How does startup funding work?
Startup funds go to people or groups of people to raise money for their new business, which allows the company to grow. When investors help to fund a startup, they do so hoping that they can receive a larger amount of money from the business in the long term. Depending on how much someone has invested into a company, they may also be able to make business decisions that affect how the company runs.
8 startup funding stages
Here are the phases startups go through to obtain funding:
1. Pre-seed funding stage
This is the research phase of beginning a startup. During the pre-seed stage, make sure to answer the following questions:
- Is your idea viable?
- Has your idea been done before?
- How costly is your venture?
- What kind of business model will you use?
- How will you get started?
In many situations, much of the business funding during this phase either comes from you or friends and family. The total value of a startup in this stage can range anywhere from $10,000 to $100,000.
Example: Anya has an idea for a new car wheel-washing kit. She researches similar products currently on the market, tests her own formula to determine its performance, examines the costs associated with producing her product and decides on her business model.
2. Seed funding stage
At this point, your idea is an actual business with some customer traction. Entrepreneurs in this phase provide company equity in return for larger amounts of cash provided by investors. Costs covered by seed funding include:
- Product launch
- Product marketing
- New employees
- Market research on product-market-fit
Startups valued anywhere from $100,000 million to $6 million are eligible for this phase of fund raising.
Example: During seed funding, Anya receives input to determine her final products and targeted customer demographics. She also hires three new employees.
3. Series A funding
The Series A funding stage marks the beginning of venture capitalist investment, and shares of the company are offered in exchange for capital.
At this point, you can begin to set yourself up for future business growth. This includes the following:
- Optimizing your business
- Offsetting financial losses or shortfalls
- Further developing your product or service
- Creating a scalable blueprint for growth
Example: Anya has proven her product is a great idea. Now she wants to show investors that she has a great strategy for future growth. She decides to go into a new market and start selling to large retailers. The more she demonstrates the ability to generate income, the more investment she'll receive.
Related: Angel Investors: Definition, Advantages and Disadvantages
4. Series B funding
Startups in this stage have dedicated user bases and steady streams of revenue. At this point, you've proven you can scale your idea. Investors can now help you:
- Employ advanced market reach activities
- Increase market share
- Form operational teams such as business development and marketing
Example: Anya uses this round of investments to open two new departments at her company: public relations and diversity and inclusion.
5. Series C funding
Series C funding is for a company well on its growth path and often interested in expanding globally. It may be easier to find investors at this stage, as they trust the startup to succeed. Funds at this phase are used to do the following:
- Build new products
- Reach new markets
- Acquire underperforming startups in the same industry
Example: Anya received Series C cash. She begins development on a product to clean car windshields and starts shipping her original product overseas.
6. Series D funding and beyond
There are usually two reasons a startup goes past the Series C funding round. They are:
- New opportunities: A potentially lucrative opportunity appears that requires the company to act before the Initial Public Offering (IPO).
- Subpar performance: The startup misses the goals set during the Series C round of funding. It then raises more funds in the Series D round to address the issues.
There is no limit to how many funding rounds a startup can go through. If a company has more advanced revenue goals, it may complete as many fundraising series as necessary.
Example: Anya planned to take her business public at the beginning of December. However, a competitor in her industry came up for sale in November. She decides to raise Series D funds to purchase the competitor instead of proceeding with the IPO.
7. Mezzanine funding and bridge loans
These loans are designed for fairly mature businesses worth at least $100 million. A mezzanine loan blends debt and equity for lenders, while bridge loans are short-term financing. They close the financial gap between this phase and the IPO. The funds might be used to buyout the management at another company or acquire a competitor. Loans typically last six to 12 months and are paid back with proceeds from the IPO.
Example: Anya's goal is to issue an IPO for her company. However, she needs to produce her product on a larger scale before an IPO is feasible. She takes out a bridge loan to buy a competitor, which increases her market share.
8. IPO
An IPO is the pinnacle of startup success. It occurs when shares of the company are offered up for public purchase for the first time. The IPO is used to generate funds for further growth or allowing the startup owners to cash out their remaining shares for personal income.
Important events occur in preparation to issue an IPO. They are:
- Formation of a public offering team comprised of SEC experts, lawyers, accountants and underwriters
- Compilation of the startup's information such as financials and anticipated future operations
- Preparation of an audit of the company's financial statements
- Completion of the governmental IPO requirements, which include filing the startup prospectus with the SEC and formalizing the offering date
Example: Jane is ready for her hard work to pay off. She uses an IPO to sell her shares in the company, amassing her a great deal of wealth.
source: https://www.indeed.com/career-advice/career-development/startup-funding-stages
