Startup Funding Rounds: The Ultimate Guide from Pre-Seed to IPO

Startup Funding Masterclass: Part Four

Photographer: Gab Pili | Source: Unsplash

Now that we had a look at the 9 most common sources of funding and an in-depth discussion on the why and when of venture capital, it is time to talk about the different startup funding rounds.

Every company goes through different stages, with different challenges and needs. Raising capital will remain a constant challenge. As you hopefully grow from round to round you will meet different players, mindsets and requirements.

Don’t worry, however… we’ve got you covered from the very beginning to the IPO! 🚀

This post is Part Four in a new Masterclass series on Startup Funding. Funding is the fuel that every business runs on. Knowing the ins and outs of funding is therefore essential if you want your startup to be successful. We searched for a compact-yet-comprehensive guide on startup funding and found it nowhere, so we decided to build one ourselves. This is that essential guide.

We bring it to you in partnership with Belgium’s largest startup and scale-up accelerator Start it @KBC, supporting and promoting more than 1.000 entrepreneurs with innovative ideas and scalable business models.

– Jeroen Corthout, Co-Founder Salesflare, an easy-to-use sales CRM for small B2B companies

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Pre-seed

You just spent 3 months tinkering on your initial idea and convinced one of your friends to become a co-founder. Guess it’s time to go official and register your company. 🖋

Beyond picking an awesome name 😇, there are a number of decisions that need to be made to ensure your business is future proof and attractive to investors.

Cartman's startup funding plan
Nope, it’s not as simple as Cartman suggests.

So go ahead and read up on the following items:

  • Incorporation structure
  • Licensing requirements
  • Intellectual property
  • Option pool for future employees

Your pre-seed round used to end right here, but as competition has been increasing at the next startup funding round (Seed), so have the expectations been growing.

Before being able to properly raise seed funding, expect to need a well-developed minimum viable product (MVP), a strong core team, early traction and great customer experiences showcasing the opportunity for your business.

Your pre-seed money will hence be used to get to the next startup funding round.

Investors in the pre-seed round are typically friends and family or business angels, with investments ranging from $50,000 – $200,000 for a 5% – 10% equity stake. They provide you with enough runway to develop your MVP.

 

Seed round

Did you just launch your minimum viable product? Did you manage to get your first users and customers? But did you also realise that it takes more capital to truly develop your initial product and prove your product market fit, so that you can really take off?

Then this is a great time to be reading about seed financing.

seeds growing

In the seed funding round, you raise capital from family and friends, incubators, angel investors or/and venture capitalists. This finances product development and initial market entry, with the purpose of proving product-market fit and initial growth.

Investments typically come in the form of equity or convertibles, so make sure to read up on these differences in our post about types of startup funding.

When is the right time to talk to investors?

Always, sort of. 😉

It is never to early to establish a relation with investors by having casual conversations on your business, the market opportunity, and what they are looking for in investments. Use this casual contact as immediate feedback that can be used at the time of fundraising.

Refrain, however, from full-blown pitches until you have gathered enough evidence to really convince them. Once you are ready, remember that investors need to be convinced that your idea is compelling, that there is an opportunity, and that you are the right team to execute.

For some founders, a story and their reputation might be enough. But for most of us, it will require a well-developed idea, a good understanding of the market opportunity, a minimum viable product, and some initial traction (take a look at comparable startups that raised funding as a benchmark).

Once you have all those ingredients, it is the right time to pursue an investment.

How much should I ask for?

In an ideal world, you would raise just enough money to reach profitability, while not giving away too much equity.

But this will hardly ever be the case, as for most startups there will be a need for a lot of follow-up rounds before reaching a self-sustaining growing business. 🤑

The key factor in deciding how much to raise is finding out how much you will need to get your company into the next state. Be it initial profitability or your next funding round; it is crucial to find out how much money you will need to get there.

So go and take a look at our following article on how to calculate your startup runway.

