The global startup market is robust, with about 50 million startups launching annually. However, only one in 10 make it past the first few years, and the other nine fail for various reasons, the top one being financial in nature. More specifically, many (82%) startups had trouble keeping cash flowing.
Getting external funding may seem like an easy solution but that’s easier said than done. Given the propensity of most startups to fail, convincing someone to fund your dream can be challenging.
That said, venture capitalists willingly take on risks for startups they believe can potentially succeed, even be the next unicorn. Founders in the early startup stages still have to work hard to get investors, but understanding the funding stages will empower them to make informed decisions.
Venture Capital – what is it?
Venture capital funds small businesses and startups based on their potential for growth. It comes in various forms, the most common of which is giving them equity or part ownership of the company. The extent of control an investor has over the startup depends on the level of ownership, typically between 20% and 50%. Active participation in the startup will also depend on the investment terms and funding stage.
It is important to understand that venture capital is not the same as private equity. Venture capitalists often work with early-stage startups, while private equity deals happen between a venture capitalist and an established company in the form of a limited partnership. Private equity firms also typically become the owners of the company they invest in. Founders may still play some role in running the business, but they have essentially sold the company.
As a startup founder, you probably want to retain ownership of the company. Venture capital is a viable option when you need more funds, especially when you don’t qualify for business loans and have no access to capital markets.
Types of Startup Funding
A startup can apply for five types of startup funding, depending on the age of the business. Let’s explore further.
Pre-Seed Funding
You might have heard of bootstrapped companies, where founders use personal resources like their savings to run the business. That is called the pre-seed stage, where you are just getting your company off the ground and developing your product or service.
It is highly unlikely that you will get venture capital funding at this point because you have no equity to offer in exchange. However, assistance can come in non-cash terms. Professional and business networks are crucial at the pre-seed stage as resources are tight, and good advice can prevent costly missteps.
Among these may be any legal issues like patent or copyright applications that first-time entrepreneurs may overlook. Aside from avoiding potentially insurmountable problems later, murky legal standing is a major red flag for potential investors.
The probable “investors” for the pre-seed phase include the founder, friends, family members, seed accelerators like Y Combinator, and angel investors. Your best bet to get funding from these sources is to build a business relationship with them and show them you are worth the risk.
Seed Funding
When your company has traction and can show its potential to become a thriving business, you’re ready for seed funding. You need a pitch deck demonstrating that your idea is a good bet and that the funds will go to key foundational activities. These include market research, crafting a solid business plan, establishing a capable management team, and developing your product. Getting seed funding proves to future investors that your company has what it takes to grow and scale.
Seed-stage VCs often participate in ongoing fundraising rounds to boost your startup’s credibility with additional backers. It’s also common for a VC firm member to join your board, overseeing operations and ensuring that milestones are met according to the strategic plan. Typically, the timeline between seed funding and progressing to Series A is around 12 to 18 months, though this can differ.
Keep in mind that VCs take on considerable risk when investing at the seed stage. You’ll likely have to give up a significant share to secure the investment.
Series A (Growth Stage)
Series A marks a crucial milestone in a startup’s journey, signaling that the founders have moved beyond just an idea to a functioning product that is active in the market. By this point, the company has typically finalized its business plan and assembled a compelling pitch deck highlighting a strong product-market fit. The focus now shifts to refining the product, building a customer base, and increasing marketing and advertising efforts. Most importantly, you have consistent revenue coming in that signals stability and growth potential.
The goal is to present a strategy that promises long-term profitability. Simply having a growing user base is not enough; founders need to demonstrate how the company plans to monetize and sustain its business over time.
When securing Series A funding, startups typically engage various key investors. These include the following:
- Accelerators
- Super angel investors
- VC firms
- Corporate venture capital funds
- Family offices, which manage the wealth of ultra-high-net-worth individuals, sometimes include startup investments as part of their broader strategy.
Series B (Scale Stage)
At this stage, your company is ready to scale and expand significantly. Series B is all about demonstrating that your product or service can perform in the market. You need venture capital to ramp up product manufacturing, marketing efforts, and sales operations. The funds will typically be much more than in a Series A because you’re now scaling proven models and seeking to solidify your market position. Your venture could still be operating at a loss, but the infusion of capital should kick off substantial long-term growth.
