Having a startup might sound catchy, but it is far from an easy task.
Although nowadays there are lots of incredible incubators, accelerators, and investors willing to back up these projects, that doesn’t mean each one of them will survive. In fact, even with all this support, only 50% of startups will reach year 6!
One of the most significant issues for these companies is liquidity.
Money is always a problem, and finding a steady stream of investment can be a hard task.
If you are a young entrepreneur, it is every bit as essential to learning about funding as it is to learn about your particular product, market, and technology.
What do I have to know about investments and startup rounds?
Startup investment is a broad topic to analyze and explain in one article.
Nevertheless, we will try our best!
Every company (exceptionally modern, tech-driven ones) is highly dependable on cash. The more advanced a company is, the higher development costs will be.
We also have to consider that employees, working in industries such as IT, biotech, engineering, tend to have very high salaries. As a result, it takes a lot of money just to put a product on the market.
Due to the high potential returns, investors are more than willing to give them a shot. Startups have various options at their disposal, from taking bank loans to providing shares of the company in return for capital.
Some owners are even able to finance themselves (otherwise known as bootstrapping). However, this usually works only during the initial phases.
That said, what are funding rounds?
Basically, every company goes through different stages of development. It takes a lot of money to go from a simple idea to a fully developed business model. With each passing phase, the company requires more and more funding to keep growing. These are known as startup rounds.
What are the main startup funding rounds?
Keep in mind that certain companies and ideas don’t follow the usual patterns. Some startups are able to immediately find angel investors who will provide lots of funds to their concept. But in most cases, it comes down to a certain number of startup funding rounds.
Here are the startup funding rounds that most new companies have to go through:
- Seed and/or pre-seed (the earliest stage of funding that will help an idea get off the ground)
- Series A (the company already exists and has managed to attract some customers)
- Series B (helps expand market reach)
- Series C (helps the development of a new product, establishing in new markets or even acquiring other startups)
- Series D and E (not that common; help fund further scaling of a business)
As already mentioned, not every company will go through precisely the same steps. However, most of them will.
Some of them are entirely optional such as series D and E. Always remember that there are a lot of things that may happen from the initial idea of having a fully functional business.
These rounds are rather complex. Furthermore, they may last from 3 months to 1 year.
Given that it takes time to spend these funds and develop certain aspects of a business, companies will not need an additional round of funding for a while. The period between two rounds usually takes between 6 months to 1 year.
Based on how long these funding rounds take, it is obvious why the startup phase of a business can take such a long time.
Before we explain each phase and series in more detail, let’s first explain how funding in general works.
Stay with us!
Explaining startup funding
On paper, all of this sounds pretty simple and straightforward. An entrepreneur has an idea that seems good, and an investor is willing to back it up.
In practice, it’s everything but simple!
There is a lot of measuring, analyzing, and modifying before any decision is made. Investors are affluent for a reason, and they are unwilling to invest in just about anything.
Everything starts with the valuation of a business.
Financial experts will analyze various aspects of the business as well as outside factors. This includes management, track record, product’s advantages and flaws, state of the market in question, the potential for penetrating the said market, financial and business risks, etc.
As a company continues its natural progression, analysis becomes more and more complex. But, at the same time, investors have a better understanding of what they’re dealing with. Investing in an idea, without any backup or guarantee, is the hardest thing to do.
With each passing round of investment, a startup requires more and more money to continue progressing. Even though earlier stages need less money, later stages are much more secure.
What do investors gain in return?
It’s simple: they get a part of the business, which we refer to as equity share. As the company continues progressing and increasing in value, equity share becomes more valuable for the investor.
So, in theory, if you see a winning business model, it is recommended that you invest early and to spend as much as possible. The projected value of a successful business model is usually lowest at the beginning, and as the company gets more traction, it will get valued at a higher price.
Now, let’s explain funding rounds!
Seed and/or pre-seed
Seed and pre-seed stages are usually coupled together, although they are two different things.
As you can presume, the pre-seed stage comes first. It is a more unofficial stage of the business and cannot be regarded as your traditional investment phase per se. During pre-seed, the company is usually funded from within. Owners invest their own money, or their family and friends may help out.
At this point, the whole company is just an idea. It might take a few months (or even a few years) until you can say that you’ve got something real on your hands. The money used is usually spent on software, hardware, or some other basic expenses.
The seed-stage follows the pre-seed.
