Startup Funding 101: investment rounds and sources
A startup is always more than just an idea. It ‘s also a lot of time, effort, focus, dedication, team, and, of course, funding.
Over 60% of all startups need external investments. For example, an estimated average cost of developing a platform in the US reaches $75 000, which is not affordable for the majority of startup owners. To raise the money, you have to understand the difference between funding rounds as well as the people that are more likely to invest in your project.
Funding rounds: A, B, C… what?
Startup owners can’t just get plenty of cash or a business loan and feel set and happy for good (although it sounds attractive, right?). You have to go through a number of funding rounds and prove that your idea deserves the money, meeting different goals, players, and challenges every time. Each round is designed to raise enough capital to grow further and this can be as short as a year. However, many entrepreneurs push things to 6 months and sometimes even 3 months timeframe.
Startup funding rounds can be divided into pre-seed/seed, series A, B, C, and IPO stages based on the raising purpose.
Seed stage funding.
Pre-seed funding takes place at the very beginning. This is when founders are trying to give their idea the initial push and invest their own money.
It is followed by the Seed stage when founders attract angel investors. These people provide funds for further research, testing market needs, hiring a team, and starting the production.
Here, startups can aim at anywhere between $500K and $2 million investments, depending on their needs and presentation. Investors are ready to take risks, and typically invest in a number of startups. Those that go through then receive additional capital.
Among the well-known companies considered for this stage are Y Combinator, 500 startups, SV Angel, and Techstars.
Next comes round A. It is focused mainly on the startups with a proven business model, decent customer base, and are already generating profit.
The investments at this stage can start from $3 million and require a specific strategy to reach higher ROI. Typical investors here are venture capital firms that need startups to show real data and progress received from previous investments. They want to see the key metrics improving and startup turning into a valuable money-making machine ready to be scaled and get to the next level of funding.
Round B helps startups turn into well-established companies (enterprises).
At this point, they have already grown, have a large user base, and are looking for VC-level participation. Investments at this stage can range from $7 to $10 million and even overcome it (for example, Mixpanel raised $65 million during this round). This stage is all about building out a successful company. The money raised can be used to scale up by expanding the team, geography, and entering new markets.
Some of the biggest investors here are Accel, Insight Venture Capitals, and Sequoia Capital.
When startups move to round C, it means a higher level of expansion.
The companies are already successful, value at least $100 million and are aiming to receive the same amount of funding (again, Magic Leap has raised almost $1 billion). As one of the last stages, round C includes not only extending current project capabilities but creating new products. So you should prepare to work with the largest VC firms and corporate level investors that are far more demanding.
Companies at this stage are getting ready with their exit strategies and smoothly move to IPO.
This is the final stage of startups’ existence. An initial public offering (IPO) is the process of opening a private company shares to the public.
This unlocks a vast amount of funding available on the public market and leads to a new level of transparency. However, it also means additional complexity because now you have to deal not only with shareholders beyond professional investors. Such relationships require a lot of effort and you can expect it would be difficult and expensive.
Fundraising for a startup takes a lot of time and a good strategy to reach the goal. Understanding how all the rounds work and their intersection will give you an advantage over the startup owners that simply look for any investment passing by.
Money bags diversity: who is your guy.
As a startup founder or CEO, you should have a clear idea about different types of investors you can meet before actually starting to raise money.
There are 7 main options:
One of the first things that come to your mind is self-funding (also known as bootstrapping). This is especially good for early stages when you are just launching a business and have enough money to cover the current needs: setting up a business plan and creating a proof concept.
These two elements become your main instruments for future investments and the expenses can be covered from your own pocket. The advantage of bootstrapping is that you get tied to the business investing your own money which is appreciated by investors in later stages. However, this is not an option for those startups that need money from day one or large businesses.
Internet capabilities are unlimited. Crowdfunding has become a popular way of raising money as it doesn’t need much to get going. The opposite of a traditional business route, here people “pre-order” your product before you even started building it. You then use the money raised for the actual product development.
Small investments from a number of people on Kickstarter or Indiegogo can make a good starting point for your startup. All you need is to introduce a business plan, a prototype, or a video where you describe your goals, timelines, and milestones to convince people. There is always a risk of your idea being stolen and the competition is quite strong, but this is still a great way to generate interest in your product.
#3 Incubators and accelerators
For early-stage startups, accelerators and incubators can become great funding options. Such programs are run by VCs, government firms, and universities. They can be found in almost every big city helping over a hundred small businesses yearly. Their goal is to support a startup in its early stages by providing infrastructure, networking, marketing, and financial assistance.
Often used interchangeably, terms do differ in functions: incubators bring up startups like children from the very start to becoming a solid business, and accelerators help them scale up. Such programs have strong competition among applicants and run around half a year helping to build good connections with mentors, investors, and other startups.
#4 Angel investors
Angel investors are individuals or groups of people that provide funds to promising startups in the early stages. They have already given a good start to such unicorns as Google and Alibaba and can become mentors or advisors of your business for good equity that compensates the risk (usually up to 30%).
These guys look at whether the product fits the market, the technical team, and the initial customers that can drive revenue. Catching an angel investor and prooving your startup’s potential is not easy. You have to prepare a rocking pitch, a business plan, and a proof of concept contacting those on AngelList who either worked in the industry your product would serve or are currently investing in similar companies.
