Funding rounds are one of the most important elements in a startup’s life cycle. They allow startups to grow, generate revenue, and perhaps one day reach an exit.
However, despite their importance in the growth of a business, many startups often have little understanding of them.
In this article, we’ll explore the different funding rounds, the capital involved in each stage, and the startup milestones each of them trigger.
Let’s get started:
What is a Funding Round?
You can think of a founding round like layers of an onion. Each layer gets you closer to achieving your goals. However, it’s crucial to know what you’re getting into before moving forward with any investor.
A startup funding round is a means by which entrepreneurs raise capital to fund their business — usually through investors.
The business uses the capital to grow their idea into a successful business model, ideally making a profit along the way that will make those who invest some money back.
It’s called a “round” because it can happen more than once, with each time the company raises money being a fresh round.
Typically, the first round of funding is known as the “seed round” and subsequent rounds are known as series A, B, C and so on.
Why Do Startups Engage in Funding Rounds?
The main reason startups get investment funding is to help them scale up.
To put it simply, this means that by increasing their capital, they’re able to grow the size of their workforce, improve the quality of their products or services, and ultimately achieve more earnings.
Let’s look at each of these reasons individually:
- Raise capital for growth
When a startup experiences rapid growth, it may be necessary to bring on new investors to support that growth.
This could be in the form of hiring new employees, acquiring additional office space, or investing in new technology and marketing initiatives.
- Supports business strategy
In the same way, many startups use their funding rounds as an opportunity to re-evaluate their business strategy.
This may include refining their target market, developing new products or services, or changing their pricing strategy.
- Acquiring marketable equity
Besides money, startups also hope to gain marketable equity through funding rounds. This could include shares in the company or a seat on the board of directors.
This equity can be beneficial for startups to raise additional money in the future.
- Builds business credibility
When you raise money from investors, it shows that you have a good idea and that other people believe in it too.
This can help you win new customers and partners, as well as attract top talents to your team.
To achieve success, startups need talent to build out their products, and customers to generate revenue with which to pay back investors.
What are the Stages of Startup Funding?
Now that you understand how startup funding works and why entrepreneurs engage in financing rounds.
Next, we’ll look at the different stages of funding and what they mean to you as a startup founder.
Let’s get to it:
- Pre-Seed Funding
Pre-seed funding is when funds are raised by an entrepreneur or founder before they begin their search for venture capital (VC).
Friends and family could do this, but it’s most often by incubators and angel investors.
In addition, this capital allows entrepreneurs to get their ideas off the ground and may help them attract VC interest down the road.
Usually, this funding doesn’t cover over two years of operation, thus it shouldn’t be considered a long-term source of funding.
Also, pre-seed funding can be used by a startup to validate their business model, acquire market insights and build a minimum viable product (MVP).
This gives early-stage companies time to develop a strategy, make connections, gather resources and make growth plans.
A good example of popular pre-seed programs includes Y Combinator (YC) and TechStars, among others.
- Seed Funding
This is the second stage of funding for startups. It’s also known as startup capital or seed money, and it’s often provided by angel investors or venture capitalists.
The seed-stage aims at developing a more refined version of the minimum viable product (MVP) and helps the startup team enhance its credibility among potential investors.
Seed capital typically ranges from $200,000 to $2 million. The average amount raised in a seed round is $400,000-$500,000, but there are cases where companies have raised millions of dollars in this round.
So, how do you find seed capital? Startup platforms such as AngelList and other accelerator programs — Startupbootcamp, 500 startups, and Y Combinator — are often a good place to start.
In addition, you should also network at events like tech meetups and pitching investors or people who might be interested in your company.
- Series A Funding
This is the second round of venture capital investments made by established VC firms, angel investors, and corporate investors for equity ownership in the company (company shares).
At this stage, the company typically raises between $1 million and $10 million, but sometimes more, as shown by recent data.
According to Fundz, the average amount raised in Series A round in 2020 was pegged at approximately $16million.
The primary aim of Series A funding is to help the company grow, get its product out to the world, and become profitable.
In addition, this capital will be used for things like legal fees, marketing costs and other operational expenses that are vital for helping your business grow.
Essentially, the capital from this round will help your company transition from being self-funded or bootstrapped to being professionally funded.
- Series B Funding
The Series B round of funding occurs when a startup needs more money to continue scaling and growing its business.
It’s often referred to as the “traction” stage because if a startup can get Series B funding, it likely has some early traction in the market.
Also, Series B rounds are typically more extensive than the first venture capital round and can include more investors who are focused on later-stage investing.
This is because investors are more willing to invest in an already successful business than one that’s just getting off the ground.
What’s the goal at this point? For founders, their goal will be to achieve major growth through expansion into new markets, as well as increased and sustained sales volume.
At this stage of funding, the company will look to raise anywhere from $10million to $60million.
In 2021, the median pre-money valuation for Series B startups was around $40 million.
- Series C Funding
After proving its worth in the marketplace, a company may pursue a Series C round of funding. This stage is referred to as the “going public” or “growth round”.
Companies with a proven business model who have achieved significant growth in sales and profits carry out this round of funding.
Often, this round is expected to bring in entirely new investors, lead an acquisition or merger with another company, or see an expansion into new markets, with the intent of generating substantial returns for investors.
So, what are investors looking for at this point? With Series C funding, investors want to see substantial growth, preferably at least 50% over the previous year.
In addition, they also want to know that the founders are still involved in directing the company’s strategy, as opposed to being sidelined by venture capitalists or other outside influences.
Also, financing rounds at this point can vary widely depending on the size of the company and its potential market opportunities.
Valuation at this point is often over $100 million. However, some startups like Magic Leap have raised almost $1billion at this stage.
How Do You Get Startup Funding?
There are many ways to get funding for your new startup idea. The one that best suits your business will depend on your business type and stage of growth.
Here are some of the most common sources of startup funding:
- Bootstrapping
Bootstrapping means using only your own money or credit for funding your business until it becomes profitable enough to generate its cash flow.
Companies with minor operations and low cash flow needs can do this, but it results in a slow start, high-stress levels and periods of complete financial dependence on family members or friends.
- Accelerators/Incubators
Startup accelerators provide seed money for a small stake in a startup’s ownership.
They also offer mentorship, networking opportunities and access to industry experts who have previously funded successful startups.
The goal of accelerators is to help nurture young businesses by giving them resources and connections they might not otherwise have access to.
Recommended Reading: Y Combinator 2022: How to Apply and Succeed at YC
- Crowdfunding
Crowdfunding sites like Kickstarter and Indiegogo allow businesses to raise money from large numbers of individuals donating smaller sums of money.
It’s essentially angel funding that uses the power of social media instead of a personal network or other connections to solicit donations from interested parties.
- Angel investors
Angel investors provide capital to startups for convertible debt or equity. As the startup continues to grow, it will eventually require venture capital (VC) funding.
Angel investors can provide seed money for a startup and can also help provide guidance and contacts that will aid the growth of the company.
- Venture Capital firms
Venture capitalists provide an influx of cash that allows startups to invest heavily in research and development, expand their workforce, and grow beyond the capacity that angel investors can provide.
VCs are often essential for startups to bring their products to market, but they require larger investments than angel investors.
Wrapping Up
While the terminology involved here can be confusing, and the definitions change depending on who you ask, hopefully, we’ve helped make things less murky.
Your next step as an entrepreneur is to figure out which stage fits you best in order to come up with a funding plan that works for your company.
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