Understanding funding rounds for startups

Starting a business is definitely no joke!

Imagine all the long hours of brainstorming with your team to build the perfect product for the market, crunching up large figures and databases in a bid to bring to life the brand that only you can see in your head.

Have you ever tried to secure funding for your startup and got confused with such terms as series A, pre-seed funding round, and the like? 

Then this article will clear your uncertainty about what these terms mean in relation to sourcing funds for your business. You need serious capital to fund your business and that’s where investors come in.

Businesses need several capital investments to be able to grow, expand and reach full potential, no matter the industry. There are different types of capital funding for every business whether a startup or an established company. 

The growth stage and valuation of a business determine how much investors want to put into it. These are called funding rounds. Usually, startups and new businesses are funded by family and friends (bootstrapping) but in order to expand and continue to test their market, they need more financing. 

This financing is provided by angel investors and venture capital firms who will assess the viability of the business, and place a value on its potentiality. 

Each funding round depends on the growth stage of a business. For instance, a business that hasn’t started operation yet or is still in its product development and testing stage will seek for pre-seed funding.  These rounds can be completed in anything as from a month to six months depending on the industry and the business.

Startups are high-risk ventures with no certain evidence of surviving in the market therefore, banks do not give them loans. Getting an investor would be difficult for any entrepreneur who is ignorant of what funding rounds are.

What is a funding round?

A funding round is simply a period of sourcing investment for a business from venture capitalists in order to expand, develop your product to market taste, or just to get your business idea up and running. Since bank loans are out of the picture your best bet is venture capitalists such as angel investors and venture capital firms. 

Usually, these rounds are led by one or two firms then the others follow. It’s like if an entrepreneur succeeds in getting an investor, his presence attracts other investors’ interest in the business. 

Angel investors are individuals who fund early-stage companies with high potential in exchange for equity. These are usually high-risk businesses because, at that early stage, they usually do not have any track records to prove their profitability or even survival in the market in the long term. 

They also offer other benefits asides from funding such as expertise, connections, business mentorship, and support.

Venture capital firms are mostly interested in financing the long-term potential of a business in exchange for equity. 

What to do when seeking for investors?

• Evaluate the current growth stage of your business.
• Conduct market research and determine how much you need to move to the next stage based on verifiable data.
• Choose the venture capitalist that is the best fit for your business.
• Create an interesting pitch deck.
• Seek for opportunities to pitch your business idea and network with potential investors.
• Follow up your presentations, build solid business relationships after rounds.
• Document your process and repeat.

Different types of startup funding rounds?

Pre-seed, seed, series A, series B, series C, Series D, E, and F funding rounds.

Pre-seed funding round

Just like in Agriculture when a seed is prepared ahead of the planting period, this is financing for a business to get off the ground. At this point the business being funded barely has any traction yet, it is mostly just an ‘idea’ being sold to investors. It is one of the first funding a business receives from investors in its early stage.

Some startups only have an MVP or a prototype of their product for market testing (and validation), when seeking this type of funding. It is usually short term financing with amounts ranging from $150,000 to $500,000. Although some startups like Spleet in Nigeria raised $625,000 and Chatterbox succeeded in raising 1.5 million Euros pre-seed funding round.

However, it is worthy of note that businesses in this category must have a high profitability potential to be able to attract investors’ interest. It must also be one that is scalable with fresh financing.

Angel investors mostly invest in early stage startups in exchange for percentage of ownership. 

Seed funding

This is the next round of funding. At this stage, the business has gained some traction but is still under the product development and testing process. It hasn’t really gotten that ‘perfect’ product for the market yet. 

There is still so much risk at this stage because the business has little experience with the market and may not make it to the next stage. 

Seed funding is used mostly to conduct market research, further test the product and make tweaks to suit the market needs, and fill crucial positions in the organization.

Depending on the industry the business might issue convertible debt or simple agreements for future equity (SAFE) to investors, if it is too young to issue equity or wants to defer valuation till further rounds.

Funding is around $3 million to $30 million based on individual industry requirements. Business incubators, accelerators, and angel investors are the major investors for companies in this stage.

Series A funding

While seed funding rounds are used for testing and product development, series funding is gotten when a business is ready to go big into the market. That is, to scale its production and build upon existing user base, all actions of the company are now geared towards the long-term.

The first stage is called Series A funding round. This funding round is used to expand based on the data from previous financing. 

By this time the testing stage is over, you now have a market-fit product, there are actual users of your product and the business is ready for large-scale production. Not very many startups make it to this stage because of its complexities.

Investors are usually VC firms or angels who will give between $3 and $30 million and expect returns usually within a year.

Series B funding

At this funding round, a business has recorded some measure of success. It has a ready user base and a lot of growth potentials. 

A firm in this stage might need more financing to diversify its target market, develop more products variety, launch new marketing strategies and open more branches in foreign locations.

A startup might also be valued at this level. Investment at series B is usually large since the business has proven to be successful and two or more VC firms may choose to finance it at this phase. 

Series C funding

Series C rounds are mostly funded by big VC firms because of the huge capital required. Companies at this stage are already well established, they might seek new capital to sponsor their expansion into new territories like the acquisition of other business, launching fresh product lines and so on. 

It is one of the most expensive yet profitable investment for an investor. It also carries less risk. Although, it is one of the most difficult rounds for business owners.

Series D, E, and F funding

Most businesses stop seeking investment financing at series C because by then, the company is already well established and can source for its own revenue. However, the few companies that press on to round D and beyond are looking to gain global recognition in the market place. Therefore they need more capital and partnership from investors.

In conclusion

To know which funding round best suits your startup, you have to determine first the level of growth and then plan appropriately to sell your business idea to potential investors. Because definitely, every startup needs external financing at some point in order to scale and expand over time.

Understanding how startup financing works will better position you for the investor space. So now you can begin planning how to accelerate your business to the next level on other people’s paycheck. Fundraising might be difficult at some point but it sure pays well if gotten.