#5 Venture capital firms
This is the time when startup owners can make big bets. Venture capitals are professionally managed funds investing in startups with huge potential and scalability. Their expertise and mentorship can be good for small businesses that grow quickly and are already generating profit. However, VC investors usually plan to return their money within 3-5 years. So they would not be interested in startups that need more time to get to the market.
VCs are looking for companies with a good plan and a dedicated team that look for strong mentorship and control. If that doesn’t seem comfortable to you, it may not be your option.
#6 Bank loans
A bank loan is the most obvious thing when it comes to the question of funding. Banks provide different kinds of loans that give entrepreneurs complete control over their business and help finance short term operations. Bank loans require a lot of documentation, track record, and strict standards in addition to a detailed business plan. Considering this option, check the interest rates and collateral you can give in return.
As an alternative, you can consider getting a business card or applying for an SBA loan supported by the government. They work directly with banks to get loans in the hands of small entrepreneurs. A business loan can reach $50 000 which would be enough to cover a pre-seed stage.
#7 Government programs
Compared to business loans, you don’t have to pay back for small federal grants which are primarily open to startups providing solutions in science, technology, or health spheres. If your business involves any research, scientific, or environmental initiatives, government programs will be able to cover a part of your expenses (if not all of them).
There are also good chances of winning fundraising contests for startups that do not relate to scientific fields. Not only does it encourage more entrepreneurs to set up their own businesses, but also provides media coverage for the contest winners, fueling publicity.
Crowdfunding and SBA microloans leave you more control over your business. If you aim at a greater amount of money, your needs can be met by angel investors, venture capitalists, and private firms. Almost all startups start from pre-seed and seed stages sponsored on their own. To move further and raise more money, you have to provide investors with something more than just an idea – a short video or an inspirational speech.
This “something” should be based on a convincing design prototype, a business plan, a proof of concept, or the MVP that demonstrates the results of your work and the prospects for future investments. These things are difficult to be handled on one’s own. so many startups opt for hiring either an in-house team or outsourced resources, depending on their business needs. A development team enters the startup at first stages and becomes a reliable partner helping you embody your idea technically: from the first design prototype to a completed product ready to hit the market.
Final round: closing the deal
Now when you know what people are right to contact on each stage it’s time to think about what you are going to say to convince them to give you the money. This is how the process looks like:
Business and financial plan creation.
First, you have to calculate the amount of money you need at this stage and make your point with a clear strategy and exact numbers;
A pitch deck.
This is where you need to be convincing, so try to:
- Keep it within 20 minutes;
- Create a presentation up to 10 slides;
- Present your goals in the first 30 seconds (start with the broad objective and move to details and steps of delivery);
- Stick to three bullets on each slide, each one should be concise and include specific details such as graphics, financial outlook, and future growth;
- Use storytelling and provide real-life testimonials;
- Close a presentation with a call to action;
- Leave some time for questions and answers.
This is a long time-consuming process that requires your constant attention and every day follow-ups. Attend conferences, meetings, email, and call potentially interested investors, build relationships, repeat.
Even if you did everything right and your pitch left a good impression, the last step of your fundraising will be closing the deal. If you fail to do this, all other steps just don’t make sense. A winning pitch has the following anatomy:
You have to sell your startup idea explaining why investors can benefit from it. That is why you have to provide exact numbers, graphics, and a clear business strategy. As people are usually not interested in giving money to startups with no potential, focus on your growth opportunities and plans;
Listening and discussing.
Carefully listen to the investors’ concerns and answer their questions. Be transparent and direct when talking about potential business relationship;
If you are looking for large investments, you may have to give up some control over your business: be ready to sacrifice something to reach the goal;
Make clear deadlines regarding your plans, from pitching to closing the deal. It will create a sense of urgency and help you get the investments faster.
On average, it can take you three to six months from the initial pitch to the money in your bank account. This process can be influenced by several factors: time of the year, market trends, your location, the strength of your data, the results of your pitch, your relationships with investors, the time a particular investor needs to make a decision, etc. If you spent over a year on fundraising and still got no results, you are probably doing something wrong.
There are five common mistakes startup owners do when raising funds:
No market for your product.
If your idea is great, but you have no potential users that may need this product, investors will not consider it a good choice for investment (obviously). Make sure you have some early users that prove the market need;
Raising in packs.
If you and your co-founder spend all your time going to meetings with investors, you leave your product and team not progressing. So when you finally reach the investor you will have nothing to show up. Do not forget about moving your product forward while fundraising and divide responsibilities with your colleagues;
Changing your mind.
If you react to each feedback that investors give you and change your strategy according to their preferences, you may end up with nothing. For example, one investor may like the idea of a marketplace while another one thinks that mobile users are the future. You never know what is best, so just stick to what you think is right for your business;
Always try to talk with investors, not their associates. Your mission is to give the impression that the train is leaving the station, it is accelerating and investors can either jump on it or miss it forever;
The biggest mistake startup owners make is being sure that they raised funds after the investor said yes. You can’t consider fundraising over until the money is in your bank account, no matter how many yes you received. If you don’t follow up investors every single day reminding about the deal, it may take ages until you get the money – if you actually get it.
Establishing a startup is always a risk. Focusing on the right investors, finding the right words for your sales pitch, and presenting a proof of concept created by the right team will help you go through different funding rounds and become a startup that not only survived but succeeded in a sea of competition.
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