Stages of Startup Funding

23 Jan 2013

Stages of Funding

Seed Capital

This is typically the very first stage of funding where the investment of money is used for market research and product development. Seed capital can be received as a loan or in exchange for common stock. Credit cards can also be used as a startup fund option at this stage.

The required funding can come from the founder’s personal savings (e.g. from the founder’s prior job) or from acquaintances aka a “Friends & Family” which is commonly referred as “F&F”.

Though this type of funding typically comes in small amounts with very little hassle or legal expense, but you should be careful. Risks are associated with every business, which may hamper relationship with friends and family. Funding Size is generally less than $50,000.

Upside:

  • Convenient, no nonsense.
  • Fewest contractual strings attached.
  • Available quickly.

Downside:

  • Limited one-time source of funding.

Angel Investor Funding

Since seed capital is sometimes limited, it is often necessary for an entrepreneur to tap into high net worth individuals outside their friends & family who are often called an “Angel” investor. Friends & Family investors sometimes may participate in this “Angel Round” of financing.

You can receive money from an angel investor as a loan that is convertible to preferred stock which is often converted to the Series A round of stock.

Along with the capital, Angel Investors provide business wisdom and valuable networking opportunities. They often like to invest in groups, each taking a piece of the deal. The funding size ranges from $25,000 to $1 million.

Upside:

  • More than money, they invest business smarts and networking opportunities.
  • Relatively patient about their investments.

Downside:

  • Often hard to find.
  • It can be hard to manage the various interests of a large group of angels

Venture Capital Financing (Series A, Series B, Series C Rounds, etc.)

Venture capital (VC) funding is typically used by companies that are already distributing/selling their product or service and have sufficiently proved their marketability. It may sometimes be the case when they may not be profitable as yet. In such cases, the venture capital financing can often be used to offset the negative cash flow.

There can be multiple rounds of VC funding and each is typically given a letter of the alphabet (A followed by B followed by C, etc.) The different VC rounds reflect different valuations (e.g. if the company is prospering, the Series B round will value company stock higher than Series A, and then Series C will have a higher stock price than Series B).

If a company is not prospering, it can still get subsequent Series-rounds of financing, but the valuation will be lower than the previous series: this is known as a “down round.”

These rounds may also include “strategic investors:” investors who participate in the round and also offer value such as marketing or technology assistance.

In the Series A, B, C, etc. rounds of financing, money is typically received in exchange for preferred stock (as opposed to the common stock that insiders/seed capital sources (and perhaps even angel investors) receive).

A typical VC fund will be a professionally managed fund with a ticket size that ranges from $250,000 to tens of millions.

Upside:

  • VCs invest smarts and networking in addition to money.
  • Typically have more money if you need more to grow.

Downside:

  • Must be a "fast growth" startup business.
  • Must be interested in selling the business or going public in three to five years.
  • Must be prepared to share or give up control.

Mezzanine Financing & Bridge Loans

At this point, companies may be eyeing the following types of opportunities that require additional funds:

  • An IPO (initial public offering)
  • An Acquisition of a Competitor
  • A Management Buyout

To do so, they can tap into mezzanine financing or “bridge” financing.

Mezzanine financing is often used 6 to 12 months before an IPO and then the IPO’s proceeds are used by the company to pay back the mezzanine financing investor.

Strategic Investors

 These equity financiers get their name because they're from the industry you're targeting and find what you're selling to be "strategic" for their business objectives – such as complementing the products or services they sell or are aligned to their funding goals.

However, they can swamp your business with opportunity, seduce you into a lopsided reallocation of your company's resources, restrict you from dealing with their competitors as your customers, and even cancel your relationship.

Upside:

  • Enhances your credibility in the industry.
  • Money can come with access to benefits like manufacturing, distribution, and marketing.

Downside:

  • Can force you to recalibrate your entire business to serve them.
  • Dependency can be risky.
  • Can prohibit you from selling to their competitors.

Comparison of Funding Options

FUNDING TYPES

STAGES OF BUSINESS

ADVANTAGES

Limitations

FRIENDS & FAMILY

SEED STAGE

  • Convenient
  • Very few contractual strings attached.
  • Available quickly.
  • Limited one-time source of funding.
  • Hamper relationship with friends and family

Angel Investors

SEED STAGE & EARLY STAGE

  • Share business wisdom and valuable networking opportunities along with the money.
  • Often hard to find.
  • Hard to manage the various interests of a large group of angels

Venture Capitalist

Expansion and Mezzanine Stage

  • Bring along expertise along with the money
  • Huge amount of money
  • Interested in selling the business or going public in three to five years.
  • Prepared to share or give up control.

Debt Funding

Seed Stage & Expansion

  • No dilution of equity
  • Low cost of capital
  • Charge on assets
  • Liability to pay regular interests

Grants

Seed Stage

  • No dilution of equity
  • No interest payments
  • Complex process of application
  • The full amount required may not be obtained in most cases

Bootstrapping

Seed Stage

  • Complete control
  • No dilution of ownership
  •  Lack of adequate capital
  • Financial constrains may hamper business activities
Last modified on Thursday, 24 January 2013 00:46
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