18 Nov How Outside Investor Funding Rounds Work
Making big ideas come to life can often require big money and although some start-up founders have the ability to bootstrap their efforts in the beginning, many times they will seek outside funding to go to the next level. There are various options, but the most traditional path is to raise outside funds through an internationally recognized series of funding rounds with each round having its own unique parameters and purpose. A company will move through the various rounds based on the stage, success, and objectives of their business.
During this stage a company is in the ideation or concept stage and the primary purpose is to raise funds to crystallize the founder’s thinking and commence development on the product or idea. This stage takes place prior to generating any revenue as funds raised in this round are intended to build the team and create a minimum viable product (MVP). The pre-seed stage may oftentimes be considered the “friends and family round” and, due to the nature of the stage, it is often informal.
The seed stage is oftentimes the first formal funding round. At this stage, a company has typically brought their idea to life with an MVP and the seed funding must now be put to work to establish a product-market fit. As the name would suggest, this is the stage in which a business is “planting a seed” or, in other words, building their foundation. Seed round investments typically fund the team and experimentation across a variety of marketing channels to attract the target audience.
In addition to approaching additional, or some of the same, family and friends from the pre-seed stage, outside funding can be sought. The most common type of outside investors at the seed round are angel investors who are typically high-net-worth-individuals that may either invest alone or in a syndicate, into early stage ventures. By nature, this is an inherently risky stage to invest in, but they do so on the prospects of generating vastly outsized returns in optimal cases. They usually make investments in exchange for preferred equity ownership.
While some companies may never move beyond the seed funding stage, those that do may require additional rounds of funding (A, B, C, etc.) in order to achieve stabilized cash flows. Typically at the Series A round, ventures have proven their concept to be viable and have established a product-market fit. The latter is stated with a caveat as some ventures may still be working to establish the product-market fit and must raise additional funds so as to not run out of runway (cash to fund operations). Series A round investments can continue to build out the team as well as be deployed towards an increased marketing and advertising budget to continue to acquire customers. A clear business model should be defined at this stage.
Like the seed stage, this round may also include some of the same investors from the prior stages that will participate in this follow-on round. Additionally, and depending on the industry, venture capital firms may be approached. Venture capitalists are individuals or funds that invest in companies that have demonstrated rapid scalability or the strong potential for rapid scalability as well as robust margins.
In previous stages, investors are typically investing in ideas and people as the business is not yet proven. Once they have reached Series A, the typical investors, venture capitalists, are looking for specific indicators of success and a solid, long-term plan. Because the company and product or service already has established traction in the marketplace, these investments tend to be slightly less risky than seed, but also command a larger check size.
Once a company has optimized existing practices and further demonstrated demand for their products or services, they will seek additional funding to grow. The primary objective of Series B is to expand market reach. Funding from this stage is primarily used for continued growth: business development activities such as marketing and advertising, ramping up production, and growing staff.
Like Series A, funding in this round comes primarily from venture capitalists. However, the investments are oftentimes larger than the previous round and can be accommodated as the valuation of the company has also increased. They may even attract a new batch of venture capitalists that specialize in Series B or later stage funding.
This is just a brief overview of the first stages and investor rounds for outside funding. On the surface it may appear relatively clear-cut, but it is often difficult to gauge the exact right time for a business to move on to the next stage or round. A skilled business advisor, such as Joorney’s Business Advisory Services, can help a company choose the right time to approach new investors as well as other key considerations. Advisors are also skilled at helping craft expert business plans and pitch decks appropriate for each round and choosing the best investors to approach.