Also, it helps increase the organization’s visibility and attracts market attention. Startup financing requires raising funds from different sources, including; personal savings, venture capital, Government Programs, banks, and Initial Public Offerings, to mention a few.
Though, startup founders should understand that raising startup funding is never easy and usually takes longer than anticipated. Though, understanding your different financing rounds is essential for success. Young, developing companies have to go through several funding rounds to prove the worthiness of their business model and product.
During each funding round, valuation is evaluated independently. Now, let’s cut to the chase and take a closer look at various funding rounds and examine what sets them apart from one another.
Startup Funding and its Stages
Emerging startup companies raise capital through different funding rounds. Each round represents a letter that identifies the number of the stage an organization is on.
These startup funding stages are:
Pre-seed funding stage
Pre-seed fundraising is an investment in an idea or a product that has yet to find its market. Investors considered it a gamble on a big idea having equal chances of success and failure.
The budding entrepreneurs often find themselves in problems while pitching to investors as they have little to back up their claims. Startup founders raise capital at this stage to demonstrate whether a product can fulfill the target market’s needs.
According to an estimate, pre-seed funding usually amounts from $50,000 to $250,000. Also, investors reported that pre-seed funding lasts 12 to 18 months from the day startup founders have started their venture.
Moreover, Docsend states that 25.5% of founders close a pre-seed round in 1-6 weeks, 44% take between 7-18 weeks, and the rest take 19 weeks or more.
Sources of Funding:
1) Your Own Money
2) Angel Investors
3) Pre-Seed VC Firms
4) Rolling Funds
5) Accelerators & Incubators
6) Equity Crowdfunding
7) Friends and family
Seed Finance
Seed finance is the initial capital collected by startup founders to get their business off the ground. Entrepreneurs use seed capital to support the company’s initial operations, including; market research, product research and development (R&D), and business plan development.
This early-stage funding can be the riskiest bet an investor can make as the company has not yet proven itself within the market. However, the seed investor invests money after ascertaining a startup’s potential and verifying “product-market fit.”
According to Marc Andreessen, Founder of Andreessen Horowitz, “Product/market fit means being in a good market with a product that can satisfy that market.” Moreover, the amount of seed finance depends on the valuation of a startup. Thus, investors expected to yield returns in multiples by getting a stake in the business.
Sources of Funding
Recently, venture capitalists have moved into seed rounds more aggressively, and the size of seed rounds has increased overall. Here are some common types of seed funding:
● Crowdfunding
● Corporate seed funds
● Incubators
● Accelerators
● Angel investors
● Personal Savings
● Debt Funding
Example:
One of the most prominent examples of the best investors’ bets in startups that returned the fund is American entrepreneur and venture capitalist Peter Thiel’s investment in Facebook.
He invested $500,000 in 2004, becoming the first significant outside investor in thefacebook.com. Once you have obtained the seed funding, the budding startup has to go through a series of funding rounds to scale its business.
Series A Funding
The series A round is the second step of startup funding after the seed round. Venture capitalists define the Series A funding round as the class of preferred stock sold and the first venture capital funding for a startup.
Here, the developing companies aim to scale their business and demonstrate their potential to investors to tap into a big market.
In Series A funding, valuation holds great importance because it helps in the decision-making of equity in exchange for requisite funds.
While assessing the overall performance of the startup in the Series A round, venture capitalists put importance on the following parameters:
● Past Records of The Firm
● Company’s development with its initial funding
● A promising business strategy
● Financial record
● Valuation of idea
● Customer acquisition cost
● Final product
● Management team
The primary funding comes from venture capitalists and private equity (PE) firms. They are wealthy investors who actively invest capital in early-stage startups with a long-term growth perspective.
Here are some of the prominent early-stage investors:
● IDG Capital
● Sequoia Capital China
● Accel
● Y Combinator
● Sequoia Capital
● Intel Capital
● Index Ventures
The benchmark for series A round varies across industries, but the startups usually set a goal of raising between $2 – 15 million dollars.
