If you’re spending sizeable amounts on R&D and marketing, you might be asking: how do I raise funds for my startup? Understanding how funding rounds work is essential when approaching capital raising.
Raising capital for your startup can be a long and difficult process. Finance news is awash with reports of successful funding rounds as the amount of capital invested in new startups grows every year — the average series A funding round in 2010 captured $4.9 million, but has increased to an average of over $6 million.
The high number of startups seeking to execute successful funding rounds, however, creates an extremely competitive environment. Data collected by CB Insights reveals that 67 percent of startups stall during the funding process, with only half of all startups that manage to execute a successful initial round proceeding to succeed in follow-on rounds.
The chance that your company may successfully raise capital through funding rounds and go on to become a “unicorn” — a privately held startup company valued at over $1 billion — is less than 1 percent. That doesn’t mean you won’t be able to execute a successful funding series, however.
The most important step when considering the funding round process and capital raising is to understand how it works. We’ll proceed to break down the how series A, B, C, and D funding works and help you understand capital raising in better detail.
Why Raise Capital Through Funding?
Seeking external funding is a powerful option available to companies seeking to scale up and significantly increase their growth. Many startups and new ventures choose to seek external funding after a “bootstrap” period in which they scale as far as possible before engaging potential investors.
The competitive funding ecosystem means that startups and businesses seeking to scale must now demonstrate compelling evidence of growth and market traction before they are able to capture the attention of investors — bootstrapping allows startups to prove genuine market interest.
Many startup investors take the form of venture capitalists. An investor willing to invest in a startup company does so because they see potential in the business, and thus exchange capital in return for an equity stake — a specific amount of shares — in it. Should the startup they invest in be successful, their equity increases in value.
The main reason an investor exchanges capital in return for equity in a startup is the potential for a successful exit in which the startup is acquired or lists on a public stock exchange. A successful exit means investors stand to generate significant profits. If the startup fails, however, the investor could lose a significant amount of money.
The risk involved in venture capital investment obligates startups to provide extensive information to potential investors before they will consider participating in a funding round. Startup founders typically need to provide a valuation of their company to investors, which is then used to calculate the potential success of the startup – in which case a financial model can really help.
The factors considered by investors can include the current revenue and market share of a startup, the size of the market it targets, and its profit margins.
Why Not Traditional Finance?
Securing business finance from a traditional financial institution, such as a bank, is difficult for a startup that doesn’t hold many assets. A startup seeking to borrow enough capital to pay for development, marketing, or sales staff will typically fail to secure finance unless founders are willing to secure a loan with personal assets.
If a startup is able to secure traditional finance, then the amount they receive must be paid back — with interest. Many startup founders are able to shoulder the burden of expenses such as travel, hardware, or other minor costs via credit cards, but the comparatively high interest rates and low capital access offered by credit doesn’t provide startups with the funds needed to hire team members, pay wages, or invest in production.
Seeking VC funding is, in many cases, the ideal solution for startups seeking to scale rapidly and delivers benefits outside of access to capital. VC investors are able to provide startups with industry networking advantages, extensive experience in working with other startups, and mentor opportunities that can deliver a competitive advantage in the saturated startup ecosystem.
Debt financing through traditional finance shouldn’t be completely ignored by startups, however. A startup with demonstrable traction has the option of turning to debt financing should it fail to capture VC interest — whether or not debit financing is suitable for your startup depends on your growth strategy.
How Do I Raise Funds for My Startup?
Attracting investor attention to your startup is a complex process. There’s no clear formula to success. If you’re planning on running a series of funding rounds, it’s essential to establish a network within the industry you’re targeting.
Many incubator and accelerator programs operate in tandem with VC, connecting promising startups with potential investors as part of their service. Growing your startup from an accelerator or incubator allows you to connect to other entrepreneurs and startup founders that will be able to provide insight into their own funding efforts.
