Making Your Financing a Success at Each Funding Round
In a startup that needs to raise outside capital, there are commonly four startup funding rounds: Seed, Series A, Series B, and Series C. The original venture capitalist must have been an engineer, since no one else would have a less creative terminology for funding rounds! I’m an engineer, so I can say that!
It is very important for an entrepreneur to look ahead and over the horizon to see how they will raise outside capital before starting the process of raising outside money. It is important to gauge when and how to raise outside money, and from whom. A good rule of thumb is to wait as long as possible before raising outside capital. Bootstrap the business with your own money, and borrow money under favorable terms from friends and family. If possible, self fund out of revenue from your business.
Before raising outside capital, it is not uncommon that founders will invest between $10,000 and $100,000 of their own money. Friends and family can sometimes account for another $100,000 to $200,000 of capital, typically in the form of a note.
I am currently bootstrapping two businesses: QuestFusion and The San Diego Lifestyle. I’ve invested tens of thousands of dollars over the last year-and-a-half into these ventures. This is in addition to my Angel investing activity.
What are the Typical Startup Funding Rounds?
The Seed Round is typically where Angels invest, and the amount of capital raised ranges from $500,000 to $1,000,000, but can sometimes be more. If this funding round is done as a traditional convertible debt offering (also known as a convert), you don’t have to worry about setting valuation at this time. Upon conversion to equity, Seed round investors typically own 10 to 15 percent of the company.
The Series A Round is typically the first institutional round of financing, and it is lead by venture capital investors. Typical Series A rounds range from $3,000,000 to $5,000,000, but can be as high as $8,000,000 to $10,000,000. Series A investors typically get 25 to 35 percent of the company, but it can be as high as 50 percent or as small as 10 to 15 percent, depending on the market opportunity and the uniqueness and value of the solution you’re providing to the market.
A good article with a great infographic that discusses how the cap table evolves and why is How Funding Works, Splitting the Equity Pie with Investors. Some of the numbers may be a bit dated, but the way they describe the key concepts is instructive.
Outside of stock that is sold to raise outside capital, and stock that is owned by the company founders, there is typically a Stock Option Pool that is established at the Seed or Series A financing rounds to provide an equity incentive to employees and outside board members that are not equity investors or founders.
The Series B and Series C Rounds of funding rounds are typically institutional rounds of financing, and are designed to raise growth capital. These financing rounds can range in size from $8,000,000 to $50,000,000. Investors in these rounds of financing typically own 25 -35 percent of the company post-money. Check-out the article Five Venture Capital Funding Insights for a look at the CrunchBase data and some analysis.
You want to get guidance from experienced professionals that can help you be more efficient in raising money. This does not mean that you need to hire bankers, but you should have strong and experienced advisors and coaches. You want to have a high quality target list of investors, if possible. Try to raise money from so-called “smart money” investors that provide experience in your vertical markets, and not just money. See my article Smart Money Startups – Why is it Important.
There are situations and circumstance where this hard and fast line of financing rounds blurs a bit. For example, at Entropic, we continued to accept addition money into the Series B financing round after we closed the B round. This investment was from important strategic investors that were potential customers’ customers. Our largest financial investors and board members were willing to accept this due to the nature of the investors. I’ve also seen bridge rounds between Series A and Series B, where a convert is raised to bridge to the next round. Hopefully this won’t be a bridge to nowhere!
Make It a Success!
All of the information about stock needs to be in a Capitalization Table (Cap Table) when raising money, so that prospective investors know how the ownership and capitalization structure look pre and post funding round.
Deal Terms can be just as important or more important than Valuation in an outside equity financing. This is particularly true in the era of “Unicorns”, which are private companies with valuations in excess of $1 billion. Check-out this article The Terms Behind the Unicorn Valuations. Educate yourself about this, and hire a good attorney. Read my article Importance of an Excellent Corporate Attorney for Your Startup.
Typically there is 12 to 18 months between investment rounds. It is critical that you raise sufficient money in each financing round to make it to your next set of critical milestones that will give your company a step-up in valuation.
As the CEO, you need to always be thinking about raising money for your startup. At the same time, you need to always be working on making the business successful!
Key Lessons from My Experience
Most of my experience in early stage financing, Seed and Series A, is as a board member and Angel investor. Most of my experience in raising startup funding is as a CEO. So I do have experience across the board with all stages of financing. The key lessons from my experience are:
- Raising money takes longer than you think.
- Raising money takes more time than you think. This is different than longer. I’m talking about it taking a lot of time out of your day if you’re the founder or startup CEO or both.
- As a result, raising money takes time away from running the business.
- It is now possible, with the advent of the JOBS Act, to raise equity financing through syndicates of Angel Investors or through Crowdfunding under certain circumstances, but investigate the cost of raising small amounts of money, under $1 million, in this way.
- Seek out experienced advisors before taking this route to understand the costs, the risks, and how to mitigate risks. See my article The JOBS Act Demystified.
Please share with us your thoughts and experience in the various stages of startup funding. Hearing your “war stories” is one of the best ways that you can help other entrepreneurs, and learn even deeper lessons yourself. I always learn a lot by hanging-out with other entrepreneurs and CEOs. We always love your feedback!
This is Patrick Henry, the CEO of QuestFusion, with The Real Deal…What Matters.