The Three Stages Of Funding A Startup

by , Apr 29, 2013, 12:13 PM
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Without an outside source of funding, most media and technology startups would perish. The cost of hiring engineers and salespeople is usually just too high to self-fund a business until it is profitable. There are usually three stages of fundraising that a startup must go through to create a sustainable business:

Stage 1: Angel round. The first money a startup often raises is from individuals —also known as "angels." Each angel typically invests between $25K-$100K. While taking money from friends and family is common, it's often better if the startup can get it from people who have a profile in the industry in which the startup operates.

An angel round can range anywhere from tens of thousands to hundreds of thousands of dollars. Like all investors, angels will want to know who else is participating.

Stage 2: Seed round. Assuming the startup has built a basic product that people seem to like, the next step is usually to raise a "seed" round of financing. Seed stage funding comes from seed firms like Lerer Ventures, Bullpen Capital and SV Angel. Their goal is to invest in startups that can make it to the next stage and be successful.

Seed firms invest more than angels but less than the larger venture firms — usually between $50K - $250K each. Seed firms will often expect that you raise more money from your existing angel investors, so it’s important to have at least a couple with deep pockets.

A seed round is usually a couple hundred to a half million dollars and can consist of multiple firms.

Stage 3: Series A. The Series A raise is the hardest to achieve because it requires a venture capital firm to put at least a couple million dollars into the startup. Not only that, but a good Series A firm will keep something in reserve in the event that the startup needs more money later on.

Sadly, most startups will never live to see a successful Series A raise. In the last decade, over 400 venture capital funds have either gone out of business or stopped making new investments. In 2012, only 86 funds were active. That leaves a relatively small group of VCs to lead a Series A round.

The best way to get an introduction to a potential Series A VC is though the seed firm that invested in the startup. A startup will usually need many introductions, as most potential Series A firms will decline to invest.

However, if everything goes right, after three stages of investment a startup will have raised upwards of $5 million. Ideally, this will provide the company with the runway it needs to become profitable or be acquired. Some startups will keep going and continue to raise additional rounds — Series B, C, or even D — until the company is either acquired, goes public or fades away.

When the fundraising process is done right, each stage builds upon itself and the result is a profitable outcome for everyone involved.

5 comments on "The Three Stages Of Funding A Startup".

  1. Andrew Fischer from Choozle
    commented on: April 29, 2013 at 3:12 p.m.
    Great primer on the startup fundraising stages. I'd posit that "Seed" rounds seem to be growing - and often reach $1 MM or more. And it seems that the lines become more blurry by the day between angel, super angels, seed stage, micro VC firms, etc. More important than the semantics, it seems, is finding the right investors at the right stage that can help your startup accelerate and scale.
  2. Steve Lindseth from YouBeauty
    commented on: April 29, 2013 at 3:14 p.m.
    Matt, I would also point out that the vast majority of companies in the US never raise capital from venture capital firms and this has been true since Vc's firms came into existence in the 70's and 80's. Although getting a first rate VC is great, one shouldn't be discouraged if no VC will invest. Wealthy individuals, angel networks (and there are more and more of these) and family offices are great sources. Also, strategic investors play an important role in funding innovation as well.
  3. Matt Straz from Namely
    commented on: April 29, 2013 at 4:31 p.m.
    Great points, Steve and Andrew. Thanks!
  4. Dan Ortega from Hyperdyme Systems
    commented on: April 29, 2013 at 4:33 p.m.
    Keep in mind the most expensive money you can find will come from VCs. If you have multiple VCs do not assume they will be aligned, they are often not. And lastly, they have their investors as their top priority, not you.
  5. Pete Austin from Triggered Messaging
    commented on: April 30, 2013 at 5:56 a.m.
    Where's your evidence that most successful startups get venture capital? My company is on a science park, surrounded by startups, and almost none have outside capital. It's mostly from personal contacts. I suspect the high cost of applying to VCs (£20K for a basic "bible"), combined with the low probability of getting funding, means it's a zero-sum game.

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