Funding Rounds: All You Need To Know About Startup Financing

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Every startup passes through many stages. Each stage has its corresponding round of funding. For each round, the startup must have achieved some milestones and should target specific investors. Targeting the right investors at the right time can save entrepreneurs a lot of time and effort. But before exploring all these rounds, let’s look at the relationship between the startup stage and the funding round.

funding rounds

As you can see in the above diagram, the startup financing rounds strongly depend on the revenue received. Previously, we discussed when entrepreneurs should raise investment. In this article, we will cover each startup funding round, elaborating on the corresponding milestones, round size, and type of investor.

Pre-seed round

Startups in the very early stage can rely on this type of financing if they have no product in hand. In this round, founders can raise capital ranging from $50k to $500k. The entrepreneur should have an idea, preferably validated by potential customers. Entrepreneurs in this stage can raise capital from friends, family, and fools (FFF) in addition to angel investors. This funding round should be invested in building the startup team and creating a prototype.

Seed round

Once the prototype is ready and has some traction, the startup can go for a seed round. The seed round usually ranges from $1M to $2M. Before raising capital, the startup should have a user base (at least 1,000 customers) and preferably some revenue. The profit margin isn’t very important in this stage. The funds raised in this round should be used to improve the profit margin and hopefully pass the breakeven point. In this stage, the entrepreneurs should target angel investors, accelerators, and micro VCs.

Before investing in this round, all investors must agree with the founders about the startup pre-money value. To determine how those investors are valuating startups, please use the startup value calculator. It’s free and it will show you how investors can evaluate your startup. The only exception to this rule is accelerators. Most accelerators invest a fixed amount of money for fixed equity. For example, Y-Combinator invests $120k for 7% equity, 500 Startups invests $112.5k for 6% equity, and Techstars invests $120k for 7% to 10% equity.

Startups that raise capital from accelerators usually get another seed round right after the program. The funding taken from the accelerator is enough to run the startup for five to six months. In addition to the money, startups enrolled in accelerators usually get temporary office space, mentorship, and lots of networking. Plus, the value of startups enrolled in accelerators increases dramatically throughout the program. After the program demo day, the next seed round should be enough to run the startup for 12 to 18 months. Money raised in this funding round usually eats up 20% of the founders’ equity.

Series A

For most startups, reaching this stage is very hard. Ninety percent of startups around the world won’t make it to this stage. For this reason, most of the area before Series A is called the “valley of death”. Even those who raised multiple seed rounds may not be able to raise Series A. To reach this stage, the startup must have a stable sales channel and be experiencing high growth in revenue, customer base, and market share. For this reason, this stage is usually called the “growth stage”.

Not only is this stage hard to reach, it’s also hard to raise investment in. While raising seed investment can take only a few weeks, raising Series A can take from six to eight months. Accordingly, entrepreneurs must plan for this round at least 10 months ahead of time. The funds raised in this round should be spent on increasing growth and figuring out the business model. Although Series A funds usually range from $2M to $10M, in some cases they can exceed $100M. For example, GitHub raised $100M in 2012, Wayfair raised $165M in 2011, and AirWatch raised $200M in 2013.

Unlike with seed investment, valuating startups in this stage is more straightforward. The most well-known valuation methods in Series A are EBITDA multiples, revenue multiples, and Discounted Cash Flow (DCF). There are many online calculator available to get the valuation through all these methods in a few seconds. Although VCs usually lead this round, some angels may co-invest in Series A.

Series B

Like Series A, Series B is for those companies with products that are growing exponentially. In this stage, the profit margin should be positive. The customer acquisition cost must be clear and have a robust business model. The founders should use the funding raised during this round to improve the business model, scale the product, and increase the customer base. Series B funds usually range from $10M to $20M. However, as with Series A, there are always exceptions. Many startups raised more than $100M in this round, like Unity Biotechnology ($116M), Zymergen ($130M), and Human Longevity ($220M).

As per many entrepreneurs, raising Series B is much easier than raising Series A. That’s primarily because startups (or companies) that reach this stage have a much lower risk than those in the earlier stages. In addition, many investors prefer not to be the first one to invest in the startup. They consider Series A to be the first funding round financed by professional investors. Therefore, if the founders attract investors in Series A, most likely they will succeed at convincing others in later rounds.

The valuation of startups in this stage is quite similar to the valuation of those raising Series A. According to the Harvard Business Review (HBR), companies in this stage are usually valuated through the weighted EBITDA multiples, weighted revenue multiples, and DCF methods.

Series C

Series C is considered the company’s third injection of investment from outside sources. In this stage, companies are no longer startups. Unlike Series A and B, Series C has no ceiling regarding the fund range. In this round, many companies manage to raise more than $200M, like Airbnb ($200M), Xiaomi ($216M), and Uber ($363M). Some unicorns can raise other financing rounds, like Series D, Series E, Series F, and Series G. You can view some of these companies in TechCrunch’s unicorn leadboard.

Mezzanine

The final funding round to discuss here is the mezzanine. Apparently, only multi-billion-dollar companies can raise funds in this round. Such funding is usually used as bridge financing to grow the business before the IPO. Unlike the previous rounds, funds in the mezzanine round are usually taken in exchange for convertible notes and preferred stock. Because it is the last round, mezzanine funds constitute the largest amount of money. It’s quite typical to find companies raising billions of dollars in this round. For example, Blackstone raised $4B in this stage. Additionally, London-based Intermediate Capital Group, raised just over $4B in the same round.

Can startups skip some funding rounds?

The short answer is yes. Every funding round represents a set of milestones. If the startup has quickly reached certain milestones, it can raise its equivalent funding round. Many successful startups reached Series A without raising seed investment. For example, the first round raised by Lynda.com was Series A ($103M). They managed to get $70M in revenue without raising a single dollar. Recently, Lynda.com was acquired by LinkedIn for $1.5B. You can read our past article about bootstrapping vs fundraising for more examples.

 

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