This is the first official stage, and now the startup becomes public. There is already a solid idea in place, and the product is ready to be created. The company will also need money for some other expenses, such as market research. It also has to determine whether or not this product is viable, and if not, what kind of changes are necessary.
Besides friends and family, new stakeholders might appear during this phase.
Incubators, angel investors, and venture capital companies may express interest in your organization. Angel investors are common during this stage as they are interested in ventures with higher risk and higher reward.
The amount of money a company need varies from situation to situation. Some startups might require small amounts to get their business off the ground and will not need any further funding after the seed stage.
The amount of money you can get also depends on the source. For example, incubators usually offer between $10,000 and $30,000, while angel investors may put more than a million into a project.
A startup can accumulate anywhere from $10,000 to $2 million. Some of them will not even need seed funding. Companies that are in the seed phase are commonly valued at 3 to 6 million dollars.
Although startups are in their earliest stages, their patents and ideas may already have significant value on an open market.
Reputable seed investors: National Institutes of Health, Y Combinator, TechStars, Entrepreneur First.
When a company reaches the series A funding stage, it should have some track record. As we already mentioned, companies in this phase are usually highly valued.
At this moment, startups seek money to improve and optimize their processes.
They might add some changes to their product, business model, or marketing strategy that will allow them to secure a better position on the market. This is the time for expansion and improvement; like any other stage of funding, this one is meant to scale the business and help it reach more customers.
Also, this is the point where a company goes from short-term plans to long-term plans. If it has trouble monetizing its product, a new stage of funding will help it detect the issues and iron them out.
Unlike the seed stage, where companies usually manage to attract up to $2 in investments, series A starts with $2 million. More successful projects may get up to $15 million, but keep in mind that these figures are continually going up.
This is especially common in tech-driven industries where every new product is significantly more advanced than the previous one. Don’t be surprised if you hear that some companies can receive more than $50 million during this stage!
As a startup matures, so do investors’ requirements. If you want to get funding during this phase, it is no longer enough to have a viable product. You also need a good strategy that would allow you to be competitive in your particular market.
This is precisely why some startups falter at later stages of development. In fact, less than half of the companies that were funded in seed-stage will manage to attract investors in series A.
The structure of investors also changes during this phase. Now it is much more common for venture capital firms to join in. While angel investors may still appear here and there, they are less critical for startup’s funding goals.
As it goes with most other types of investments, the hardest thing is to get one investor to bite. But, once a person shows interest (especially if it’s a reputable investor/expert), it is much easier to get investments from other sources.
Because of that, crowdfunding has become more and more popular as of late.
Reputable series A investors: Greylock, Sequoia, Benchmark, Tencent Holdings
When a company reaches Series B, it is regarded as a more stable project.
Still, most investment experts regard series B as an early-stage investment.
At this point, it is presumed that the product is tweaked to meet customers’ demands, that you have a proper business strategy, and that a project can make money.
Investment sources are mostly the same as venture capital firms leading the pack. However, some new faces might appear, in particular companies that specialized in series B and later phases.
A startup still has to work hard to attract initial investors who will pull the rest in. Nevertheless, it will be much easier this time around as you have proven that your business model works.
Series B focuses on expansion.
Startups don’t have to worry about their overall business strategy, product flaws, and whether or not they can convert. Instead, funding is used to scale the business, improve distribution, and exposure. Depending on how far you want to take it, marketing costs may soar.
During this stage, startups can accumulate between 7 and 15 million dollars. The sum can be very similar to what you received during series A although the minimal funding is usually raised.
Series C is regarded as late-stage funding. The company is already established; there are no longer any uncertainties regarding the viability of the business or whether or not they can make an impact on a particular market.
Startups have a proven track record that attracts new types of investors who can funnel significant amounts of money into a business.
At this point, calling a company a “startup” is more of a formality rather than a true statement.
So, why do companies still need funds?
Basically, the investments are used to penetrate new markets, develop new products, and acquire other companies (often such that are in some way related to the business). Sometimes, these acquisitions can be beneficial for both sides and represent a natural progression.
The predictability of business attracts a wide variety of investors. Keep in mind that investors who have joined earlier will always get higher returns. Still, that doesn’t mean that institutions that joined during series C will leave empty-handed – most of them are looking at profits of at least 50% or more.
Hedge funds, private equity firms, and investment banks are some of the new players. They usually deal with more secure investments but are also able to dish enormous amounts of money.
