The Stages of Startup Financing

A person starts with an ddea that he wants to make big. Once he has made up his mind about trudging through the turbulent times he would have to endure in the foreseeable future(and beyond), that’s when he becomes an Entrepreneur.

After the Idea has been validated, the entrepreneur needs money to keep the ship sailing. I’m not going to tell you how bad it is out there for entrepreneurs looking to raise money. If you don’t  the sense of that by now, you probably ought to look for other work. The money is out there, it’s just that the investors are tight-handed and indisposed due to the previous fiascos with big E-commerce startups(you know that already) but don’t let those debacles discourage you. Globally, the best companies were built during tough times, Google emerged after the dotcom bust of the 90s and Facebook, post the 2008 recession.

Sources of Funding
Raising money may not have been your dream when you began building the company, but your ability to do so will determine how far it will go. Moving along, there are various ways to finance for your startup. Some ways to get funding are:

Bootstrapping, Friends & Family
Money from your savings(if you have it) is always a preferred option. Benefit from your goodwill with your inner circle before widening your horizons. Professional investors like to see real skin in the game – your own, of that of people who trust you. This gives them the assurance that you are not following a fad. There are certain advantages of it as well. You don’t have to abdicate any control in your company.

Incubators and Accelerators
They may help you with guidance an office, and get you a potential funding from an investor. This may come at the cost of some equity or there may be a fee involved.

Loans or lines of credit
If your company is fairly new, getting a loan may be a herculean task, alternatively, you can avail a line of credit if your bank allows for it. The thing to note here is that, a credit line will come at a lower interest rate than a loan.

Venture capital and Angel Investors
It is advisable not to go for a VC early on in your entrepreneurial journey as they are more demanding and may take a pound of flesh for the investment they make, along with control. Angel Investors may allay your apprehensions when thinking about parting with equity, but in this case a good network is imperative to secure funding. However, an excellent idea and a great team may do the trick to attract an Angel Investor to invest in you.

Stages of Funding
Now that you are familiar with potential sources of funding, let’s move on to the stages. While making ends meet to secure an investment, understanding the different needs at each stage of funding will equip you with the confidence to engage investors with a clear vision of what each of will get out of the exchange. Below are the broadly classified stages of funding for startup financing.

 

Stages of Startup Financing

Bootstrapping, Friends and Family:  $5,000 –$10,000
The first stage will always be self-funding or bootstrapping. This is when you set-out to achieve your entrepreneurial dream, and work on your idea. As mentioned earlier the investors want to see how much of your own skin is in the game, before they think about investing in it. On the other hand, you can also approach your friends and family as they have a certain level of trust and relationship with you, which may make it easier for them to invest in your idea/business. The quantum of investment here may range between $20,000- $30,000. It is critical not to give up too much equity here. As a rule of thumb, you should not part with more than 5% equity at this stage if required.

Seed Round
$1M-2M Funding: After you have successfully bootstrapped, the seed stage of investing the preliminary phase of raising outside capital. The term seed suggests that this is a very early investment, meant to support the business until it can generate cash of its own or until it’s ready for further investments. Seed money can be used to pay for preliminary operations such as market research and product development. Investors are primarily angel investors but can be outside Venture Capitalists, Equity Crowdfunding Investors or Government Programmes.

Growth/Early Stage

Sources of Funding: Private equity investors, VCs and crowdfunding.

Series A Round, $3-$7M Funding
This is the first major round of funding after a successful seed round. You have usually figured out the product and the size of the market by now. Your venture generates revenue from the business model, though it may not be generating net profits, you need capital to scale and improve distribution systems. During this stage, you hire seasoned executives to be on the board. Series A and the preceding stages are riskier for investors, given the doubts surrounding the startups, their products and their teams.

Series B Round$8-$50M Funding
This round is all about scaling up. You have generally advanced your business, resulting in a higher valuation by this time. Your startup has a product and business model and needs enough capital to bring the product to a broader market. Investors here usually pay a higher price for investing in the company than the Series A investors. Equity investors typically prefer to receive convertible preferred stock to common stock because of the special features of the preferred stock. Valuations and committed capital are heavily negotiated.

Series C Round $50-100M
This round, if it ever comes, is all about fast growth and large scale expansion, maybe even internationally. The Series C Round financing stage represents an additional expansion stage for the company. At this stage, your company has fully matured, its business model is working – whether the company is profitable or not, and the company has proved its potential for a larger market. It probably has an exceptional management structure and a history of growing profitability.

Apart from the quantum of investments, the primary difference between Series C and other rounds is that here the leading investors are Private Equity Firms, Large VC Firms and Investment Banks.
At this point, the venture capitalist will have already passed the break-even point and is now looking for an exit strategy. After Series C, there’s theoretically no limit to the number of investment rounds a startup can raise: some companies will go on to raise investment through Series D, E and beyond.

Mezzanine Financing or Bridge Funding, $20M-$50M:
Mezzanine financing is typically known as bridge financing because it finances the growth of expanding companies prior to an IPO. At this point, your company has several hundred employees and is probably operating in more than one country. Such funding is usually made up of convertible debt or preferred shares, which are costlier and provide investors certain rights over the holders of common equity. To attract mezzanine financing, your company usually must demonstrate a track record in the industry with an established reputation and product, a history of profitability and a viable expansion plan for the business, such as through expansions, acquisitions or an initial public offering (IPO). The typical interest rates for Mezzanine financing are from 12% to 20% which makes it a high risk and high return debt. This may significantly increase an investor’s rate of return(ROR).
IPO (INITIAL PUBLIC OFFERING):

Renowned CEOs like Travis Kalanick and Mark Zuckerberg(before Facebook IPO), were averse to going public. This might be because of increased costs, imposed restrictions on management, trading and maybe loss of control on decision making. However, if you have raised money through each of the preceding stages, going public is an option to expand further and prove you with ultimate success. All of the investors who have traded their money for equity until this point will ideally recover their investment along with additional profit.

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