New companies who wish to succeed often go through different stages of funding. Each startup stage comes with its own set of requirements and conditions. That’s why it’s important for startups and investors to understand what they are and how they work. By doing so, they can make informed business decisions that propel them toward incredible growth. Below, we’ll take a closer look at the various stages of startup funding.
The angel investment stage involves angel investors who offer capital and expertise in exchange for equity in a startup. In most cases, they’re wealthy individuals who have a great deal of experience and take a more active role in the success of a company. They’re often accredited investors with a net worth of at least $1 million or a minimum of $200,000 in annual income. They may be doctors, lawyers, or other types of professionals.
It’s quite common for angel investors to take on a more hands on approach. They might mentor startups, share their knowledge, and offer access to valuable connections. Unlike venture capitalists, angel investors use their own money and invest between $25,000 and $100,000. Typically, they come into play after a startup has received friends & family funding but before they require a greater investment from a venture capital company.
Also known as the friends and family stage or bootstrapping stage, the pre-seed investment stage is when startups receive funds from friends, family or sometimes, angel investors or incubators to get their business off the ground. This is usually when they hope to build a viable product, use market research to prove it’s desirable, and prepare for seed funding or series A funding. It often involves a prototype of proof of concept and the development of copyrights, partnership agreements, and other legal components.
While the ideal amount of pre-seed funds will depend on a startup’s unique needs, anywhere between $400,000 to $500,000 is typical. These funds can help cover the initial setup costs of the company and get them ready for operations. In most cases, the pre-seed investment stage lasts 12 months with a three month buffer for unexpected circumstances. Research shows that 9 out of 10 startups don’t make it past pre-seed investing.
Seed investment is the first official equity funding stage as it represents the first official capital that a startup raises. During this stage, the startup plants the “seed,” which will help it grow into a mighty “tree.” With seed funding, startups can hire a team that assists with market research and development. They may also hone in on their final product or service offerings as well as their target demographic. In addition, the seed funding stage might involve a pitch deck that proves the startup is a viable investment opportunity.
Many times, seed funding comes from friends, family members, angel investors, and the original founders of the company. While the capital amount in this stage can vary significantly, startups often generate between $500,000 and $2 million. It’s important to note that some startups stop at this stage as they believe they don’t need additional funding and have enough to get up and running.
Series A Investment
Once a startup builds traction that they might measure through revenue, users, views, or any other key performance indicator (KPI), they’re ready for the series A investment stage. This is when they have a strong business plan that explains how they’ll develop their business and generate long-term profit. In addition, they use the funds they raise to increase revenue.
While startups don’t have to make a profit tomorrow while they’re in this stage, they do need to prove to investors that they will profit in the future. Put simply, Series A is all about starting to scale. It differs from seed capital in that it follows a more formal approach with due diligence and a valuation process.
Typically, series A rounds raise between $2 million to $15 million from super angel investors or well-established venture capital firms and private equity firms. Many well-known companies, such as Google, Amazon, and Uber have all raised millions of dollars in capital during Series A.
Series B Investment
If a startup finds their fit in the market and would like to expand, they’re likely ready for a Series B round. Oftentimes, they’ve already generated stable revenue streams and even earned some profits. The focus of Series B is to attract more customers and develop a winning team that can better serve them and hopefully lead to an IPO sometime in the near future.
Therefore, the funds, which are usually between $7 million and $10 million are primarily reserved for business development, sales, talent acquisition, and new technology development. While Series B is a lot like Series A, the greatest difference is their investors which are venture capital firms that specialize in supporting well-established startups. You can think of it as a larger Series A round.
Series C Investment
Series C is quite different from Series A and Series B. Startups who raise Series C funding have already proven their success through strong revenue streams and customer bases. They seek additional funding from private equity firms, investment banks, hedge funds, and secondary market groups in order to launch new products and services, enter new markets, or acquire other companies.
During Series C rounds, investors provide funds that hopefully lead to quick and significant growth. Ideally, startups in this stage increase their valuation prior to an Initial Public Offering (IPO).
Series D Investment
The reality is that most startups never go past the Series C funding round. The ones who do, however, may have discovered a potentially lucrative opportunity that they must act on before the IPO. They might also raise more funds because they missed the goals they set during Series C and require additional capital to meet them.
While the amount a startup raises will depend on their industry and what they plan to do with the capital, the average Series D amount can easily exceed $50m. It usually comes from investment banks and private equity firms.
Series E Investment
Very few companies make it to Series E. Oftentimes, Series E allows them to remain private for a longer period of time so they can increase their value before going public. A startup might also come across a new opportunity that they can’t act on without capital from Series E. In addition, they may be facing a downturn that they can’t survive without additional funding. The reality is that only the most successful and active business may survive the Series E investment stage and beyond.
Mezzanine financing is a hybrid between debt and equity. It provides the lender with the right to convert debt into an equity interest in the startup in the event of default. This type of financing can be structured as subordinated debt, preferred equity, or a blend of the two. Since mezzanine financing funds the growth of expanding companies before an IPO, it’s often known as bridge financing. It’s typically provided by lenders who specialize in these funds, which can range from $100 million to more than $5 billion.
An Initial Public Offering or IPO is every startup’s dream. It’s when their shares go public for the first time. With an IPO, a startup can generate funds for further growth or allow its owners to cash out their remaining shares as personal income.
It’s important to understand that issuing an IPO doesn’t happen overnight. In fact, it’s a long, extensive process. Before a company is able to do so, it usually develops a team of SEC experts, accountants, lawyers, and underwriters. This team helps them compile their financial statements and complete all IPO requirements, which are set forth by the government.
In most cases, an IPO acts as a successful transition that enables startups to increase their reputation, awareness, and market value. It gives them the chance to pay their executives through stocks and puts them in a better position for mergers. Sometimes, however, an IPO doesn’t go as planned and causes the overall value of a company to decrease.
While starting a business is a challenge, it’s also very rewarding. By raising capital through different funding stages, a company can transform from a startup to a profitable enterprise. As long as they are familiar with these stages, they’ll be able to set feasible goals that steer them toward success.