Startup Funding in 5 Stages

September 17, 2015

4:00 pm

Raising money for your startup is never fun, but it might be the only way to get your business off the ground. It is a time-consuming, and often humbling experience. Many founders would rather have a root canal than seek investment, but is part of the startup game.

The stages of getting your startup funded

The first stage of startup funding is getting seed capital. Seed money is normally used for market research and product development. As you can tell from the name, seed capital has to do with the very beginning of a company. It is an early investment, pre-cash flow. Sometimes people joke that seed money comes from one of the three “F”s, family, friends, or fools.

Realistically, sources of seed capital are:

  • Crowdfunding
  • Government
  • Bootstrapping (use funds from another part of the business)
  • Self (credit cards, home equity lines of credit, retirement savings)
  • Family members or friends

The size of a seed investment could be as little as $10,000.

The next stage of investment is angel investor funding. Sometimes angel investment is in the form of a loan. Angel investors are high net worth individuals, often successful entrepreneurs, but they can also be friends and family.

Normally, angel investors are required to meet the Securities and Exchange Commission’s (SEC) definition of accredited investors. They each need to have a net worth of at least $1 million and make $200K per year (or 300K per year jointly with a spouse).

Companies seeking angel capital might already have some revenue. The investment is normally used for further product development, marketing, and hiring staff.

The size of angel investment is normally under $100,000, but the actual amount varies a lot.

Stage three is venture capital (VC) financing. There is a huge difference between angel money and venture investment. Angels invest their own money – note that there there is such a thing as an angel fund where a group of angels pool their money to make investments – and VC’s invest other people’s money.

There are several stages of venture capital investments, starting with the Series A round. Series A is the first institutional round of investment. Subsequent VC rounds are called Series B, Series C, and so on.

The size of VC investments are much larger than angel investments. VC’s want to invest millions in businesses.

There are legal fees of about 1% for a Series A. If you raise $3 million dollars expect to pay $30,000 in legal fees.

Both Angel and VC investors will take a percentage of your business. Many early stage VC’s will want to take about a third of your company. Of course, there is a wild amount of fluctuation as to what percentage of equity founders must part with to get the optimal amount of investment.

In addition to the three early-stage funding options there are two additional options for more mature businesses.

The first one is mezzanine financing which is popular with pre-IPO companies. Once a company goes public the IPO’s proceeds are used to pay back the investor.

Stage five is IPO. For many companies the ultimate goal is to raise money through an initial public offering (IPO).

Taking your company public through an IPO has many advantages:

  • Access to capital through selling stocks.
  • The stock can be used as an incentive for employees.
  • If your company performs well, your stock value will, most likely, rise.
  • Your shares are used as liquid equity.
  • Going public increases the public profile of your company. It is great PR.

There are also several disadvantages of an IPO. It costs a lot of money to go public. For example, Facebook paid $182 million in fees which is about 1% of the 17 billion their raised. Most IPOs are much smaller and they cost a much higher percentage. Paying over 8 percent is not unusual.

Another disadvantage of running a public company is dealing with regulations which is very expensive.

Whatever stage your company is in, there is a chance that you need additional capital. The good news is that you have many options to choose from.

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George Meszaros is a serial entrepreneur and the co-founder of Success Harbor an entrepreneur interview and advice site for small business. Success Harbor is dedicated to documenting the entrepreneurial journey through interviews, original research, and unique content. George Meszaros is also a web designer and marketing company co-founder.