So, you have a start-up, up until now you have just boot strapped the concept… But its now time to grow and expand the business, welcome to the world of start up funding. It can be a tricky world to navigate that is why today I am going to explain how start-up funding works.
There is a bit to go through, so strap yourself in and let’s get into it.
What is a funding round?
There are generally two sides in a funding round, there are individuals hoping to gain funding for their start up. As the start-up matures, it tends to advance through the funding rounds until its exit.
Then on the other side is the potential investor, the investor wants to see the start-up and its founders succeed and transition into a successful exit but… they also hope to gain something from the risk they have taken to back the new venture in the form of equity in the company.
How does a funding round work?
Both parties will generally meet and the start-up will pitch their business to the potential investors, the investors will ask a multitude of different questions, by the end of the meeting the start-up will have walked away with some much needed capital, and the investor with another potential unicorn under their belt.
The following is the way most typical funding rounds happen for start-ups
Pre-seed Funding
This is the earliest form of funding and generally not counted on the list. BUT… This round of funding is by far the most important! This is the stage where founders are getting their operations off the ground, they have jumped off the cliff. (metaphorically, don’t actually go and jump off a cliff). They have decided to back them self, and bring a new idea, new product, or a new service to the marketplace.
The level of risk here it generally extremely high as everything is new and un-proven the founders must be flexible and be able to pivot at short notice. The investors that normally invest at this stage of a start-up’s life include:
- Founders
- Close Friends, Family & Supporters
Seed Funding The Round For Start-Up Funding
So, you made it through the Pre seed round, CONGRADULATIONS!!
Welcome to the first ‘official’ equity funding stage. The seed round represents the first official money that a start-up venture raises.
The term seed round comes from the analogy of planting a tree. There are many trees in the world all of which started from a seed, over the years some trees grow massive soring high into the clouds (in start-up lingo this is normally referred to as a unicorn) some trees grow steady for a long period of time and other trees die.
The seed round for the founders is a critical round its where they get the much-needed capital to continue operations and the knowledge from investors. This round can shape the direction of the company long into the future as well as open more doors for future investment rounds.
Making it to the seed round typically opens the doors to a wider pool of investors willing to take on a little extra risk then the normal stocks and bonds on offer. Investors could include: \
- Founders, friends and family
- Incubators
- Venture capital
- Angel investors
The amount of money on offer in this round dose vary wildly depending on many various factors. Its not uncommon for these rounds to produce anywhere from $10,000 to $2,000,000+ for the start up in question. Most start-up valuations come in to around the $3,000,000 – $6,000,000 post money mark (keep reading to find out about valuations)
Series A
Series A, welcome to a major milestone by now you should have a proven, scalable business model that’s getting people excited. You may have received some major traction in the public or on finishing the next stage of development what ever it is series A funding is major.
The reason Series A funding is so major is because investors are not just looking for great ideas anymore they are looking for great ideas and founders who have a strategy of turning that great idea into a viable, scalable, money-making business primed for success.
The Series A funding round can also get political as more venture capital and larger investors come on board don’t loose sight of the companies Mission and Vision.
Generally the investors in this round are going to be the bigger funds such as venture capitalist, larger angle investors like wealthy families or fellow founders that have had a successful exit or two or the larger accelerator programs. But it is becoming increasingly common for founders to use equity based crowdfunding in order to generate capital.
Fewer that half of the start-ups that secure seed funding go on to generating enough interest in investors to receive a successful series A round.
However the start-ups that do make it through the round received approximately $2,000,000 – $15,000,000 with valuations around the $10,000,000 – $30,000,000 mark.
Series B
Ok things are starting to get serious welcome to series B funding, at the series B funding stage its all about taking the business to the next level. Start-ups that have passed through the seed and series A funding round have developed a significant user base and are primed for success on a larger scale.
The series B funding round will provide much needed capital so the company can expand with the growing user base or product demand. Money will be spent on things such as; talent acquisition, business dev, sales & marketing, tech, support the list goes on…
The average capital raised in a series B round will be $15,000,000 – $ 30,000,000 investors could include earlier venture capital funds and Late stage venture capitalist, you may have an anchor investor who draws in other investors to help fill the funding round.
