Learn about the different stages of funding and which one will help your startup.
Funding is often among the most important elements of building a successful startup, which is why a lack of access to capital can be a primary reason that startups fail in today's market. Startups often seek funds throughout every phase of building a company from the formation of an idea to a possible listing of an IPO.
While some entrepreneurs with a brilliant idea for a business have enough cash flow to get up and running and a network of high-value connections, any future growth will likely require additional capital to fund necessary resources to build a successful startup including a workspace to build your business, equipment and facilities to prototype your ideas, and access to marketing resources. Since your customer base will be low when you're just starting out, it can be difficult to bring in funds through revenue alone. By obtaining funding for your startup as opposed to trying to grow your company with a limited cash flow, you'll be able to effectively increase your access to capital and resources allowing your startup to grow.
Even though investors who provide you with funding will often expect positive returns on their investment, this approach is still highly typical of a high growth potential startup. There are several different types of funding rounds open to you, which extend from pre-seed funding to Series C funding (and beyond to D and E rounds -- which will not be covered in this article as they are not as common as the following funding rounds).
Before you get involved with your financing rounds, it's important that you learn about the different stages of funding to better determine which ones are applicable to your startup.
While not used by every startup, the first stage of funding that startups have access to is referred to as pre-seed funding. Since this is the very first stage of funding, it may not always be necessary for your startup. When seeking funding at this stage, most participating startups will consist of only a few team members or sometimes just the founder of the company themselves. The focal point of this stage of development is the creation of a proof of concept or prototype. This funding could also help you hire a team member who could assist you in growing to the next stage of funding.
While the money used for pre-seed funding can come from incubators or angel investors, the main sources of funding at this stage typically includes friends and family. Some of the money that's used to fund a pre-seed stage can come from the founder of the startup. In most cases, these investments will be small and will only be necessary to help you complete an initial phase of growth. The average funding amount for this stage is well below $1 million and can be as low as $10,000.
Since your startup will likely be in its initial stages, it's important that you don't try to obtain too much capital early on in this process. Larger investors will want a return on their investment or equity in your company, which is something that you likely won't want to promise at such an early stage.
The seed round of funding can be essential for a startup and may allow you to grow to a point where you can begin to raise additional funding through the more common forms of Series A, B, and C funding. This funding is designed to help startups move past their initial stages of concept development and into product development or even early stages of revenue generation.
When you obtain seed funding for your startup, you'll also want to think about expanding beyond the founding team for your company. It's at this stage of funding when investors will begin to have some initial expectations for your startup. These expectations can vary substantially depending on the type of product you're developing and what kind of business you're looking to bring to the market.
When an investor provides you with some much-needed funding during the seed round, they will likely want you to display clear signs of market or product fit, which means that you will need to understand how your service or product fits into a certain market and if this product addresses the needs of customers within that market. You could show prospective investors that you're experiencing growth in your month-to-month revenues or that the wait list for your product has been growing substantially. While these signs will help you obtain seed funding, they are also essential for later rounds of funding.
In the vast majority of instances, angel investors will provide funding during this round. However, the ever-growing aspect of startups has caused larger venture capital firms to provide seed round investments from time to time. As such, the average amount of capital involved in this stage of funding can differ substantially.
If you're receiving funding from an angel investor, you can expect anywhere from $50,000-$200,000 at this stage. However, venture capital firms provide around $1.5 million. While this may seem like a substantial sum of money, you should be wary of seeking funding from a VC firm at this stage due to the expectations that often will come with it. Most startups that seek funding at this stage have a valuation of anywhere from $3-$6 million.
Series A funding is focused almost entirely on revenue growth. At this point in time, it's essential that your startup team has displayed how your service or product will fit into the market. The data you obtain while conducting research pertaining to the market viability of your product will help you determine how much revenue growth you should be showing. The evidence of a strong market fit that you've built should also translate to substantial revenue growth via new customers.
The sales numbers of your service or product are key to Series A funding. Before this stage of funding, the growth for your startup will come from a single channel that often won't be scalable at this point in time. If you want to continue to grow at an accelerated pace, it's important to create new marketing and sales processes while also identifying any new channels for revenue that you could tap into. Before your startup applies for Series A funding, you should be very aware of what your target audience is. By this point in time, your business will likely have gone through an extensive amount of scrutiny by potential investors, which means that you need to have a high potential to successfully enter a large market.
The funding that you raise at this stage of your startup should be used to bring your business model to fruition. The most common elements of growth during this stage involve developing products, performing some initial branding and marketing, and conducting some early-stage operations for your business.
While angel investors can invest in a startup at this stage, venture capital firms are the main investors of Series A funding. The amount of investment that's typically involved in this stage of funding is just over $10 million. Often startups fail at this stage because they have difficulty convincing prospective investors that their business concept will make for a success long-term high growth company.
The valuation for your company at this time should be anywhere from $10-$30 million. If you're able to get through the Series A funding stage, your startup will have a much higher chance for continued success.
Series B funding is sought when your company has already proven market viability and now needs to expand. Even when you're bringing in a substantial amount of revenue, this increased cash flow may not be enough for you to expand quickly under an appropriate timeline. In the previous rounds of funding, you will have used the money that you gained to formulate a promising idea, display how your idea fits within a market, gain early traction with customers, and show some initial signs of substantial revenue growth.
Make sure that you don't take these first signs of success for granted. Many startups tend to reach this stage and then breathe a sigh of relief. However, growth is more important than ever at this stage of your startup, which is why it's important that you look for ways to expand.
The Series B investment that you receive can help you expand in a variety of ways. If you'd like to expand through the types of employees you hire, optimal areas of expansion for new hires include marketing, business development, and strategic accounts. You could also think about expanding into different market segments, which could open up your business to many more customers.
A more aggressive means of expansion from your Series B funding involves buying out a business that provides you with a competitive advantage. The amount of capital that's usually provided with Series B funding is around $15-$25 million. Most of this money is provided via venture capital firms, which includes firms that are focused solely on late-stage startups. Your previous investors may choose to reinvest at this point in time, while your company should have a valuation of $25-$60 million.
The (often) final stage of funding is referred to as Series C funding. If you've reached this stage of funding, it's likely that you've been able to convince investors that your business will achieve long-term success. This funding is primarily sought when a startup wants to take part in large-scale expansions.
These expansions typically involve moving into a new market or acquiring other businesses that you believe are invaluable towards the future success of your company. Startups that want to expand into a new market at this stage are usually looking to expand into international markets, which is why such an extensive amount of funding may be necessary.
Keep in mind that other rounds of investment are possible following the Series C funding round. These additional rounds of funding don't have a widely-accepted label because the amounts of funding and reasons for funding can differ substantially.
If you've reached Series C funding, your company has clearly displayed that it's here to stay, which means that there's typically less risk for investors to fund your business. Because of this low risk, you'll begin to see financial institutions provide funding, which includes hedge funds, private equity firms, and banks.
The average funding amount at this stage is right around $50 million. The amounts, however, have been much larger over the years, which is displayed by the fact that the Magic Leap startup received $800 million of Series C funding in 2016. The standard company valuation of a startup at this stage is around $100-$120 million.
If you want your startup to become successful and maintain success, funding rounds are often going to be essential. Before you schedule any meetings with investors, you must be prepared to prove to these prospective investors that you're ready to take your business to the next level.