Outside funding for startups
While pre-seed funding, which is money the founders got from themselves, family and friends, is a start, it’s not enough to take their business through the next phase, which can include market research and product development.
Without outside funding, startup businesses can take a long time to grow and make money. Businesses that are worth anywhere from $3 million to about $6 million often seek financing from venture capitalists or angel investors who have significant funds available to invest. The first phase of startup funding, known as seed funding, can produce as little as a few thousand dollars to $2 million.
As businesses grow and prove their potential, they have the track record to seek larger venture capital firms that have more money available to invest. They go through three main phases of funding: Series A, Series B and Series C.
Related: How to Grow Your Business
What is Series A funding?
The goal of Series A funding is to provide businesses with money to pay employees, optimize their offerings, scale across different markets and develop a marketing strategy. It’s generally the first or second round of funding for a startup, depending on whether the founder went through a seed round or if the business was self-funded.
In the earlier days, businesses in the Series A investment phase usually sought between $3 million and $7 million. Since then, valuations have risen and so have A-Rounds. In August 2021, the global average for Series A was over $18 million. For companies valued at $60 million to $80 million, they may be able to raise $20 million for their A-Round.
While angel investors are known for investing thousands of dollars in a business during the concept phase, Series A funding generally requires proof of concept. This means that market tests have shown a demand for the product or service and there’s room for growth into a multimillion or even billion-dollar company, known as a unicorn.
During negotiations, investors and founders decide on a fair valuation based on startup equity. For example, if a tech company asked for $5 million in exchange for 25% of their equity, they would be valuing the company at $20 million. The factors investors consider when determining valuation include:
- Past sales. It’s possible to evaluate how much a company in any industry may be worth based on revenue.
- Risks. This happens with the help of methods, such as the Risk Factor Summation, to consider the number and types of risks associated with the startup.
- Current growth rate. This shows that there’s a definite path to profitability.
- Size of the market. Quantifying the company’s value proposition means there’s a viable marketing strategy.
What is Series B funding?
After a business has launched its initial products and started making money, founders can pursue Series B funding. They seek a cash injection from venture capitalists to flood the market, refine a brand or develop new product lines to capture a wider audience of customers.
In 2021, the total number of Series B funding recipients was more than 25% higher than the previous year, and the investments went from over $25 billion to almost $50 billion. Series B funding has a high level of risk because businesses that succeed in a small market may not be able to survive and grow in a larger market.
Those trying to capture market share have the challenge of educating the public about their product or brand while competing with well-known businesses that have steady cash flow.
Series B investors may account for this risk by asking for more equity. At the same time, business owners need to protect their equity and valuation during B-round funding to ensure that the valuation reflects the growth of their business.
What is Series C funding?
Series C funding has the goal of preparing a company to be acquired, go public on the stock market or undergo significant expansion, possibly through acquisition. It’s usually the last stage of fundraising a startup goes through, although some businesses pursue additional rounds to raise more capital.
Companies that go to this round of investments already have proof of their success and are valued at about $118 million. While previous rounds of funding use investment money to start making money and carve out their space in the market, Series C funding funnels large amounts of cash into profitable businesses to scale them up as quickly as possible and get a fast return for the investors.
Businesses that seek out Series C funding are not startups anymore. They are mature entities, but still young, with a dedicated customer base and strong brand recognition. Private equity firms, hedge funds and investment banks often contribute to this round of funding due to the low risk, proven business plan and the chance to back a company that could grow to be worth billions. The average Series C investment in 2020 was about $59 million.
How to find investors at each level of funding
One of the main benefits of getting an investment from a venture capitalist or angel investor is their connections and industry knowledge. Even a highly successful small business owner may not know the next steps for expanding into a new market or who to talk to about funding their growth. Follow these steps to find investors who have the capital and skills to push your business into maturity:
1. Join a startup incubator
Joining a startup incubator, also known as a startup accelerator, can put you in contact with investors who are interested in working with new businesses. Incubators are programs that mentor companies during their beginning stages, offering training and valuable mentorship for promising startups. Startup incubators usually lead up to opportunities to pitch your business to a range of investors for seed money or Series A funding.
2. Know the major players
Knowing who invests in startups in your field can help you know what connections to seek out. Research the most active startup investors and what kinds of projects they invest in. Many venture capitalists work with any company that has potential, while others prefer to invest in a niche field and leverage their industry connections in one space. Some of the top investors for Series A, Series B and Series C funding are:
- Google Ventures
- IDG Capital
- Sequoia Capital
- New Enterprise Associates
- General Catalyst Partners
- Kleiner Perkins Caufield & Byers
3. Use your professional network
Once you’re connected with an investor who believes in your business at the seed or A-Round level, they can often help you raise startup Series B and C funds themselves or connect you with people in their network. As part-owners, they want the equity they own to grow in value, giving them an incentive to connect you with people who can increase the business’s valuation.
Series of funding FAQs
What is the difference between seed funding and Series A funding?
Seed funding provides smaller amounts of investment capital and occurs before Series A funding. Some businesses may take out a line of credit as part of their seed funding, while Series A funding is equity-based.
How long does Series A funding last?
Series A funding is meant to last between six months and two years to guide development. Business owners need a clear plan for how much money they will need in the Series A round to sustain their business throughout the product launch.
How long does Series B funding last?
Series B funding can last a few months or a few years, depending on what it’s being used for. It is meant to last long enough to oversee major scaling and new product launches until the business can sustain its growth through its own revenue.