Guide to Startup Funding Rounds

Startup Funding Rounds

The whole process of funding and developing startups has become more widespread because the cost of getting a product to market has dropped so precipitously in the past couple of decades from millions of dollars to typically anywhere from under $20,000 to $500,000.

The funding levels are relatively manageable by investors and the potential returns are huge. Potential. The risks are very high of any return, but the few startups that break out create legendary fortunes. That is why there are startup founders and startup investors.

A startup goes through a series of funding rounds on its journey from founder’s idea, through developing an MVP and customer discover, to finding Product/Market Fit, and scaling up operations and sales.

There are a lot of terms tossed around to describe the various rounds of funding that a startup can potentially receive.

These are the typical rounds encountered in an Angel and Venture-Backed Startup and not all startups receive all these rounds. Most small businesses don’t plan on scaling to become Unicorns and don’t pursue this funding journey.

The following rounds are presented in their evolutionary order relative to the development of a startup.

 

Sweat Equity

In the beginning of most startups, the founders will work on the idea for free. This is where things start. All the ownership resides with the founders at this point and they figure out how to develop the business concept using their own resources. This is where hustlers and builders push the development of their company forward without outside funding. Like Teddy Roosevelt said: “Do what you can, where you are, with what you have.”

If your idea is compelling enough, you can enlist the talents of others to work for sweat equity. This may take the form of paying a computer coder to help develop an MVP in exchange for stock in the company instead of cash.

 

Bootstrapping

Bootstrapping is taking early revenues from products and services developed with sweat equity and plowing it back into more development work. There is some outside money from early adopter customers, but not from investors. This is an important milestone because it signals that there is a need for what the company is creating. It is a signal that the founders are resourceful and committed to finding a way forward. This is the kind of grit investors look for in founders.

 

The 3 Fs

This is usually referred to as: Friends, Family, and Fools but I like to replace the last one with Fans. Once a fledgling startup has developed the concept and identified some preliminary customer interest and has a clearer idea of what the next steps should be then it is time to tap the founders’ personal network. This is risky because raising money from your grandmother or uncle and then throwing in the towel in six months can make for an uncomfortable Thanksgiving get-together. You want to be sure that you are on to something before hitting up loved ones and old college roommates. The first two stages move the idea along and also help develop discipline about how to parsimoniously deploy these precious funds in the most effective and efficient manner.

Here you want to have a plan to get to clear milestones and deliverables that will be inflection points of added value and reduced risk. This plan needs to include a detailed budget of how to get from here to there. An entrepreneur needs to be scrappy and capital efficient.

 


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Self-Funding

This is a select group that has the resources to fund the initial development. A serial entrepreneur who has sold previous startups are in this category. These are founders that want to focus on building an MVP without having the distractions of pitching investors before knowing whether the idea is feasible and customer interest is reasonable there.

These folks also realize that the further along the business is, the higher the valuation for the company and the less equity they need to give up in order to raise capital.

 


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Incubator and Accelerators

Incubators and Accelerators are formal programs that accept startups and put them through a program to help develop their idea and then present the graduates to an investment community during a presentation day.

Founders can get a modest amount of funding from these programs. They also get credibility because they have been scrutinized, vetted and accepted by the incubator program.

Y Combinator is one of the most popular incubators and they have had some great success stories come through their program like Dropbox and Airbnb.

 

Crowd Funding

Kickstarter, Indiegogo and others have made crowd funding a viable option for taking projects from ideation to execution and prove market validation. These website driven funding sites are attractive because the represent a funding vehicle that is non-dilutive. This means that the money raised is not in exchange for equity (ownership) in the company. Other incentives besides equity are offered such as exclusive access to the founders or early access to the product.

A crowd-funding project can also act as a way to gauge demand and interest in a concept early on.


This is an extract from my latest book Startups: A Guide to Entrepreneurship.  It’s available on Amazon.  Check it out!

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Angel Investing

This funding round is also called Seed Funding and represents the first professional outside investment. Most founders get their seed round after successfully going through two or three of the early-stage funding strategies discussed above.

Angel investors are individuals who scout for great startup opportunities and generally make a lot of relatively small money investments in early-stage high-risk ventures. They are essentially buying lottery tickets on the character of the founder and the potential upside of a company breaking out into a huge success. They are look to make 100 times their money back if a company “exits” successfully by being acquired or going public.

Angels represent varying degrees of professional investor and they must be convinced of the potential of a startup to really scale and become hugely valuable.

 

Bridge Funding

The next significant round of funding is the Series A round where a company is funded by Venture Capital firms. But in many situations, founders underestimate how much time and money it will take to reach the milestones they need to achieve in order to warrant VC interest.

This gap between breakeven or profitability, or VC funding, is filled with a Bridge Round. It is designed to get the startup through to the next growth milestone. This follow-on funding round typically comes from the seed investors who are motivated to ante up or see the venture close down and their initial investment evaporate.

 

Series A

The Series A is the funding round where the company becomes a professionally organized entity: a corporation. Professional venture capital firms who as part of the deal join the board and create proper “governance” do this funding round. Proper governance means that the company is legally incorporated and holds regular board meetings and keeps a detailed record of board resolutions all designed to increase the share price of the company.

Prior to the Series A, founders run the show and answer to no one. Focus is on trying to find product/market fit. After Series A the CEO will spend a significant amount of time (25%) managing the board and the legal requirements of running a corporation.

 

Series B,C,D etc

These are the follow-on rounds once a company makes the transition to being a professionally managed operating entity.

 

Cap Table

The cap table is short for the capitalization table. It is the official list of all the shareholders in a company and how much they paid for their shares. The above funding rounds represent the people that make up the cap table.

 

Exit

This is the event that represents the big payday for early investors and founders. An exit is either an acquisition or an IPO Initial Public Offering. An IPO is where a company gets listed and traded on a stock exchange and sells shares to the general public. IPOs are relatively rare.

The more usual exit is an acquisition where the startup is bought by an established company to add to its portfolio of offering or for some other strategic reason.

The purchase price of the company is split among the various shareholders and the value of their pro rata portion is what determines their return on their original investment. The exit is the end game goal of venture-backed startups.


This is an extract from my latest book Startups: A Guide to Entrepreneurship.  It’s available on Amazon.  Check it out!

http://amzn.to/2fc9mdC

 


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