A Startup company will have multiple stages including Idea Stage, Development Stage, Startup Stage and Expansion Stage in its life cycle. Each individual phase of the life cycle presents unique challenges that can make or break any Startup. Each Startup, irrespective of the nature and size of operations, require funds to convert its innovative ideas into reality.
Most of the businesses generally fail because of their inability to raise sufficient funds. After all, you need financing or capital to keep the business going at every stage and finally reach to the path of profitability. It is important to understand the distinction between different rounds regarding the Startup and the investing world, by grasping the context of what exactly a round means for the prospects and direction of a company.
As the business becomes increasingly mature, it tends to advance through the funding rounds; it is common for a company to begin with a seed round and continue with A & B funding rounds. Series A & B funding rounds are merely stepping stones in the process of turning an indigenous idea into a revolutionary global company, ripe for an IPO (for example: Facebook).
Before any round of funding begins, analysts undertake valuation (Mainly during post pre-seed Stage Funding) of the company in question. Valuations are derived from multiple factors including management, proven track record, market size and other risk factors. One of the key distinctions between funding rounds has to do with the valuation of the business, as well as the maturity level and growth prospects. In turn, these factors impact the types of investors likely to get involved and the reasons why the company is seeking new capital.
Funding rounds and the respective stages outlined below provide a framework as to how the funding for the Startup works.
The earliest stage of funding a new company is called as” pre-seed “funding. It is generally not included among the rounds of financing. This round of financing happens at the Idea Stage and the founders are first getting their operations off the ground. The most common pre-seed funders are the funders themselves, as well as close friends, supporters and family. It is most likely that investors at this stage are not making an investment in exchange for equity in the company. In most cases, the investors in a pre-seed funding situation are the company founders themselves.
Seed Funding is the first official equity funding stage. It typically represents the first official money that a business venture or enterprise raises. We can think of the first official money that a business venture or enterprise raises. We can think of the “seed” funding as part of an analogy for planting a tree. The early financial support is ideally the “seed” which will help to grow the business into a “tree”. Seed funding helps a company to finance its first steps, including fund utilisation for market research, product development/MVP and the recruitment of a founding team. Potential investors for the seed funding include founders, friends, incubators, VC companies and angel investors. All the potential investors at the seed stage expect an equity stake in the company or SAFE instrument in exchange for their investment.
If the funding sources described above aren’t available, seed accelerators are potential options. 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 anywhere from $30K to $2.5M. Angel investor funding is also potential solution at this stage. They may invest individually or pool their money with another group. Angels differ from other investment entities like VC firms since they are using their own money and should be treated as such when solicited for funding. Investors will expect a compelling & well researched pitch.
Series A Funding
Once a Startup has developed a track record and the proven KPI for an established customer base and acquisition, consistent revenue growth, the company may opt for Series-A funding round in order to optimise its customer base and product offering. In this round it is important to have a plan for developing a business model and a proven revenue model that will generate a long-term path to profitability. This stage details the implementation & progress of a detailed plan including how the business is going to monetise the plan.
Typically, Series A rounds raises anything between approximately $2M to $15M, but this number has increased due to higher valuation of intangible assets for the tech industry valuations, or unicorns. The average series A funding as of 2020 was $15.6M. It is common for Startup’s going through series A funding rounds to be valued anything been $23-$25M. The investor involved in the Series A round come from traditional VC firms and often specialised in the respective sector. By this stage, it is common for a few VC firms to lead the pack. In fact, a single investor may serve as an “anchor”. Once a company has secured a first investor, it may find it is easier to attract additional investors as well.
Series B Funding
Series B rounds are about taking businesses to the next level. Past the development stage. Companies that have gone through seed and series A funding rounds have already developed substantial customer base and looking to increase the market presence and have proved to investors that they are prepared for a long-term growth and profitability. Series B funding is used to grow the company so that it can meet these levels of demand.
Building a winning product and a growing a team requires quality talent acquisition, spending on sales & marketing, business development, tech, support and employee’s cost. The average estimated capital raised in a series B round is about $33 million. Companies undergoing a series B funding are well established VC / PE companies. Most series B companies have valuation between $40 million and $65 million with an average of $55 million. This may go up for technology related companies with high component of Intangible Assets.
Series B appears similar to series A in terms of the process and key players. Series B s often led by many of the same characters as the earlier rounds, including a key anchor investor that helps to draw in other investors. The difference with series B is the addition of a new wave of other VC firms that specialise in later-stage investing.
Mezzanine Financing & Bridge Loans
At this stage, the Startup is growing and looking to scale significantly with a commercially available product. Revenue should be coming in regularly with a clear path to profitability. The fund raised at this point will be geared to new markets, mergers, acquisitions or preparing for an IPO. This stage is ideal to bridge the GAP between Series B and IPO. Mezzanine financing can cover the expenses for IPO and with the profits made from IPO mezzanine Investor is paid back with interest. VC and PE firms and IB division of large commercial banks can be the source for Mezzanine Financing
IPO (Initial Public Offering)
If the Startup has raised money through each of the preceding stages, going public is an option to expand the business further. All of the investors have invested their money for equity until this point will ideally recoup their investment along with additional profit. Some investors may retain their shares, but many of hem sell their shares at the beginning to reap the rewards for getting in early. After the IPO, stock options can be leveraged to attract top talent and the increased access to capital can provide resources to push the momentum of the business forward. Once the Startup is listed on Stock exchange, they are no longer in the Startup phase and they are in the big leagues post IPO.
Expect full due Diligence process compliance and Enterprise Valuation conclusion at all the stages from Seed Funding to IPO stage, from the potential investors. Various offerings for Seed Stage, and Series A and Series B round may include equity, SAFE (Simple agreement for future equity) and convertible notes. The different rounds of funding operate in essentially the same basic manner; investors offer cash in return for an equity stake in the business. Seed investors and Series A & B investors will help ideas come to reality. Series funding enables investors to support entrepreneurs with the proper funds to carry out their dreams, perhaps cashing out together down the line in an IPO to yield a meaningful ROI.
Stay tuned for more in startup valuation in two weeks!