For many entrepreneurs, understanding fundraising is a critical component of building the business, with many entrepreneurs thinking of the new venture existing on a timeline, starting from the time the idea was created and the business model conceived.
The fact is, the investment market evolves with the startup ecosystem it exists in, often following the trends found in major investment ecosystems like Silicon Valley and Israel, who often happen to be the trend-setters in this regard.
The company progresses along this timeline as the idea gains credibility via the validation of its business case and gains forward momentum. But along the way, various milestones must be met, among these are the various fundraising stages.
As critical as the product milestones are, even more critical in the early stages of the business are these funding benchmarks, ranging from seed to Series A, Series B and onward, with different rounds serving different purposes. Throughout these all, the business case and business model remain critical components of fundraising, coupled with the aptitudes of the core team.
Any business ventures requires three components to succeed: financial capital, knowledge capital and social capital. And financial capital is especially crucial to startup ventures, due to the need to scale and grow the business implicitly imposed by venture capitalists. But even then, company founders need to be aware of specific things prior to fundraising.
Seed Stage Fundraising
The first funding benchmark is the seed stage. This represents the initial capital used to do product and/or service development, patent filings, market surveys, research& development and talent acquisition.
At the seed stage, the emphasis is on evaluating and assessing business case feasibility, as well as preparing for operations commencing. These seed funds often come out of personal savings, severance packages from a prior job, cash raised from friends and family members or sustained by the income of a full-time job or other venture.
Many VC (venture capital) funds prefer not to invest at the seed stage, due to the high risks involved, as well as the attrition of the ventures at this stage. Most fail to mature to the Series A stage from the seed stage, which has become a process of attrition that often helps validate the viability of startups, at least in the Asia-Pacific market.
Increasingly, seed funding is becoming a process, rather than a single event, according to Dr Manu Kumar, a visiting lecturer at Stanford University, as well as founding principal of K9 Ventures, a venture fund that provides funding and support for concept-stage and seed-stage ventures in Silicon Valley.
Series A Funding & Market Entry
The second benchmark comes when the enterprise is ready to launch with its minimum viable product (MVP). Also known as start-up financing, this stage see’sthe first revenues, but profitability is yet to be achieved by the business, despite its business case being validated.
Often referred to as the series A investment round, this is typically where enterprises seek external investment. After a successful product/service launch proves the viability of the business model/business case, funds are needed to further develop the business, expand the various staff and management roles (i.e. business development, sales & marketing, engineering, content, events, growth hacking, etc.) and establish strategic partnerships.
Series A is often the point where market entry ramps up, as customer acquisition and brand development emerge as the priority of the founding team. Often, founders are displaced at this stage as organisational priorities emerge to take precedence and a delicate balancing act is required between the interests of investors and company founders.
The goal of a series A round is to cover the payroll costs, fund additional market research and to further develop and finalise the product being introduced in the market, beyond the MVP that is currently available. The goal is generating revenue, not achieving a net profit.
In terms of risk, seed rounds and series A rounds entail the highest risk for investors, due to the high chance of failure. And for entrepreneurs, it often entails risks to their psychological health during the duration of this growth stage.
Series B Fundraising
When approaching investors, the first round of external funds, aside from initial investors in the seed stage, should generally be called series A funding. The second external investment round is termed the series B.
In this case, series B should refer to a stage when the product/service is already being sold in the market. Series B is when scaling up, in order to face competitors and acquire customers occurs. The goal of this funding round? To generate a net profit, rather than reach a break-even point like series A funding
This third benchmark in fundraising is often referred to as the second-stage (i.e. Series B) round. In some cases, the seed round accounts for all ‘internal’ funds from the entrepreneur, in the case of friends and family, as well as referring to the series A round.
Using this terminology, each subsequent round of external investors knows where they stand with respect to prior investors who go in post-seed.The fourth benchmark involves securing a line of credit from a commercial bank at a time when revenues are gaining momentum.
At this point, when monthly cash flow is at the break-even point, the business merits “working capital, with few investors, especially VCs, being involved at this stage. Working capital at this point measures liquidity, efficiency and overall financial health of the business.
Series C Fundraising
When this fourth milestone arrives, firms are looking to expand their operations at a faster pace, due to internal funds (i.e. profits and lines of credit) being insufficient to support further growth, in term of the development of assets and internal capabilities necessary for stronger sales.
Ventures seek to raise another external round of funding seek to use it in substantially expanding existing operations and positioning the firm as a significant actor in their particular industry vertical.Many businesses will engage in a series of funding rounds, from seed to series A and series B, followed by a merger/acquisition or an IPO (initial public offering) of common stock.
To reach this, This stage is usually short-term debt and referred to as ‘mezzanine’ or ‘bridge’ financing.
Some business entities may even engage in distinct series D rounds, with the exceptional and uncommon series E, F and G, in order to further grow the business before considering a mezzanine round.
This ‘mezzanine’ debt supports continued growth opportunities, while preparing for an acquisition, management buyout, leveraged buyout or an IPO. At each stage, the venture has to be valued, with too many rounds overly diluting the founders’ stakes in the venture
It’s also critical to avoid early IPOs, as the firm’s industry position and market value might not be assured. While some firms bootstrap their growth with internally generated funds only, avoiding need for external investors, most investors have to engage in external investment.
The reason? Most entrepreneurs don’t know the key is to know their growth track, sales performance and profit benchmarks. Entrepreneurs need to be shrewd when valuing their startup at each stage of funding.
As for most entrepreneurs? There’s always some key lessons to keep in mind, especially when it comes to bootstrapping your business. There’s more than a few secrets, a wisdom and some essential intelligence and many lessons available online. And critically, founders need to ensure that their term sheets and legal documents are in order.
Image Credit: Startup Freak