Different Stages of Start-up Funding and Sources of your Capital

by Zaara 26, Feb 2017

A Guide to Finance your Business

Startup funding is a prominent part of any founder’s start-up lifecycle. There are various stages to get funding and it becomes necessary for the company founders to familiarize themselves to the terminologies and the processes. Little information helps a long way and connections built over a period of time to establish business and professionals as well. Please find the different sources of financing for Start-ups (i):

a) Seed Capital:

This is the first type of investment round offered to a start-up. It is a preliminary stage investment, which helps a start-up to establish the direction of its business. This is typically the very first investment of money, used for market research and development of the product or service. In many cases, it can come from the founders’ personal savings or from acquaintances (friends & family). Seed capital can be received as a loan in exchange for common stock. Not all start-ups need seed funding, but in some cases, seed funding is critical to get a start-up out of its infancy and bringing the product to market.

b) Angel Investment:

Another preliminary stage of funding, a start-up can tap into the network of individuals such as friends, family or acquaintances. They are referred to as “angel” investors. The money that is taken from an angel investor can be converted to preferred stock.

c) Venture Capital Financing (Series A, Series B, Series C Rounds, etc.) (ii)

d) Companies that are already selling their product or service, typically use venture capital funding to promote, establish and scale their businesses. An external round of funding becomes necessary for hiring key resources as well, irrespective of the fact that they may or may not be profitable.

VC funding happens in multiple rounds: Series A, B, C., and further rounds. The different VC rounds reflect different valuations. If the company is prospering, the Series B round will value company stock higher than Series A, and then Series C will have a higher stock price than Series B. In the Series A, B, C, etc. rounds of financing, money is typically received in exchange for preferred stock.

Series A

A Series-A investment is usually the first round of funding when the preliminary stages do not require outside funding. At this stage of funding, start-ups have a strongly defined goal for the product or service. Series-A investment primarily takes the start-up to the next level.

Series-A capital may be used for:

  • Adverting and brand visibility.
  • Distribution of the product or service.
  • Entering new markets, engaging with different demographics.
  • Scaling the Start-up
  • Achievement of defined goals and sales targets.

Series B

Start-ups generally raise Series-B when it has achieved its targeted goals, established a market for its product or service and requires more financing for further scale up. We can assume that the advertising is going strong, and customers or users are actively purchasing an associated product or service as planned.

Series-B may be used for:

  • Expanding a team.
  • Infrastructure: equipment, office space, salaries.
  • Taking the business globally, if applicable.

Series C and Beyond

Technically there is no limit to the number of investment rounds a start-up can get. Further investment rounds will depend on the anti-dilution agreements. Although there are exceptions, investors and founders don’t want their stake to get diluted. As the investment rounds progress further and more equity of the company is released, Series C rounds are considered very carefully by both founders and investors.

Apart from the above-mentioned sources, start-ups and growing businesses can avail alternative source of funding. The most common and popular way of raising finance is through VC’s, but every business need differs and hence not all businesses are suited for VC funding.

  • Bootstrapping: Sometimes own savings becomes the best option to fund your own business. This option helps in cutting unnecessary costs and streamlining the processes from the very beginning. The founders will have their own equity and do not require dilution, as no other investment is involved. Investors and market demand validity of the business concept, and financing your business becomes a proving point.
  • Crowdfunding: A modern tool of financing your business is to persuade individuals to provide founders small donation. The most common type of crowdfunding sites today is Kickstarter and Indiegogo. Dubai has its own crowdfunding platform- Eureeca. Crowdfunding provides the start-ups or early-stage companies to take their product to the next level, such as rolling out a product and getting consumer feedback before the product or service is subjected to Angel or VC Investor etc (iii)
  • Debt Financing: Debt financing is cheaper than equity financing and also depends on the stage of business. Typically debt financing is preferable for advanced stage companies.
  • Bank Loans and Lines of Credit: Bank loans require inventory or accounts receivable and a guarantor for the business. This is a preferable mode for business owners, as Bank relationship often helps business owners with other facilities (credit cards, cheaper loans depending on credit history).
  • Cash flow from operations: Investing your own profit on your own business creates a higher return on investment. Maximizing cash flow is the key to your business. Using profits and not the revenue for the upfront payments as a financing mechanism drastically reduces the need to seek outside capital.
  • Government and Private Grants: These are a great source of financing your business and it does not dilute equity. It is especially prudent to seek this type of funding if the business is in the social sciences or educational sectors. Government grants for R&D technology is an excellent source of funding (iv).
  • Understanding the various investment rounds and alternative sources of funding helps a potential start-up decide on the most appropriate course of action. A big part of this is to understand the various rounds of investment so that you may negotiate them with ease and confidence. At the same time choosing the right type of financing is advantageous to scale your business without stressing too much on founder’s equity.

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