Make sure to raise enough to get to your next startup funding round without giving up too much of your company. A typical range is somewhere between 12 and 18 months.

There are significant differences in the amount raised by companies at this stage, but expect rounds to range from $50,000 to $2,000,000.

How should I value my company?

Let’s be real, there is no way to determine a price for your startup at this point. Without the availability of data points, you can’t project sales.

how should I value my company?

It is also difficult to value the skills of a team that hasn’t delivered yet on such a project. Finally, every investor will value the combination of skill and opportunity versus product and delivery differently.

Focus on raising the right amount of capital to get you into the next startup funding round and try to get this money on the best terms. 💰

Shop around, talk to several investors, and let the market set the valuation or price cap (in case of a convertible note) of your startup. Additionally, take a look at similar startups at your stage for a reference point in terms of valuation.

Realistically, you should expect to give away between 10% and 25% at this point.

This round is all about getting the necessary funding to build your product, to figure out your product-market fit, and to search for that scalable growth channel.

As an added bonus, a good investor can deliver great advice and share his network, while you are building your business as fast as possible.

 

Series A

Once you have found your product market fit, have developed a scalable and repeatable product, and have laid the foundation to create scale in your sales, it is time to super-fuel your growth.

This is where a Series A comes in.

In order to succeed in this startup funding round, it is all about convincing potential investors that your company can become a business with long term profit potential.

Expect investors to look at industry-relevant KPIs and metrics with great focus on your initial revenue and user growth to support their investment thesis.

The capital raised can then be used to truly optimise your product and business for scalability while growing your team to generate extraordinary demand. Following your Series A, investors expect to see exceptional growth.

4 stages of hockey stick growth
Source

Typical investors for this round are venture capital firms, with Accel Partners, Sequoia Capital, Benchmark and Greylock amongst the biggest names. But other profiles such as family offices, (super) angels and corporate ventures arms might also compete.

This is also the start of some political moves as you will probably need multiple investors on board.

One of those will take the lead, so make sure to select an investor that is truly bought in, as she will be an important supporter throughout the lifetime of your startup. Initial investors that do not participate in following startup funding rounds is never seen as a great sign.

Round sizes differ significantly per geography as market size matters. Expect EU rounds to be around $1m – $5m, US rounds to range from $2m to $15m, and Chinese rounds to go even beyond, for a 20% – 35% ownership stake.

 

Series B

The B stands for growth. 😂

After making your startup a growth machine with the Series A funding, it is now all about growing the company fast enough to deliver on the generated demand.

Investors need to understand how you can deliver at least 100% revenue growth yearly. They also need to understand where the opportunities are to further scale your business across markets and geographies.

The capital can then be used to grow your team across all key aspects (tech, sales, support, marketing), to enter additional markets, and to really scale up your business.

It is now even more important to find the right group of investors. They should help you to grow your business to be ready for the stock market and/or an attractive acquisition target.

This drags most companies towards VCs, as fueling aggressive growth is certainly in their field of expertise. But there is also a recent trend of bigger investors coming down to these rounds. So don’t be surprised to hear that mega players like Tencent, Softbank and Naspers, or even private equity and hedge funds, get involved for the most promising names.

companies Naspers owns
Here are some of the companies Naspers owns (2017).

At this point, investment sizes vary widely, but a range of $7m – $10m for a 20% – 35% stake is often cited as a normal round.

 

Series C or more

We’re entering the big leagues. 💪 From now on it is a race to the exit.

Having made it here is quite exceptional. You are probably running a startup valued at over $100m at this point, with several years of aggressive growth behind you.

There is a clear plan now to the exit.You have probably also had discussions with investors and advisors on what it takes to become a successful public company.

These startup funding rounds are all about optimising your company. You can do this by aggressively growing in key markets, gaining scale to establish yourself as the dominant player in your industry, and hiring mature leaders to bring your company to the next level.

As you have now gone from being a potential acquisition target to a potential acquirer yourself, you might also consider strategic buyouts or several talent acquisitions.