Investors at this stage are not just evaluating potential—they’re looking for tangible evidence. They want to see metrics that prove your company has a viable path to profitability and can grow at scale. Key investors during this phase include the following:
- VC firms
- Corporate VC funds
- Family offices
- Late-stage venture capitalists
- Venture debt providers
- Revenue-based lenders are a flexible option for startups that want to supplement equity financing without diluting ownership
Series C and Beyond (Expansion Stage)
Reaching the Series C stage clearly indicates that your startup is on a strong growth trajectory. By this point, you’ve established significant success, and the next round of funding will enable you to build innovative products, enter new markets, or even consider acquiring other startups. Companies that reach Series C quickly typically do so within two to three years, showcasing exponential growth and stable profitability.
Your startup must be well-established with a solid customer base, consistent revenue stream, proven history of growth, and clear desire to expand globally. Investors are particularly keen to join in at this phase because your track record of success translates to lower risk for them. Among those looking to invest would be the following:
- VC firms
- Corporate VC funds
- Hedge funds
- Investment banks
- Private equity firms
However, securing Series C and subsequent funding often comes with a serious trade-off: Founders typically give up a considerable share of equity, depending on your company’s valuation and the funding amount.
Mezzanine stage
In venture capital, the mezzanine stage is the final funding round that is a hybrid of debt (loan) and equity (ownership). It’s a bridge between traditional venture capital and a liquidity event. like an initial public offering (IPO) or acquisition.
Mezzanine funding allows the lender to convert the debt into an ownership or equity interest in the company. This usually happens when a founder defaults on payment or under specific conditions. This stage is crucial for well-established businesses that need additional capital to finalize their growth strategy or prepare for going public.
Key Features of Mezzanine Stage Financing:
Entering the mezzanine stage, also known as the pre-public stage, means your company has beat the odds in the startup stakes. Many early investors who have supported you up to this point may decide it’s time to sell their shares and reap the returns on their investment. This change paves the way for late-stage investors to step in, looking to benefit from an upcoming IPO or acquisition.
- Flexibility: Mezzanine financing can be used for many businesses’ needs, helping them through their final growth phase before going public or reaching another major milestone.
- Greater Risk and Reward: Mezzanine financing is riskier for lenders because it is repaid after other debts, so investors expect higher returns through interest, fees, and equity.
- Equity Benefits: Investors might be able to convert their loans into company shares if the company does well.
- Maintains Ownership: It is less ownership-diluting than equity funding because it is often structured as a loan or convertible note.
Exit stage
The exit stage in venture capital is the phase where investors, such as VC firms, realize the returns on their investment by cashing out their equity in the startup. The exit can happen in various ways, but the most common are:
- Initial Public Offering (IPO): The company goes public by offering shares on a stock exchange, allowing investors to sell their shares on the open market.
- Merger and Acquisition (M&A): The company is acquired by another business or merges with a larger entity, with the acquiring company buying out investors’ shares.
Going public (IPO) requires assembling a team that includes underwriters, lawyers, certified public accountants, and SEC experts. You’ll need to gather detailed financial performance records and project future operations, ensuring your financial statements are audited by a third party who can also evaluate your offering’s value. After preparing these essential steps, you’ll file a prospectus with the SEC and decide on a date to launch the public offering.
The exit stage is critical for venture capital firms because it’s the point at which they can monetize their stake in the startup, providing the profits that justify the initial risk of investing. A successful exit can lead to significant financial gains for both the investors and the founders, validating the years of development, growth, and scaling of the business.
So, how can venture capital help your business?
Venture capital can be a fantastic path to funding a startup, but it’s not a one-size-fits-all solution. Venture capital involves trading private equity for financial and technical support, which is often just the right mix for startups gearing up for rapid growth.
In most cases, VC firms form long-term relationships with the founders they choose to support. But, as with anything, there are trade-offs. Startup leaders must do their homework to determine whether VC funding is the best fit for their present circumstances.
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