09 Sep Startup financing – a short overview
In recent years, entrepreneurship has grown tremendously. For multiple reasons that exceed the scope of this article, it is increasingly common to see, hear or read news about entrepreneurs who found startups and obtained million-dollar investments.
But what many people don’t know is that those astonishing investments that often go viral are, actually, part of a whole system of financing rounds that involves many different actors. In this article we are going to explain some basics regarding how the startup financing system generally works.
Pre-seed financing
The earliest stage of a startup’s funding occurs so early in the process that it’s typically not included at all between funding rounds. This stage, known as “pre-seed”, generally refers to the period in which the founders of the company are starting to operate. The most common funders of this stage are the founders themselves, but they can also be close friends and family. Depending on the nature of the business and the initial costs established with the development of the business idea, this financing stage can happen very quickly or it can take a long time. Investors at this stage are also not likely to be making an investment for shares in the company. For this reason, in most cases, the investors in a “pre-seed” financing situation are the founders of the company.
Seed funding
The seed funding is the actual first stage of capital financing. It usually represents the first official money raised by a company or business venture. Some startups never make it past this seed funding to Series A rounds or beyond.
Logically, the idea of ”seed” establishes an analogy with a tree; this initial financial support is ideally the “seed” that will help grow the business. With sufficient revenue and a successful business strategy, as well as the perseverance and dedication of investors, it is to be hoped that the company will eventually grow into a “tree”. Seed funding helps a business finance its early stages, including things like market research and product development. Thus, the startup obtains assistance in determining what its final products and its target demographic will be. Additionally, seed funding is used to employ a founding team to complete these tasks.
There are many potential investors in a seed funding situation: In addition to founders and friends and family, incubators and venture capital firms with a riskier profile appear in this instance. At the same time, one of the most common types of investors involved in seed funding is the so-called “angel investor”. Angel investors tend to appreciate riskier companies (such as new startups with little proven track record so far) and expect an equity stake in the company in return for their investment.
While seed funding rounds vary significantly in terms of the amount of capital they generate for a new company, it is not uncommon for these rounds to produce between $10,000 and $2,000,000 for the startup in question.
Series A financing
Once the business has built a track record (an established user base, consistent revenue figures, or some other key performance indicator), it can opt for Series A financing to further optimize its user base and product offerings. At this point, opportunities to scale the product in different markets can be taken advantage of. To get investors in this round, it is important to have a plan to develop a serious business model that will generate long-term profits. Typically, Series A rounds raise approximately $2,000,000 to $15,000,000, but this number has increased on average due to high-tech industry valuations and the rise of new unicorns.
In Series A financing, investors aren’t just looking for great ideas. They look for a solid strategy to turn that great idea into a successful and profitable business. For this reason, it is common for companies going through Series A funding rounds to be valued at up to 23 million. Investors participating in this round come from more traditional venture capital firms.
It is also common for some venture capital firms to lead the pack of investors in this round. In fact, a single investor can work as an “anchor”. Once a company has secured a first investor, it may also find it easier to attract additional investors. Angel investors also invest at this stage, but they tend to have much less leverage in this round of funding than they did in the seed stage.
Series B financing
Series B rounds aim to take companies to the next level, beyond the development stage. In this stage, investors help startups expand the reach of the market. Companies that have gone through seed and Series A funding rounds have already developed a substantial user base and demonstrated to investors that they are poised for success on a larger scale. Therefore, the funds that arise from the Series B are used to grow the company so that it can meet new levels of demand.
Building a truly successful product and growing a team requires the acquisition of quality talent. At the same time, increasing business development, sales, advertising, technology, support and employees is not easy at all. In that sense, the estimated average capital raised in a Series B stands between 30 and 40 million. This round is similar to Series A in terms of processes and key players. Series B is often led by many of the same characters as the previous round, including an “anchor” investor who helps attract other investors. The difference between Series B and Series A investors is the addition of venture capital firms that specialize in later-stage investments or more established companies.
Series C financing
Companies that make it to Series C funding sessions are already pretty successful. What these companies are looking for is additional funding to help them develop new products, expand into new markets, or even acquire other companies. In Series C rounds, investors pump capital into the heart of successful businesses in an effort to receive more than double of that amount. Series C funding is focused on scaling the company, growing it as quickly and successfully as possible.
An interesting way to scale a company could be to acquire another company or also to merge. This is known as mergers and acquisitions. To the extent that this happens, the company’s operations become less risky, allowing more investors to come into play. For this reason, in Series C, groups such as hedge funds, investment banks, private equity firms and large secondary market groups appear as key players in investment. As the company has already demonstrated a successful business model, these new investors come to the table hoping to invest significant sums of money in companies that are already thriving and thereby secure their own position as business leaders.
The last link of external financing
In general, the now consolidated company that started as a small startup, ends its external financing after closing the Series C round. Some carry out one or two more rounds, known as Series D and Series E. However, most of the companies that raise hundreds of millions of dollars in Series C rounds are already definitely ready to go public and grow on a global scale.
Knowing in depth the external financing scheme of startups allows us to better understand the stages they go through. It also makes us aware of the different actors involved in this process, their roles and their profiles. Every entrepreneur must know in depth this roadmap, which he must venture to follow thoroughly in order to turn his idea into a successful business.
