Let’s put our imagination hat on for a moment. You have launched the startup of your dreams. The customers are loving what you have built and you are getting a lot of love on social media. But there is a problem: the revenues are low and you need to spend more on marketing, advertising, and operations. You have already exhausted all your savings. What do you do next? Sell your house, or is there another way?
Raising funds adds stakeholders to your startup and increases the legal requirements. Most founders want to avoid that, but find themselves in a place where it is the only option. In this article, we will try to understand the different stages of a startup and the corresponding funding options available at every stage.
What are the funding options for different stages in the startup journey?
Startups can require funding at any stage to prosper and achieve their goals. Different stages require different funding types depending on the company’s nature and progress. Here are the typical stages in the startup lifecycle.
Family and Friends
Startups at early stages can always go for a family and friend’s round to raise funds after they have tried bootstrapping. A founder at this stage might just have an idea that they aspire to build into a functioning product. Founders must share their brilliant idea with their friends and family and ask them to invest. In this case, it is all about trust and convincing your friends and family about the profitability or future growth of your startup. The investment might be small but can be used effectively to shape an idea and validate it against market needs. This initial investment can be raised based on equity or debt, based on whatever works perfectly for the founder and the investor.
Next comes the pre-seed stage. This is required when a startup decides to kick off its operations. But most importantly pre-seed investment is raised based on the idea and its product-market fit. In most cases, founders start developing the MVP or prototype to be able to get a clearer picture of the product-market fit and idea validation. Pre-seed usually consists of raising the initial cost of setting up a business idea or developing a product successfully.
Startup founders get funds from angel investors for the pre-seed stage. Why are these investors named angel investors? It is because they choose to invest in early-stage startups despite having a higher risk of failure. Finding angel investors is relatively easy, it mostly takes a good PR to find one in your circle or at startup events.
During this round, founders can get $50,000 to $200,000 for an equity stake of 5% to 10%, which is enough to develop an MVP. Having just a validated idea and an MVP development plan, this round is the riskiest one, and only the ones who truly believe in you might offer to invest. To convince investors, founders need to come up with a persuasive pitch deck that explains what problem their startup solves, the idea, and the product-market fit.
Seed funding is often declared as the first official capital raised by a startup.
Just as the name suggests, seed after the pre-seed stage is used to nurture and strengthen the product as well as the business strategy of a startup. This funding is meant to finance the early stages of converting an MVP into a fully high-functioning product.
Investors at this stage expect a startup founder to share the ultimate idea, the developed MVP, and its progress. In case an MVP is not developed yet, a founder can surely convince the investors by sharing how much time has he or she invested in the project. However, if the MVP is ready, the only thing that can convince investors is numbers and calculated revenue growth. Investors at this round are only interested in a startup’s current traction and growth possibilities.
To convince investors for the seed round, a founder must pitch the business model, its market fit, the challenges, the audience, and the current traction. A founder must share accurate facts and figures related to product progress and revenue growth. Besides, investors need to know everything that has been cooking at a founder’s end and what good can a company be to them. Most companies raising a seed round are valued at around $4 million to $8 million. Whereas equity of 10% to 25% is given off during the seed funding rounds, however, this can vary on multiple factors. These factors include the competition, nature of the product, founder’s expertise, market maturity, growth strategy, etc.
To sum it all up, the seed round is raised by startups to successfully launch and acquire users via effective marketing strategies to penetrate the market. A few common sources of seed funding include accelerators, incubators, angel investors, and venture capital firms.
Series A funding is for startups that are up and running successfully in the market but now want to optimize their product and launch new updates or userbase. Startups often manage to pull off profits after seed rounds but soon lose track of the monetization strategy. Many startups today like Uber are not profitable but are running and expanding globally.
Startups going through Series A funding rounds are valued at around $24 million. The round sizes however differ as per geographic market size. Series A in the US is between $2 million to $15 million, whereas, in China, the rounds go beyond this value. During this round, most investors lock the deal at a 20%-35% ownership stake.
Investors interested in Series A funding look for companies with great ideas and strong business models to convert an idea into a money-making business. At this stage, investors come from traditional venture capital firms, making the process much more political.
Venture Capital Firms are limited liability companies that invest in startups in exchange for equity. These firms are focused on funding startups that bring out a higher return on investment for their set of investors. In most cases, VC firms actively hunt for worthy startups, but one can always find them at startup events.
For series A it is expected that a startup is running with a 3X YoY growth in terms of revenue. Not just this, by this stage, a founder must have a solid team and have taken over more than one big market. The consumer market must recognize the product and the product itself must be capable to scale with the latest technology available.
One step ahead, Series B is aimed to streamline business development, a much-improved user base, a better team, marketing, and customer support after the product demand has significantly increased. Startup founders seek Series B funding to boost sales and scale the development efforts to optimize the product effectively. At this stage, founders are meant to raise capital for taking their business to the next level, past the development stage but to optimize the product better.
Most Series B companies are valued between $30 million to $60 million. During these rounds, startups can raise around $7 million to $10 million at a 20% to 35% ownership stake.