In most cases, series C is the end of all funding cycles. Some companies will require series D or series E, but these are sporadic cases. Keep in mind that with a new stage of funding, owners’ equity is diluted. If you own a company, you have to ask yourself whether or not this additional money will prove to be worth it.
Series E and D can be useful if you want to go global. In these situations, it is more than worth it to get some additional money that will help you reach that next level. Sometimes, series E and D may be a bad sign for investors as they might indicate that a startup didn’t manage to achieve their goals with series C funding, or that something else went wrong.
Series C is often used to increase the value of a business before its stocks go on the stock market.
Startups that reach series C are usually valued at more than $100 million. During this stage, they can quickly get more than $50 million from various sources.
Reputable series C investors: Bain Capital Ventures, Citygroup, Lightspeed Venture Partners.
What do you need to know about different sources of funding?
Although everyone is looking for their own profit, financial organizations can vary significantly in their approach and background. Besides the fact that each institution has its investment policy, certain things are mutual for groups of investors.
Here is what you need to know about each source of funding!
Bootstrapping refers to startup owners who managed to fund themselves.
Although most experts will define bootstrapping as “funding from your own money, or by involving friends and family,” this can also refer to some other things. For example, it can also involve other potential investors who you reached through your contacts.
It can basically refer to any cold or warm pitch that you made without going through official channels.
Bootstrapping pitch is usually less formal, but to make the best results possible, you still have to professional. An excellent presentation is a must!
Financial agreements are also more flexible. You can create a custom contract that will suit both sides. This gives you much more leeway than when dealing with standard financial institutions, which usually have predefined terms or fees.
- Angel investors
Angel investors usually join during the seed or pre-seed phases, but in rare cases, you might be able to make contact even before that.
Like with bootstrapping, communication with angel investors is usually less formal, and it allows the creation of customized contracts. However, even though angel investors provide much fewer funds than some traditional investment institutions, they need much more convincing.
I also mentioned that series A is often used for improving your strategy. But if you were to pitch angel investors, your approach would have to be flawless. They want to mitigate every possible risk as soon as possible.
These guys can provide you with tens of thousands of dollars, so it is more than worth it taking your time to create a proper pitch.
Perhaps the greatest benefit of angel investors is that some of them are willing to share resources to ensure the successfulness of the project. Here, we’re talking about contacts, marketing channels, expertise, and other intangibles and tangibles.
Bear in mind that most of them want a significant equity share of your company, so that’s something you will have to be prepared to give in return.
Crowdfunding is the most intriguing option on our list.
Unlike some other sources, crowdfunding or crowdsourcing is quite specific as it doesn’t tie you to a particular individual or organization. Instead, you are pitching your idea to many people.
This option isn’t that different from other things on the list in the sense that you still need a good pitch to attract potential investors.
However, the financial proficiency of people investing in these projects can vary significantly. Furthermore, you have much more control over information that is provided during the development of the project.
Your ability to get funding has nothing to do with the market opportunity or the long-term feasibility of the project. Instead, the stakes are usually much lower, and they might come down to giving the investor one finished item.
Most companies will offer a copy of their product. This is especially common for gaming projects. The more people give, the more they will receive. There is always some exclusive content or exclusive service that you will provide to those who are willing to give a bit extra.
Still, you can create a concept where investors get an equity share. It all depends.
A startup can increase its reach and ability to gain funds by investing more in marketing campaigns. There were situations where companies and individuals were able to get significant sums of money just by having the right approach.
Needless to say, funding your startup through a crowdfunding platform gives you much more leeway and leverage compared to dealing with traditional types of investors.
- SBA microloans
Microloans are another great option that allows you to retain the majority of control.
These loans are tailor-made for startups as they can give them enough money to get a business off the ground. Of course, they cannot even compete with venture capital firms or investment banks in terms of volume. However, if you have smaller needs and think that this amount of money will be enough to start working, microloans are an excellent option.
SBA microloans, on the other hand, refer to microloans given by Small Business Administration. SBA is a government institution that connects individual lenders and startups. Through Small Business Administration, you can get a loan of up to $50,000.
You have to remember that these loans can vary from case to case. Some investors are unwilling to provide a loan if they don’t have a say in the company’s business. Others might want an equity share on top of everything.
If you want to mitigate the risks and retain full control, it is necessary to create a custom contract that will specify the roles of each side.
