Funding is arguably one of the most crucial elements of growing a company. Businesses seeking to expand may do so by appealing to investors — individuals or firms who offer money on the promise that they will receive a substantial payout once a company becomes profitable. Appealing to these investors is a process that comes in phases, with each phase providing businesses with the opportunity to meet larger and more substantial goals. To be successful in growing their companies, entrepreneurs should be intimately knowledgeable about each stage of startup funding.
5 Startup Funding Stages
The process of startup funding comes in five general stages. Each one is designed to help further the maturation of the company and increase both its revenue and competitiveness in the market.
Stage 1: Seed Capital
Seed capital is considered the beginning of the business venture process. At this phase, all money used to begin a business comes from smaller sources, such as an individual’s savings or the financial assistance of family and friends. Other avenues may also provide support, explains Evus Technologies, such as crowdfunding, incubator programs or accelerator programs like Y-Combinator or Techstars. (The National Business Incubation Association estimates that there are more than 1,250 business incubators in the United States.) Venture capital funds are usually not involved in this stage because of the high risk associated with investing in new companies. Some sources consider this stage as actually two separate ones: pre-seed and seed. According to QuickBooks, the pre-seed stage is defined as funding that remains under $15,000.
At the seed stage, business concerns include:
- Doing research on the market, the viability of the product or service, and costs
- Recruiting business partners
- Developing products
- Refining ideas
- Building a board of advisors
- Working out legalities, including partnership agreements and copyrights
- “Grass-roots” advertising, including social media efforts and referrals
To be successful in acquiring funds at this stage, TechDay suggests that entrepreneurs devote their efforts to preparation and research before approaching potential investors.
Stage 2: Angel Investor Funding
In this stage, businesses are trying to build momentum. “Angel” (or “accredited”) investors are those with earned income that exceeds $200,000 ($300,000 with a spouse) or those who have a net worth of more than $1 million, reports the U.S. Securities and Exchange Commission. At this point, venture capital firms are still not involved in the process. Instead, “angels” are all individual investors. Some may be former startup entrepreneurs themselves, and they may even be interested in adding their own personal management or influence to business operations along with their money. At this stage, businesses are usually concerned with:
- Increasing sales
- Expanding marketing
- Hiring more employees, particularly those considered competitive or high-talent
- Ensuring a solid business foundation within their initial desired audience
It is suggested that those seeking angel investment funding do significant research and provide a well-substantiated sales pitch.
Stage 3: Venture Capital Financing
When a business begins to show revenue but has yet to show profit, venture capital financing (VCF) begins. VCF is unique because it takes place in rounds. Each round is assigned a subsequent letter of the alphabet and varies somewhat in its intent. There is no set number of rounds that may take place, and the amount of money raised in each round is not contingent on the amount raised in any other.
These rounds are explained below:
- Business in question identifies preferred stock investors
- Money invested is around $10 million
- Name recognition becomes increasingly important to the business
- Company funds are being used to recruit additional employees (including those in sales, marketing and customer support) and to grow a customer base in new demographics
- Company goal is to improve product and position in the market
- Round is used to procure funds needed to expand marketing, hire more employees and establish strategic alliances in the market
- Funds raised often result in increased market share and revenue
- Round can be used for increased marketing, talent recruitment and product development
- Company experiences increased press coverage
- Acquiring competition may happen during this time
- Advertising is designed to reach a wider audience
- Round C and other subsequent rounds are used almost exclusively to expand the business
- This round happens because current funds are not enough to ensure the proper support and development of assets and capabilities necessary for growth
- Companies are seeking to expand operations at a quicker pace
- Capital is used to move the company into a prominent position within its industry
Although each round ideally provides an increased amount of cash flow, “too many rounds can overly dilute the founders’ stake in the venture,” Entrepreneur explains. This can hurt business growth.
Stage 4: Mezzanine Financing and Bridge Loans
Also called “bridge financing,” this stage is categorized by the business in question taking on short-term debt. By acquiring loans that last approximately six to 12 months, businesses are able to “bridge” the gap between their current financial position and the amount needed to reach the point of going public or acquiring a major competitor. A company may even get bought out. Money from mezzanine financing may also be used to expand a company’s reach in the market even further. At this stage, companies are generally worth around $100 million. While revenue at this stage may be coming in with regularity, the business has not yet become profitable.
Stage 5: Initial Public Offering (IPO)
Although an initial public offering (IPO) is not necessarily the end goal for all startups, it is a significant opportunity for a business to continue to expand. An IPO is the process of taking a company public, meaning that it gains the opportunity to be traded on the stock market. At this point, a business is valued at more than $100 million and has reached “full maturity.” Investors will often recoup their money with interest at this juncture, and stock options can now be used to attract and retain top employees, as well as provide resources for further development of the business, its products and markets.
Understanding Business Growth and Development
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