According to a UK Startup database, Fundz, the mean of a Series A funding round is calculated at $22.2 million for 2021.
It shows a significant increase from $15.6 million in 2020, a 30% increase. As of 30th May 2022, the mean Series A estimates at $23.3 million.
Series B Funding
Series B is the second round in venture capitalism after Series A funding. The main objective of this stage is to assist established businesses in further increasing their presence in the market, managing teams, meeting customers’ needs, and improving scalability.
Given that the firm has achieved specific milestones in building up its business, investors have high expectations from the companies seeking capital at this stage. Thus, making this phase more challenging. Venture Capitalist at Redpoint, Tomasz Tunguz, regarded Series B funding as the most challenging round for a startup company.
The investments in Series B funding rounds are often higher. According to Fundz, an analysis of 38 Series B deals in June 2020 showed the mean Series B in the U.S. to be $33 million; the median was $26 million.
Also, Fundz reported that Series B startups have a median pre-money valuation of around $40 million in 2021. This middle-stage financing round is funded by venture capitalists, crowdfunded equity, private equity investors, and credit investments.
Often, early investors from Series A financing continue funding the startup in the second round. The but by receiving preferred stock as compared to common stock.
Here are top key VCs that invest in Series B rounds:
● Google Ventures
● New Enterprise Associates
● Kleiner Perkins Caufield & Byers
● Khosla Ventures
● General Catalyst Partners
Series C Funding
In Series C funding, successful companies in their late stages of development raise capital during the fourth stage of the venture capital financing process.
The main objective of these companies is to expand into new markets, develop new products, or acquisition of other companies. Companies that raise capital in this round of investment are usually well-established and therefore, regarded this phase as the last stage of venture capital financing.
However, some companies do undergo more rounds of financing to raise their Series D, Series E, Series F, and even Series G before the company goes for an IPO. In series C, the following investors are interested to finance the organization keeping in view the successful track of business, the low risk, and proven business plan.
● Private equity firms
● Hedge funds
● Investment banks
● Past venture capitalists
According to Fundz’s analysis of 14 Series C deals in the U.S. in June 2020, the mean Series C round was $59 million; the median was $52.5 million. Also, the median pre-money valuation of a startup receiving Series C funding is currently around $68 million.
Moreover, the average Series C funding amount is generally between $30 and $100M, settling on an average round of $50M.
Initial Public Offering (IPO)
Initial public offering (IPO) is a stage in startup financing where a company issues common stock or shares to the public for the first time.
In this phase, the unlisted company sells new or existing securities to the public.
Growing startups that need funding often use this process to generate funds and boost the company’s public profile. Following an IPO, the company trades its shares on a stock exchange.
After listing on the stock exchange, the company becomes a publicly-traded company whose shares can be traded fly in the open market.
Many startup owners retire or become angel investors after they’ve gone public.
A private company planning an IPO has to file a ton of paperwork and financial disclosures to meet Securities and Exchange Commission (SEC) requirements. Therefore, the company hires an underwriter, usually an investment bank, to consult on the IPO and help it set an initial price for the offering.
Once the company has set an initial price for the IPO, the underwriter issues shares to investors, and the company’s stock begin trading on a public stock exchange, like the New York Stock Exchange (NYSE) or the Nasdaq.
Final Thoughts:
Startup financing is challenging when entrepreneurs lack adequate knowledge of the market and an effective business plan. The strategic plan involves identifying a business’s financial needs demonstrating when it requires the money and how much it requires.
Simultaneously, knowing the different stages of financing in the startup cycle and how it works will help you understand the role of different types of investors in funding promising companies. It will enable you to make a well-informed decision while deciding on sources of finance.
To further determine how much funding will you require to get your startup off the ground, you will need the next article to describe available financial resources and how to choose the right one. Furthermore, financial experts at Numberly help emerging entrepreneurs manage their ventures with the right financial wisdom and insights.
If you are an aspiring entrepreneur looking for clarity, business intelligence, and a customized business model for your business, get in touch with us and book a no-obligation consultation session.