- Venture capital firms
Even though term venture capital sounds modern, it is everything but that.
The concept was created at the beginning of the 20th century and has gained popularity during the 1980s.
Venture capital firms focus on tech-driven companies that can bring high returns. However, besides their money, these organizations are also willing to provide connections and expertise. Given how much money is in play, most of them are eager to go the extra mile to make sure the project performs as intended.
These organizations are willing to invest several million dollars into a startup. In return, they expect a hefty ownership share.
It is worth mentioning that some of the biggest tech companies (such as Facebook, Google, Instagram, Skype) were supported by not one, but several venture capital firms.
- Private equity
Private equity firms are one of the most common investors in startups.
Their primary focus is on buying shares to gain partial or total control over an organization. In some instances, they will invest some money, but they will try to avoid interrupting the internal processes. This way, they will be able to gain the full benefit of the company’s growth, but will not have to micromanage it.
Private equity firms acquire funds from various sources, including pension organizations, charities, universities, and so on. Some of the biggest private equity companies in the world are TPG, Goldman Sachs, and The Carlyle Group.
Main things to keep in mind when pitching investors
As much as you might hate this, having a proper pitch is sometimes much more important than having a great product.
Presenting your startup in the right way makes investors confident; it makes them more willing to part ways with their money. In the end, if you’re confident in your own product, why wouldn’t they be?
Creating the perfect pitch is far from an easy task. In fact, it is recommended that a company has a person with a background in sales.
Preparation is one of the crucial factors allowing you to showcase products or services properly. You need to learn more about product specs, company strategy, and everything else that potential investors may inquire about.
Here are some tips that will help you create a perfect presentation:
1. Start with preparation
As already mentioned, the whole process starts with proper training. You have to get acquainted with every aspect of your product (and offer), and more importantly, you have to prepare for questions that investors might ask you during the presentation.
2. Emphasize growth
Every investor starts with a question: “What’s in it for me?”. The best way to answer this question is by presenting a proper long-term strategy. Keep in mind that these strategies might change over time, but you still have to have one. During this step, it is essential to rely on financial numbers. Most investors have a strong background in finances, marketing, and investing, and are usually reluctant to proceed with a project if it doesn’t sound feasible on paper.
3. The presentation has to be short
Your presentation must be no longer than 20 minutes. It is even better if you can cram everything in 15 minutes. A lot of startup owners make a mistake by thinking that more is better; they believe they will impress investors with more figures, words, and generally content. But it’s quite the opposite. If you’re unable to make a strong impression in a few words, this can be a sign that you don’t understand your market or your product. Furthermore, long talks tend to have a negative impact on people. You have to catch their attention from the onset, and the optimal way to do it is by clearly and concisely presenting your goals in the first 30 seconds.
4. When can investors expect a return?
Not only do you have to talk about long-term plans, but also assure potential investors that they will get their money back at one point. While this is really hard to predict (especially if you’re a startup), you have to predict when they’ll get their money back.
5. Start from broadest
As we said, you have to start strong. Explain your idea and how you can make money from it. Then, go slowly towards minor details and financial plans. Always start from the most significant point and slowly build downwards.
6. Make it personal
There is a good reason why storytelling is so popular. You have to gap the bridge between you and the investors, making it more likely that they will fund the project. Learn more about people who are coming to your meeting and, if possible, try to profile them. You can easily do these things nowadays with the help of social media and a little bit of research. You can also add examples from your own life, which will make things more personal and relatable.
7. Communication is the key
We shouldn’t have to tell you that the right communication is the key to making a good impression. Nevertheless, it is a point of emphasis during any investor presentation. You have to be an active listener, think about the questions, and try to answer them in a way that will not only be correct but appropriate for the person asking it.
8. Be prepared for compromises
Startup owners are usually very enthusiastic before these pitches. However, things may turn around in a blink of an eye. In other words, they might be forced to give a more significant piece of the company than they initially anticipated. Compromises are a crucial part of negotiations. While you might be forced to provide a more substantial piece of the pie, you also shouldn’t underestimate your startup. Ideally, you should make the correct assessment of the business beforehand so that you know how far you can go.
Securing enough money for your project can be a tall task, but it’s a goal you need to achieve if you want to be successful.
If you do manage to pull it off, you can put most of your worries aside.
After reading this detailed guide, you should know enough about startup funding rounds and how to manage investors. Let us know in the comments below!