As the funding ends in series B your start-ups valuation is going to be approx. $30,000,000 – $60,000,000.
Series C The Final Stages Of Start-Up Funding
If you have made it to a series C funding round you deserve a round of applause as its quiet the achievement.
In the series C round we are getting to the pointy end of the stick in terms of funding, by now you should have quiet the successful business with a proven scalable model. By this time you should be seeking funding in order to develop new products, expand into new markets or even acquiring other start-up’s with the IP your start-up needs to expand at exponential rates.
Investors are looking to inject large sums of money into successful start ups in the hopes of major returns in the not to distant future ( Que exit plan). At this later stage of funding, you are going to encounter more sophisticated investors such as hedge funds, superannuation funds, investment banks and private equity firms. These firms are looking to invest significant sums of money into companies with a proven business concept they do this as a means to secure their own position as business leaders.
The approx. size for most series C funding rounds is $50,000,000 – $500,000,000 with valuations of around $100,000,000 – 120,000,000.
Most start ups will end their external funding rounds at a series C from there they will look for a potential exit. But some start-ups go on to conduct series D & E rounds. The start-ups that go on to do more rounds typically are in the search for a potential IPO or have not yet achieved the goals set out in the series C funding round.
The Exit..
There are two main exit strategies start-ups use IPO’s or Merger and Acquisition.
IPO’s
I.P.O stands for initial public offering it’s the process of applying a countries stock exchange to list a predetermined number of corporate shares on the exchange.
If a start-up decides to go the route of IPO thena number of things start to happen:
- The formation of an external public offering team is formed. This compromises of underwriters, lawyers, certified public accountants and experts from the exchange.
- Compilation of the start-ups information including financial performance and its expected future operations.
- Audit of the start-ups financial statements takes place which generates an opinion about its public offering.
- The start-up files a prospectus with the exchange and determines a date for going public.
Merger and Acquisition
M&A’s is a general term used to describe the consolidation of companies and assets through various types of financial transactions.
There are many types of Mergers and it depends on the strategy to which one/s are used, here are some that a company might consider:
- Merger: In a merger, the board of directors for two companies approve the combination and seek shareholders’ approval. Post-merger, the acquired company ceases to exist and becomes part of the acquiring company
- Acquisition: In a simple acquisition, the acquiring company obtains the majority stake in the acquired firm, which does not change its name or alter its legal structure
- Consolidation: creates a new company through combining core businesses and abandoning the old corporate structures. Stockholders of both companies must approve the consolidation.
- Tender offer: In a tender offer, one company offers to purchase the outstanding stock of the other firm, at a specific price rather than market price. The acquiring company communicates the offer directly to the other company’s shareholders, bypassing the management and board of directors.
- Acquisition of assets: In an acquisition of assets, one company directly acquires the assets of another company. The company whose assets are being acquired must obtain approval from its shareholders.
- Management Acquisition: In a management acquisition, also known as a management-led buyout (MBO), a company’s executives purchase a controlling stake in another company, taking it private.
The Bottom Line of Start-up Funding
The bottom line is the different rounds of funding operate in essentially the same basic manner; investors offer cash in return for an equity stake in the business. Between the rounds, investors make slightly different demands on the start-up.
Nevertheless, investors from seed rounds right through to Series A, B, and C investors all help ideas come to fruition. 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 or Merger.
FAQ’s
- Q. how to get seed funding?
If you are at a stage where you have a great idea and have somewhat proven an idea is feasible on paper, then you should start looking for seed funding to get the spark of entrepreneurship started. A great place to start looking would be family and friends but also local incubators.
- Q. What are valuations?
If you hang around the start-up scene long enough you will start hearing the terms pre & post money valuations thrown around, in essence it means this:
Pre-money valuation refers to the value of a company not including external funding or the latest round of funding. Pre-money is best described as how much a startup might be worth before it begins to receive any investments into the company.
On the other hand, post-money refers to how much the company is worth after it receives the money and investments into it. Post-money valuation includes outside financing or the latest capital injection.
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