Startup Funding Stages
The startup world is thriving. According to TechCrunch, global funding grew by $8 billion in January 2021, $16 million more than the previous year when the Coronavirus devastated the startup ecosystem.
Initially, most startups get a start in life thanks to the founder’s own money and that of friends and family. However, there comes a stage where this is no longer viable, and the startup has to look for outside financial help to be able to develop its product and grow the business.
In terms of startups, a unique funding culture has developed over the last two decades, called Series funding. It consists of pre-seed and seed funding rounds that allow startups to approach investors for increasing funds for different purposes as the company grows and its needs expand.
While providing founders with the cash to grow their business, these funding rounds give investors an opportunity to invest their money in a company in exchange for monetary reward, usually equity or partial ownership of that company.
Let’s look at the different funding rounds in more detail
The investors in this round are usually the founders themselves, close family and friends and other supporters. This stage is also referred to as “bootstrapping.” This is the earliest funding stage. Usually, there is no product as such yet, and the success of the funding greatly depends on the founder’s ability to tell a convincing story of why the product or service is unique and warrants investment. Family, friends, and other supporters are not necessarily putting money into the company in equity.
Some entrepreneurs will use their connections among startup founders to bounce their ideas off them and sometimes these fellow entrepreneurs also make a small initial investment.
This is the first equity funding stage. This is the money to grow the very beginnings of the new business, “the seed” so to speak.
With this money, the founder(s) can go ahead and do product development and market research. The founder may also employ a founding team who typically works very long hours and gets involved in many different aspects of the business in order to get it off the ground.
The investors in this round are often so-called angel investors. These are wealthy individuals who invest in startups in their early stages in exchange for part ownership of the company.
Seed funding can raise anything between $10,000 and $2 million for a new company. For some companies, this round is enough to get them off the ground, and they don’t go for more funding rounds. It’s also true that most startups don’t make it past this round.
Some companies never extend beyond seed funding into Series A rounds or beyond. Not all startups make it past the seed funding stage to Series A funding. For that to happen, the startup must have developed a track record, like an established user base or consistent revenue to show that the business is already viable.
Series A Funding
Companies move on a Series A funding round when they need venture capital to scale the business. At this stage, the startup already has a product and a customer base and needs finance to scale to the next level. Founders must show that the company has potential for rapid growth.
In a Series A funding round, investors want to see if the founders have a plan to take their great idea and turn it into a money-making business. Basically, they want to see the potential for return on their investment. So, founders must show that they have a solid business plan to generate long-term profit.
Series A funding rounds keep on getting bigger. In 2020, the average Series A funding round brought in $15.6 million and by November 2021, this amount had grown to $21.8 million. High tech and biotech companies are responsible for enormous funding rounds that exceed these amounts. These figures are according to the startup database company Fundz. Fundz also reports that the average Series A Startup has a median pre-money valuation of around $24 million.
Venture capital can come from wealthy investors, investment banks, and financial institutions, but these days it’s usually traditional venture capital firms that invest in early-stage ventures. A number of investment firms usually participate in a Series A funding round, often led by a main investor. Well-known venture capital firms that participate in Series A funding include Sequoia Capital, Global Founders Capital, Benchmark Capital, Goldman Sachs, and Anthos Capital.
Venture capital investors don’t only (or even always) invest capital. They can also contribute valuable technical or executive skills in return for a stake in the new venture. This stake comes at a price for founders who are now no longer in full control of their venture.
Funding rounds usually involve more than one investment firm and once a startup has secured one investor, it’s usually easier to get others to invest as well. If the funding round and subsequent collaboration go well, the startup stands a better chance to gain more investments from the same firms in later funding rounds.
In practice, very few startups are successful in Series A rounds. According to Investopedia, fewer than half of them succeed at this stage. Knowing this, many founders rather go for equity crowdfunding to obtain funding.
Series B Funding
A company at this stage of funding already has an established customer base and wants to expand further. It has already shown that it is successful and is ready to grow further.
To achieve that, the company needs to invest in resources, which requires substantial monetary investment. Depending on the type of business and industry, the business needs to expand its infrastructure, human skills base, business development, advertising, tech, and more.
Series B funding round amounts are also increasing. According to Crunchbase, the average Series B funding amount in the first half of 2021 was $40 million; in 2020, it was $27 million. These companies are already well-established and can be valued as high as $60 million, according to Fundz.
A startup’s Series B funding often involves the same venture firms that invested in the first funding round. They are usually joined by venture firms that specialize in later-stage startups rather than early-stage ventures.
Series C Funding
Businesses at this stage are established and successful. They want funding to enable them to develop additional products, expand to different markets, or acquire other companies with skills or technology that can help them grow or conquer a market segment. In fact, at this stage, companies looking for funding are no longer typified as startups; they are full-blown business undertakings.
This round usually involves previous investor firms, but also attracts new investors. Investors usually include venture capitalists, large financial institutions like investment banks, and hedge funds.
Because a company at this stage is already successful and is likely to thrive in the future, the investment risk is small, so more investors are prepared to invest since they stand a good chance of getting their money and more back. However, since the company is more valuable now, they will also have to pay a premium for their shares.
Additional investment rounds
Most equity funding ends at the Series C stage. Few companies go on to a Series D or further funding rounds. In most cases, companies have gained enough funding by this time to continue functioning successfully and grow further.
Companies may go for a Series D funding round because the previous funding round didn’t put them in a position to reach their goals. Alternatively, companies use the money raised in a Series D round to increase their value in preparation for going public. Companies may also enter into a Series D funding round with the express intention to raise funds to acquire another company.
The average Series D funding amount is somewhere between $50 and $60 million, but huge sums have also been raised at this stage. Recently, Getir, the 10-minute grocery delivery app from Turkey, raised $550 million in Series D funding to expand into the U.S. market.
Occasionally a company may apply for Series E financing. This may happen if the company needs to increase its valuation, it’s still working to reach its growth potential, or the founders choose to remain private for longer.
Successive funding rounds look different for different startups as many factors play a role. Each funding level represents a different stage in the development of the startup with angel investors, Series A, B, and C investors all helping to bring the startup to a full-blown business. Ideally, when the venture goes public, investors can cash in on their investment.
An IPO is the final funding stage. This is when founders sell shares in their company, not only to investors, but to the public at large. This is a major step for any undertaking, which involves many hours of work by various teams to prepare documentation and ensure that the company complies with all the prerequisites to be listed publicly.
This is a strategic time for previous investors to get a full return on their initial investment, as they usually benefit from a premium share price. An IPO is seen as the ideal exit strategy for investors and some founders.
An IPO gives the company access to even more money to grow even more. The process to get to an IPO is very complicated and requires the expertise and input of financial institutions, so companies at this stage hire investment banks to prepare for the IPO.
Apart from the additional funding raised, an IPO has another benefit of increasing the company’s reputation in the eyes of the public. In addition, the company becomes an attractive employer for top talent.
The process of funding early-stage ventures through different funding stages has developed over the last few decades. It is a well-structured process that garners much media attention, but few startups actually participate in the entire process, with most not progressing past the seed funding stage. However, this funding process has worked exceptionally well to bring some of our most recognized companies to life, such as Facebook, Google, Uber, and Twitter.