives through stock and this is more attractive, particularly if the value is on an upward trend. A public also has the advantage of recruiting better talent due to perceived trustworthiness. Mergers are also easier for a public organization as it can utilize public shares to acquire another startup.
In conclusion, the valid startup funding stages allow entrepreneurs to scale their startup at any stage of their entrepreneurial journey. This scaling practice allows them to identify where they need external investors in order to help them grow.