Sewing the seeds for ABC: A funding guide for startups

Entrepreneurs will understand that capital is crucial for their ideas to come alive and for their company to become competitive. At different points of a business' growth, the amount of money a company will need to progress will change. These different stages of development are reflected by investment rounds, where founders and co-founders can engage in different stages of funding to reflect their business growth. Startup funding and fundraising can seem daunting so in this guide, we will take you through the different stages of funding and types of investors at play.

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Startup Funding Rounds

A successful startup will typically go through a series of funding rounds, beginning with pre-seed or seed investment and ending with C funding rounds. As the business comes increasingly mature, the company will advance through the rounds to gain investment that will fuel the company's growth and business plan. Investors that take part in these rounds will typically receive and retain partial equity ownership of the company.

In order to assess which investors are likely to get involved and the reasons why the company is seeking new capital (what it plans to do with the money), the company will undergo a valuation that will consider the companies track record, user base, risk and development plans.

In the next sections we will discuss the different funding rounds.

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Pre-Seed Funding

'Pre-seed' funding is the earliest stage of funding a company will engage with and usually happens straight after an early stage startup's incorporation. Pre-seed funding, whilst not generally considered a funding round, concerns the funding that a company's founder or co-founders receive to put their ideas on the ground. This pre-seed period typically involves the initial costs of set up and commercialising or developing the idea. The pre-seed round is often funded by the founders themselves or by close friends and relatives.  At the pre-seed stage, founders will work to show that the product is feasible and fulfils a market need. Startup founders might receive assistance from incubators, which can give advice in these early stages. Early stage companies can also choose bootstrapping at this stage to fund their business and avoid dilution. This also gives founders the time to gain some traction which will in turn help them find the right investors.

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Seed Funding

As a step forward from pre-seed funding, raising seed funding helps prove the product-market fit of the business idea and product development. As the first official equity funding stage and represents the first time a company receives official money. Seed money is used to, as the name suggests, plant the business idea and allow it to grow.  At the seed stage, a company will typically employ its founding team and begin developing the product for market. At this stage, the company will also start collecting market information and developing sales and marketing strategies. into a coherent business model. Seed funding might manifest in a variety of ways.

Firstly, it is common for startup founders to gain seed funding from angel investors. At this early stage, angels appreciate that investing at this seed stage is risky and therefore will typically expect an equity stake.

Secondly, start-up founders might enrol in accelerator programmes and make connections with venture capitalists that are attached to venture capital firms (VC firms). For example Y combinator and Entrepreneur First accelerate startups and help them build their MVP and obtain funding from seed investors. These potential investors differ from angels and will often have seed funding rounds which founders must apply to. Companies might also receive funding from funds or VC funds as well as angel investors.

Once a company has gained seed capital, it is expected that the company will pass the development stage and begin to market and sell the product as it develops.

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Series A

Series A funding is the next level of investment. Companies will raise a series A round once they have developed a record of success and interest. For example, once a company has established a user base, revenue or progressive development of a product that due to its nature, such as medtech, is not ready to market. A rule of thumb is that businesses can raise a Series A when they hit $1M in ARR but this figure will vary depending on the team, market and investors.

Unlike seed funding, the focus at this stage is less on the idea but more on the successful implementation of that idea. In this round, the founding team should have a clear plan of how to scale the product and set significant milestones, such as using capital to venture into new markets.

Investors at this stage are typically traditional venture capital firms such as Accel Partners and Benchmark Capital. Companies will need to present a pitch deck detailing their previous successes and their plans to scale. Unlike at the seed stage, companies applying for Series A funding will have to undergo a valuation set by a lead investor. The terms of the funding round will be defined in a term sheet. At this stage, companies might also consider crowdfunding or using a convertible note for raising capital.

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Series B

If a company is applying for series B funding, it has proven its product and its tactics. If a company has matured enough to reach the series B round, companies will have moved past the development stage and will need funding to grow the company in line with demand.

As a later stage, companies that gain Series B funding are well-established and their valuations are in the multimillion. At this stage, companies will likely be approached by different investors who are interested and specialised in later-stage investing.

Series C

At this stage, a company will already be turning over large revenue. One of the reasons that a company might apply for series C investment is to develop a new product. At this stage, the business is less risky meaning that more investors come into play, such as private equity firms, investment banks or hedge funds.

Series C is typically viewed as the last round of funding however this isn't to say that a round after this is unheard of. Some companies might continue onto Series D and even E funding but this is rare as series C funding, and even series B, is often sufficient to cover global expansion.

Companies that are developed by this stage might partake in series C funding rounds in order to qualify themselves for pre-initial public offering (Pre-IPO) platforms or improve their valuation for its initial public offering (IPO).

When a fund or firm is choosing to invest in a company, they will do their due diligence. Making sure that your IP is protected through your employment contracts, consultancy agreements and NDAs is one sure way to ensure your company passes these checks. Legislate's patented technology also provides insights into the key metrics across your contracts, such as total pay roll or average confidentiality term.

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The opinions on this page are for general information purposes only and do not constitute legal advice on which you should rely.