The startup ecosystem is home to hundreds of associations, networks, and groups, many of which host events that connect startups to investors. Attending funding and networking events is an effective method of connecting with potential investors.
When engaging investors, it’s important to remember that your startup will be judged not only by business valuation and a pitch deck. Investors will assess the experience of your team and their ability to reach their goals. The startup ecosystem are inundated with investment opportunities for investors — a startup must differentiate itself with demonstrable experience and traction in order to capture their attention.
How does Series Funding Work?
Funding typically occurs across multiple rounds. In many cases, startup founders will offer investment opportunities to their personal network before launching an initial funding round. This “family and friends” round precedes the first formal round, which is referred to as the seed round. Each subsequent round is designated in alphabetical order: series A, series B, et cetera.
“Angel” investors, or investors that invest in a startup with their own capital, often engage startups in the seed round or series A stage along with venture capitalists. Later stages attract private equity firms and secondary market groups that become interested when a startup begins to develop inertia in the funding process.
Each round in series funding can be a step closer toward mainstream success for a startup. Understanding which rounds attract various types of investors and what the purpose of each round is for will help you develop an effective capital generation strategy.
Family & Friends Round
Running a family and friends round is often the first step startup founders take before launching a formal seed round. Executing a family and friends round without proper planning, however, can cause structural problems for future investors. It’s essential that founders raising a family and friends round ensure they don’t over-value their startup.
A family and friends round should be treated in the same manner as a seed round — formalizing and documenting this round ensures the process is as transparent as possible, and functions as the foundation for future rounds.
Seed Round
Seed rounds primarily attract angel investors and early stage VC interest. The capital generated in a seed round is typically used to cover the initial expenses of a startup until it gathers enough traction to begin earning revenue.
A seed round should be executed when a startup is developing a MVP, validated the market that it targets, and quantified the value of potential customers. In a seed round, the founders of a startup are selling their vision of the future for their business, a prototype, and the experience of their team.
Seed rounds capture a variable amount of capital that ranges between $100,000 and $2 million.
- What should a seed round do for your startup?
- Confirm that your product will be successful in your target market
- Employ your first team members
- Develop and launch a minimum viable product
- Gain traction
Series A
Series A rounds attract the attention of early-stage venture funds, professional angel investors, and VC firms. A series A can represent the first round of shares offered to external investors, who must be provided with a valuation that assesses proof of concept delivered by a startup, current progress, market size, and team experience.
Series A rounds are typically raised when a startup has established a user base and a marketable product.
- What should a Series A round do for your startup?
- Product optimization
- Key team member salary payment
- Business model development
- Early scaling efforts
Series B
Series B is focused on venture capitalists interested in the later-stage growth of a startup, but often interests the same parties as a series A. Startups typically raise a series B in order to increase scaling efforts.
Series B rounds are launched at a growth stage in which a startup has a proven business model and possesses a customer base. The criteria used to value a startup during a series B round includes the current it owns, industry performance, and the revenue it generates.
- What should a Series B round do for your startup?
- Increase market share and accelerate scaling
- Expand team and hire quality talent
- Reach break-even and begin to generate profit
- Eliminate market competitors
- Expand marketing and sales channels
Series C, D, E and Beyond
Private equity firms, hedge funds, investment banks, and secondary market groups typically participate in series C rounds and onwards. The capital generated in series C rounds and beyond are used to maximize market share, scale further, and, in some cases, acquire other firms.
- What should a Series B round do for your startup?
- Market domination
- International expansion
- Research and development
- Potential M&A activity
Series Funding & Your Startup
Executing a successful series funding round provides entrepreneurs with the opportunity to take their startup from the garage to an IPO — if they’re dedicated and focused enough to approach the right investors with an attractive value proposition.
Attracting investors and capturing their attention is no easy task. A successful funding round is based on competence, effort and effective capital raising strategy. If you have questions about how to approach series funding for your startup, reach out to Fullstack today for VCFO expertise and investor ready financial models.