Series B investors pay higher than Series A investors because companies at this stage require more funds to grow their teams to meet consumer demand. The reason is a better consumer market, a strong user base, and better YoY growth. Some common sources of Series B funding include private equity investors, venture capitalists, and credit investments.
Series C is for successfully established businesses who now want to either grow their product range, penetrate new markets or acquire smaller companies to compete in the market. After a successful Series B round and market traction, startups focus on rapid scaling and thus require more funds. Companies going through Series C funding are valued at or above $120 million.
During this round, far more investors come forward and show interest. The reason? In Series C rounds, investors choose to invest in fortune-rich companies already doing great in the market with little risk involved.
During the Series C round, investors mostly ask for current hard data instead of the future expectation of profit or loss. They need to know from where you raised round B and how was the investment spent and how did your startup grow. Were you able to grow into a unicorn?
Capital and investment vocabulary are the founder’s favorite especially when there is a need. Knowing and understanding how funding rounds work is all fun and games until one must raise funds. The real question at this point is how to raise funds for startups. As a relief, there are multiple ways of doing so but not all fit perfectly for various stages of building a startup. A few common sources of series C funding include investment banks, private equity firms, and large secondary market groups.
IPO – Initial Public Offering
IPO is defined as an initial public offering, which is the first time when a company opens its shares to the public for purchasing. After successfully progressing with Series A, B, and C, startups now look forward to getting an IPO when they want to pay debts or expand as a company. However, investing in an IPO can be risky for the investor himself. You never know whether the stocks will grow profitable or not.
The best startups that make this choice are ones that already have a solid track record and are in an industry that’s booming at its best. Startups that look forward to getting an IPO for raising funds must have audited financials for the past few years, as well as a remarkable YoY growth. Companies join hands with investment banks to bring their shares to the public market. It is only a company’s good reputation, financial growth, and vigorous marketing that motivates investors to purchase stocks.
Types of Startup Funding
Raising funds is a systemized process that requires a lot of research, documentation, representation of data, and terms and conditions. Investors choose to invest in startups based on the following terms and conditions:
Startup funding is often set based on equity. This means that investors agree to invest in a startup but in return, ask for a percentage of shares. By doing so, investors get partial ownership of the startup itself.
In other words, investors purchase shares from founders based on their valuation. Once a startup succeeds and grows revenues, investors agree to pay more by the next rounds of funding.
Just as the name suggests debt funding works like getting a loan from a bank. The difference, in this case, is if those investors give loan to founders which works on interest-based terms and conditions. In this case, startups do not need to let go of partial ownership but must pay back the debt along with interest. Whereas the interest keeps increasing as time passes until the debt is completely paid off.
Debt is required to be paid back alongside the growing interest. However, most startups choose debt funding so that they do not have to offer equity at the early stages of growing their startup.
Convertible note works around one simple condition. Investors invest in a startup in the form of short-term debt that is backed by a certain condition that mostly consists of a growth milestone. If a founder achieves that milestone in the given time, the debt converts into equity, and if not, the debt remains solid with growing interest.
In other terms, the loan is paid in the form of equity only if growth milestones are achieved. This way founders can save themselves from paying huge sums of interest to the investors.
Founders need to have a keen understanding of all these terms and conditions before going for fundraising. Besides, understanding the sources of funding is also equally important.
Other sources to raise funds for startups:
As a startup founder, you will come across multiple ways for raising funds. However, you will need different sets of strategies at different sets of rounds that are mentioned above. Still waiting for your answer on how to raise funds for a startup. Here are some common sources to raise funds for a startup…
This is known as the safest way of raising funds for a startup. The founders of Airbnb have a history of selling cereal for crowdfunding during the initial stages of their startup. Crowdfunding in this age is even easier as multiple online platforms and communities allow founders to raise funds from the masses.
In this case, the crowd is responsible for funding the startup. A founder may offer equity or reward investors with early bird discounts for the product or service that is about to be launched.
Startup incubators do not usually demand equity unless they provide funding for a startup. However, startup incubators can help startups grow by offering them free of cost mentorship about hiring, drafting a business or a marketing plan, workspace, workshops, opportunities to meet like-minded entrepreneurs, and much more. In most cases, startup incubators also assist founders to meet angel investors. Incubators incubate and mature startups over 3 months to 1 year to prepare them further for accelerator programs.
Accelerator programs are meant for startups that have finally developed an MVP and have launched it into the market. Many startup accelerators fund startups in exchange for equity with terms and conditions varying each time. However, not every startup needs an accelerator, many are well equipped as they pass the incubator stage.
Getting bank loans for startups is not an easy job. Unfortunately, not every state supports the idea of startups demanding bank loans. Hence, the policies may differ.
However, if a founder has access to a bank loan, he or she must have to agree to markup on the money. Besides, the startup will have to provide a solid guarantee in the shape of an asset to get the loan sanctioned. This can surely be tricky.
Different countries offer government grants to support startups. This is a common practice in the United States; however, grants are not free. Non-profit and for-profit, both types of startups get active grants to make things work.
As a founder, you can avail any of the mentioned ways for getting your startup funded. While the most favorite among all is bootstrapping. Zero risk but a lot of struggles.
No matter what you pick, keeping liabilities at a minimum during the initial stages of setting up a startup is always good.