How Does Start-Up Funding Work? – A Timeline
“Seed Capital”, “Friends, Families and Fools”, “Series A Round”, “IPO” – the start-up world and all its investment terms may seem complex and confusing at first sight. But it does not have to be.
You, Your Idea and Your Money
At the very beginning it is the founder’s idea, work and capital. Because the value is being created only by yourself, you own 100% of the pie. You might have started a formal process by registering your company already and given yourself 100% of the shares in your company.
People start joining your team. You either pay them as employees or in the framework of a project contract, or – if you do not have the capital – you may give them shares in your company as compensation for their work. This is called “sweat equity”. There are also hybrid types of this: sometimes you pay them a small salary and top it up with shares; sometimes, co-founders also contribute their own money in addition to their work.
If you run the company only by using your own capital and/or those of your co-founders, it is called “bootstrapping”. There are many examples of successful companies which bootstrapped for a very long time – Facebook, Apple, Coca Cola or Hewlett-Packard, to name a few. One of the advantages is to limit external influence.
Family and Friends
You have reached the stage where your own money is not enough to keep the company alive. So where should you start looking for potential investors? I always recommend tapping in your immediate network first. Would you consider taking on family members as investors? Have friends noticed your work and would be willing to invest? The investment amount usually ranges from a view hundred dollars to a five figure number.
After bootstrapping and/or investment by family and/or friends, the next stage is called the seed investment round. It is more formal. While some people settle the investments in the co-founder and family/friends stage less formal – sometimes without even registering a company – this round will require you to incorporate.
In this seed round, investors are called “angels”. These angels can be individuals or so-called “family offices”. Family offices are usually a dedicated formalized arm of families owning companies or conglomerates.
The investment amounts of this seed round typically range from 5 figure numbers up to a million dollars. However, it always depends on the specific circumstances, the country and overall environment.
During this stage (often also before that) incubators and accelerators are an investment option as well. However, for the sake of simplicity, I am leaving them out here. Stay tuned for a separate post about incubators and accelerators.
Venture Capital Rounds
Once you have passed the seed stage, you may want to grow and expand your business. There is no set timeframe. I experienced that most of the start-ups I know entered this round one to two years after the seed stage. Some companies bootstrapped until this point and go to the venture capital round without raising any seed money.
These rounds are typically called Series A, B and C. They are related to the age, size, stage and plans of the start-up. Most of the Series A rounds I experienced in my professional vicinity and circle of friends was between 1 to 10 million dollars. Depending on the business strategy, the A round usually lasts for around three to five years. Series B and C heavily depend on the specific case. Again, I would like to stress here that there are no set rules for investments. It is always a case-by-case decision.
For some companies, going public is a long-term option. An IPO (Initial Public Offering) is a way to raise money on the stock market by addressing millions of people. It may be easier than addressing one investor or a small group of investors for a larger capital amount. Another reason to go public is to give previous investors the chance to sell their shares. However, going public means that a lot of information about your company will be available to the public. Furthermore, your business focus might shift from an entrepreneurial long-term perspective to a shorter shareholder value oriented one pleasing the market. These are among the reasons why some companies decide to stay private. There are very famous privately held examples such as Red Bull or Cargill.
I am currently working on another post about IPOs this topic as well. Furthermore, I have intentionally left out the option of bank loans and co-working spaces here. I actually hardly know any start-up which started with a bank loan recently. And from my own experience, I have to say that sometimes it seems easier to get a loan for a house than for a business. In my view, co-working spaces do not offer the same value in terms of capital as the other investment forms listed above.
Have you raised funding or are you currently in the middle of the raising process? In which stage are you? Let me know in the comments below!