This is also an incredibly demanding funding stage. As rounds go from $50m to way beyond, you should expect grueling and long due diligence processes with a lot of parties involved.

At this point, there is a wide spectrum of investors looking at your deal. Beyond venture capital, expect large corporate investors, financial institutions, private equity, and hedge funds to take part in these rounds. Everyone is looking to get a piece before a potential exit.

With the abundance of capital interested in high growth startups, it is now becoming increasingly attractive to keep raising in private markets while delaying a potential IPO. However, as startup funding rounds keep being added, the investors participating are also increasingly similar to the big ticket names that you would expect to participate in an IPO. They will have the same expectations for corporate governance and due diligence.

 

IPO

Welcome to the grand finale? Kind of.

An initial public offering (IPO) is the process of making shares of a private company available to the public (on the stock market) in order to raise capital. In doing so, the company unlocks a vast amount of potential funding.

IPOs on Wall Street

Why would I consider an IPO?

Access to more funding faster

Lately, there is a vast amount of funding available in the private market due to the recent success of VCs, the rise of mega funds like Softbank, and the entry of public investors like Fidelity. This is however still small compared to the available capital on the public market.

And it’s not just more funding, you can also access it faster. Being a successful public company allows you to raise additional funding virtually overnight through a rights issue.

Shares as a transparent currency

The company’s listing will provide you with a transparent valuation. This allows you to easily use shares as part of the compensation to the acquiree when doing acquisitions.

The transparency also allows you to easily compensate existing and future employees through the use of stock grants or options.

Liquidity to existing investors

Becoming a publicly traded company provides what is called a liquidity event to existing shareholders. Following the IPO and the subsequent lockup period, investors and employees are able to sell their shares as part of daily trading to monetize their stakes.

This allows investors to close out their positions and return cash to their Limited Partners (more on Limited Partners in this article about workings of VC funding).

Institutionalisation to enterprise standards

A public company is required to comply with additional regulation, increased reporting and improved corporate governance. This all leads to a new level of transparency, trustworthiness and in some sense stature.

Gaining this institutionalization will allow for easier access to debt markets and can be an asset when trying to close larger clients.

What holds me back?

Simple, being a public company is not always easy and it is expensive.

While in the private market you typically deal with professional investors who should correctly assess any risks involved, the public markets are different. In principle, this is the moment that anyone can buy your shares.

Therefore, there are a lot of protection mechanisms to protect such investors, which leads to regulation and requirements.

I guess we all remember the famous “funding secured” tweet from Elon Musk. He would have been in no trouble if he had done the same without being public. Once you are, however, a tweet like this becomes an official release of information. It should always be factual and fairly distributed among the public.

tweets by publicly traded companies - the Elon Musk tweet
The tweet that cost $40m in fines and Elon Musk’s step down as chairman of Tesla.

This all means that you should expect to add a layer of complexity to your business. You will need to invest in corporate governance, compliance to security laws, additional reporting, and investor relations.

The process of going public is also a monumental task. Processes can easily take six months up to more than a year. Given the importance and public nature of the event, the top management will be super involved.

Finally, being public introduces a new level of scrutiny. The quarterly or semi-annual reporting cycle can put tremendous pressure on your company to perform in the short term. You also lose the ability to choose your investors, so you better have a strong team to weather the storm of bad performance and unhappy shareholders.


What startup funding stage are you in? And what will it take you to get to the next round(s)? (If you’re at all looking to raise VC money.)

We hope this post made it all a little bit clearer! 😁

Let us know if you have any questions left; we’ll be happy to elaborate! Also, don’t forget to tune in next week for Part Five in our Startup Funding Masterclass: How to split startup equity!

Or check out this summary of the Startup Funding Masterclass.

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Frederik Hermans

Tech & Finance Enthusiast. From banking to startups, looking to combine a passion for business and innovation.
Frederik Hermans