Transforming your startup dream into a profitable business often requires attracting funding to help launch and ultimately grow your organization.
Financing from venture capitalists is a source of equity funding for startups with high growth potential. Whereas traditional debt financing requires you to repay a loan through payments and interest, capital from equity funding is acquired in exchange for shares of ownership or convertible notes that start off as debt and are later converted into company shares.
Equity financing is normally raised in stages and can be comprised of multiple rounds. Within the larger venture capital (VC) industry, individual investors (also known as “angel investors”) and micro-VCs usually participate in early-stage investments–generally called “pre-seed”, “seed”, and “Series A/Series B” rounds. A description of each follows.
Pre-seed funding is the initial stage of equity fundraising. This is the stage when your startup is developing its proof-of-concept or prototype with just a few employees (typically yourself and any other co-founders). Since businesses in this stage usually lack proven track record, it can be difficult for companies in the pre-market phase to easily attract small business loans from commercial banks, credit unions, or other financial institutions.
Instead, pre-seed money will likely come from your own personal savings, or your friends and family or even angel investors.
While the investment amounts during this funding stage are usually under $15,000, this capital can be critical to getting your business off the ground. You may use pre-seed money to refine your business plan, create your website, build your company’s management team, and purchase any other necessities required to kick start operations. Keep in mind that, once you begin taking capital, you should have a business plan and legal structure in place to protect the legal rights of your startup’s employees and investors.
During this stage, angel investors and early-stage VCs invest in your startup to help expand the development team and take additional steps towards product/market fit.
In other words, seed financing is meant to support business activities focused on building and refining your product. Moreover, seed funding can also be used to hire additional product engineering and design and marketing talent as well as outreach activities.
Typically, angel investors will invest under $1 million during the seed stage. Angels are accredited investors with either a minimum personal net worth of $1 million or an annual income of at least $200,000. Many tend to be former entrepreneurs or executives with previous experience starting and growing successful companies.
Angel investors typically provide smaller financing amounts than venture capital firms, but may take a hands-on approach to their investments. Like venture capitalists, these investors may actively participate in the management of your company to ensure the profitability and security of their investment.
Early-Stage (Series A and Series B Rounds)
Following the seed round, startups enter early-stage financing, or what’s commonly known as Series A. The name refers to the class of preferred stock investors receive in exchange for their investments.
During the Series A round, your business will most likely have achieved or be approaching product/market fit. Investors will also be looking for a growing user/customer base and monetization of your product. The money invested at this stage, which could be upwards of tens of millions of dollars, is primarily focused on continued recruitment of employees—particularly in sales, marketing, and customer support—and growing your customer base.
If your business needs more funding, the equity funding process moves to the Series B round. Consequently, this capital is typically used for ramping up business activities, including marketing, product development, talent recruitment, etc.
As your company approaches the break-even point and shows signs of being able to achieve profitability, your chances of attracting additional rounds of funding increase as well.
Beyond Early Funding Stages: Liquidity, IPO and Beyond
When your business focuses almost exclusively on expanding the business by producing and shipping products, growing the number of paid subscriptions, increasing product inventories, and boosting revenue, you’ve entered the growth stage.
At this point, company founders, early employees, and investors who own company shares or have stock options may be ready to cash out some or all of their stake. The growth stage is often geared towards a “liquidity event,” typically in the form of an acquisition or initial public offering (IPO), which provides an opportunity for shareholders to trade equity in exchange for cash.
The Equity Funding Process: An Ever-Changing Landscape
Equity funding patterns and investor expectations are always evolving and shifting. Keeping your eye on larger market forces can be extremely helpful as you’re negotiating deal terms with early investors.