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Wednesday, July 21st, 2010

Here Are The 5 Major Stages of Startup Funding

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A friend of mine recently asked me about the different stages of startup financing –  so I figured I’d write it down for you too!

There are certainly other sources of startup capital besides the ones listed below, but these five are the top ones; and they’re typically used roughly in the order I list them.

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5 Stages of Startup Funding

1) Seed Capital

This is typically the very first investment of money used to for market research and developing product.

It can come from the founder’s personal savings (e.g. from a severance package from the founder’s prior job) or from acquaintances (aka a “Friends & Family” or “F&F” Round).

Seed capital can be received as a loan on in exchange for common stock.

Note: Credit cards/American Express are also used as a startup fund option around this time.

2) Angel Investor Funding

Since seed capital is sometimes limited, it is often necessary for an entrepreneur to tap into wealthy individuals outside their friends & family — this is often called an “Angel” investor.

You can receive money from an angel investor as a loan that is convertible to preferred stock (often it converts to the Series A round of stock below).

Friends & Family investors sometimes participate in this “Angel Round” of financing.

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

Venture capital (VC) funding is typically used by companies that are already distributing/selling their product or service, even though they may not be profitable yet.

If the company is not profitable, the venture capital financing is often used to offset the negative cash flow.

There can be multiple rounds of VC funding and each is typically given a letter of the alphabet (A followed by B followed by C, etc.)

The different VC rounds reflect different valuations (e.g. 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).

If a company is not prospering, it can still get subsequent Series-rounds of financing, but the valuation will be lower than the previous series: this is known as a “down round.”

These rounds may also include “strategic investors:” investors who participate in the round and also offer value such as marketing or technology assistance.

In the Series A, B, C, etc. rounds of financing, money is typically received in exchange for preferred stock (as opposed to the common stock that insiders/seed capital sources (and perhaps even angel investors) receive).

If you want to learn some tips on VC funding, check out my How To Raise Money From A VC: Insider Tips article.

Note: A line of credit from a bank is another startup fund option around this time as well.

4) Mezzanine Financing & Bridge Loans

At this point, companies may be eyeing the following types of opportunities that require additional funds:

  • An IPO (initial public offering)
  • An Acquisition of a Competitor
  • A Management Buyout

To do so, they can tap into mezzanine financing or “bridge” financing.

Mezzanine financing is often used 6 to 12 months before an IPO and then the IPO’s proceeds are used by the company to pay back the mezannine financing investor.

5) IPO (Initital Public Offering)

Finally, companies can raise money through selling stock to the public in what’s called an Initial Public Offering…or IPO.

The IPO’s opening stock price is typically set with the help of investment bankers who commit to selling X number of the company’s shares at Y price, raising money for the company.

Once the stock is out, it is traded through a stock exchange (like NASDAQ or American Stock Exchange).

Companies can offer more of their stock through additional offerings.

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