Many entrepreneurs are in need of capital to support the early costs associated with starting a business. With so many funding options out there, raising funds can be a confusing, and somewhat overwhelming exercise. Further complicating the issue, the type of funding an entrepreneur will pursue depends on the unique needs of their company, stage of development, and anticipated milestones.
That said, understanding the most common small business funding options will give you the foundation you need to develop a customized fundraising strategy. So, here is an overview of the most common funding types for early-stage startups.
I realize bootstrapping isn’t considered “fundraising,” but sometimes the best funding option is not to seek funding at all, and instead cut corners wherever you can and working on building your company from your personal savings. Besides saving you money, bootstrapping also helps you focus on execution and building traction without outside interference. It’s also a means for avoiding dilution and yielding larger profit margins.
Equity funding is an umbrella term that refers to any means of financing your company in which you receive money in exchange for issuing shares of stock. There are multiple methods for raising equity capital but, depending on how you raise this money, you could be giving up anywhere from 1-100 percent of your business. Equity rounds include:
Seed financing, as the name implies, is the relatively small amount of money a business needs early on to get started. Usually businesses seeking a seed round are still in the concept stage and need just a small capital infusion to cover expenses until they can start earning revenue. Seed money can also be a helpful tool for attracting future money from bigger investors.
Because seed capital is smaller and more of a high-risk investment, it generally will come from friends and family or smaller angel investors. While borrowing from family and friends can be appealing since it’s less formal than borrowing from a professional investor, it also holds personal as well as professional risks. If you are going to go this route, make sure you formalize the process and are a transparent as possible about the risks of investment.
It can be easier to raise seed rounds from a smaller angel investor, as opposed to going for the brass ring of VC investment. With an angel investor, you will usually pay less of a premium in the amount of the stock or percentage of your company you give up because angel investors have other means of making money. They may not be looking for as specific a level of return as venture capitalists might be.
However, there are downsides to working with angel investors. Often you will need to find multiple investors to give you the kind of capital you need (as opposed to working with just one VC). This can lead to the “herding cat syndrome,” wherein you find yourself facing the challenge of managing multiple people and relationships. But for seed money, your angel investors are still generally going to be a good first bet.
Series A refers to the first round of stock offered to investors during early-stage rounds. Typical Series A rounds fall in the range of $2-5M, offer options for 20-40 percent of the company, and are intended to support a company through the early stages of building a business — from product development to hiring to marketing. Because the Series A round is for more significant cash, investors are usually professional angel investors or boutique VC firms who specialize in this first round of financing.
Series B refers to second-stage financing. Series B usually happens after the company has already achieved certain business milestones and thus proven its potential viability as a company. This series is also sometimes called a venture round since it is at this point that venture capitalists usually get involved. Venture capitalists don’t just offer a greater capital investment for a given round; there’s also a greater possibility for going back to this same well for future rounds. Also, experienced VCs can offer the kind of networking opportunities and mentorship that unconnected smaller angel investors may not.
As companies grow, they might continue to seek additional funds to meet future milestones. Each successive venture round follows alphabetically down the line (e.g. C, D, E…). VCs and private equity investors support these financing rounds as well as future funding rounds that more established companies may have to look forward to such as bridge financing, expansion capital, late-stage capital, and leveraged buyout.
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