When you're building a startup, how should you go about funding your company?
The early days of a company are virtually utopian: a founder and a co-founder batting ideas back and forth in an environment of perfect creative bliss.
Even the term we use for this creative space—the incubator—calls to mind the warmth and coziness and protection of a womb. There comes a point, though, when a company needs to move from ideas toward an actual product, and in order to do this, they need to think about generating money. But how to get money before there is a product to sell?
Well, when startups raise money, they do it with rounds of investments called the Seed Round, Series A-B-C, all the way until they either incorporate or sell. In each round, the company receives money from venture funds that focus on specific growth points at specific sizes.
Basically, you can break a startup’s funding rounds into the following stages:
- Seed Round: This is usually a small amount of money given to a company to give it the momentum it needs to produce its initial product. Normally, the company will have a concept and will know that it has potential viability on the market, but they won’t have a working prototype yet. Seed money gives the company just enough runway to move from this early conceptual phase toward a product.
- Series A: At the point when a company has a prototype, they can seek funding from a venture capital group to work toward bringing the product to market. The series A funding will be larger than the seed round (usually between three and seven million dollars), and will be offered in exchange for a portion of the company. Startups typically use series A funding to figure out the best business model for their company and to work out the nuts and bolts of moving your product into the actual marketplace.
- Series B: By the time they’ve reached series B, a startup has a product and a business model and need enough capital to bring the product to a broader market. This represents a significant increase in the funding, from $7 million to upwards of $50 million.
- Series C: This is all about fast growth. In series C funding, companies might move the work they’ve been doing in series B toward international markets or focus on diversifying their product for multiple different platforms.
How long do you spend fundraising rounds?
Funding rounds can go on forever if the startup wants, but that’s not really practical. In each round of funding, you offer a piece of your company to your investors. That works great in the first few rounds, since the company’s valuation grows as people invest, but since you give up about 25% of your company each time someone invests, after a couple of rounds of funding, you don’t have much left to offer an investor. At that point, it’s important for a company to either sell (like Instagram did) or to start trading publicly (like Facebook).
A good model for thinking about how this form of growth works is Instagram. They started with a $500,000 seed round, and then within two years of that raised a $7 million series A and a $50 million series B, before they were finally bought out by Facebook.
Generally, a startup can expect between a hundred thousand and a million dollars in their seed round. With each round of funding, the startup gives up a portion of the company (usually about 25%) to their funders. Occasionally startups skip the seed round and raise a few million dollars of series A funding right out of the gate, but the Instagram model above is much more typical.
- Startups raise money in rounds of investments with venture funds that focus on specific growth points.
- Most of the time, you’ll start with seed money and a short runway. More than a million dollars and you’ve skipped straight to series A.
- It’s important to plan for growth. After too many rounds of funding, you won’t have much left to offer investors.
- Business Insider — On Instagram’s Business Efficiency
- A VC talking about how the Seed Round affects the growth of the company later
The Startup Fundraising Series:
- What is Equity?
- Why Should You Incorporate Your Startup In Delaware?
- LLC or C-Corporation — Which One Is Right For Startups?
- What are the Different Stages of Startup Fundraising?
- Valuation: How Do You Measure the Growth of Your Company?
- How I Learned to Stop Worrying and Love Dilution
- What Are Convertible Notes And Why Use Them?
- Exits: When to Get Out to Stay in the Game