When should a startup raise money and how much? These are burning questions for all startup founders so let’s take it step-by-step.
The Stages of Fundraising
The first things to understand are the different startup funding stages or ‘rounds’ of fundraising involved. Here’s what they are in brief followed by further details on the all-important first two rounds.
- Pre-Seed Funding: As will be seen in the next section, Pre-seed funding is the earliest stage of funding.
- Seed Funding: This is the first equity funding stage and generally represents the first official money that a startup raises. Again, more details will be explained in the separate section below.
- Series A Funding: This round is an option once your business has begun to establish itself. At this stage, you will have such things as an established client base and some consistent revenue figures to show. Other key performance indicators should be shown depending upon the product or service sector you are operating in.
- Series B Funding: This is all about taking your venture to the next level and beyond the development stage. Those investors who are interested in Series B rounds of funding are prepared to assist by expanding market reach. Any startup reaching this round of funding will have proven to potential investors they are ready for success on a much larger scale.
- Series C Funding: Any startup that reaches this stage must be congratulated! It means your business is now seen as well-established and very successful. Looking for additional funds at this stage would be aimed at such things as new product development or expanding into new markets (these new territories could well be focused on extending the business globally).
It is also the case that some companies will use Series C rounds of funding to acquire other companies.
Because the first 2 stages mentioned above are the foundation of a startup’s future let’s take a look at each in turn:
This is where it all begins. While pre-seed funding is not always included in rounds of funding without it founders would struggle to get their business venture off the ground. The most common funders in this round are the founders themselves, family, close friends, or supporters of the business vision the founder has.
The amount of time it takes to raise initial funds will depend on the nature of the new company and projected costs to set the business idea rolling. This stage of funding can either happen quickly or come over an extended period. It is also most likely that anyone putting the money up at this stage is not doing so in exchange for equity in the startup.
As the term would suggest, “seed” funding is so named because it relates to the early investment support required to help grow a startup’s business. It is typically the first round of official funds that a startup will raise. This is a crucial funding stage for all and some startups do not need to extend beyond the seed round into Series A rounds or beyond.
In essence, seed funding will help a startup to finance its first steps. It includes covering costs for such things as serious, in-depth market research and product or service development.
This funding helps startups to determine what their initial product(s) or services will be and a clear demographic target market. A good proportion of seed funding will also be used to attract the right founding team to complete this work and get the new venture up and running.
Who are seed investors?
In terms of who are classed as seed investors, there is good news for startups because they come in many forms. Examples are founders themselves, family, friends, incubators, and venture capital companies. However, it is “Angel Investors” who are most commonly associated with seed investment.
This is because an angel investor tends to appreciate riskier ventures. A point in case is a startup that has little in the way of any proven track record to date. As can be expected, their investment does not come free because, in return for this funding, angel investors expect an equity stake in return.
When Should You Consider Fundraising?
Timing is the key when it comes to a startup beginning the fundraising process. As will be seen, this involves taking a variety of factors into account. But seeking funds should only begin when you have maximized your potential internal infrastructure and have completed all short-term goals.
When the scaling of your new venture is imminent that is the time to begin raising funds. With that premise in mind let’s first take a look at 4 reasons why a startup should wait before considering fundraising efforts and then move on to 4 key reasons for beginning the fundraising process:
4 Reasons for Waiting to Fundraise
A startup’s ability to raise the required funding can make or break its business development and expansion plans. This means that many startups are tempted to seek additional funds from investors during the early part of their new venture.
While that may be tempting it should be avoided! Here are 4 valid reasons why that is the case:
Are you generating sufficient interest?
Startups need to be able to show prospective investors that their product or service is generating positive end-user and/or customer interest. This will vary depending upon your chosen target audience.
Examples are: Some investors will not be willing to provide funds unless your consumer-focused product already has a healthy waiting list of interested customers. On the other hand, this tends to be less important to those investors looking to fund startups that are focused on business-to-business or enterprise target markets.
Either way, a startup should hold off on the fundraising trail until they are confident that interest in their existing and potential client base is sufficient to attract the attention of would-be investors.
Inability to show a short to mid-term return:
Any would-be investor is very likely to be hesitant when it comes to investing in a startup unless they can see a short to mid-term ROI (Return On Investment).
Important note: While the time taken to show an ROI can be an issue it is not always an indication of when to prevent or start your fundraising activities.
Ability to manage your current financial books:
If your startup is in a reasonably healthy financial position it can be beneficial to hold off on raising additional funds. The reason for this is that it will give you time to further improve your internal operations and structure. It will also allow more time for you to explore additional fundraising options.
With patience and leeway to consider what type(s) of fundraising are available you will be in a stronger position to maximize the fundraising route that best meets your needs.
Negative growth impact:
Unless you have a solid development strategy in place or the products and/or services offered can be effectively replicated or scaled, reaching out for additional funds too early could have a negative growth impact on your business.
This is because your internal structure and procedures must be ready to cope with the expected increase in demand for your products or services that any additional investment is provided for.
Reasons to Start Fundraising
Let’s match the 4 reasons to wait for fundraising with 4 key reasons that you should begin to actively seek additional funding.
Being able to confirm each of these points will ensure you are in a strong position to start effective fundraising negotiations:
Startups looking to increase their operation must have robust processes in place. This relates to the creation of their product or service business model and its management. During the early stages of life, these processes will be refined through trial and error.
Once these refinements are advanced it will show that you have a proven development strategy for business growth. This will be seen by investors as attractive and a solid reason to ‘buy in’ to your business.
MVP (Minimum Viable Product):
This is a basic version of your product or service. Creating an MVP that acknowledges the needs of investors and that answers questions raised by potential investors is an interaction that will prove to be successful.
Important point: It may be the case that an MVP is not possible without additional funding. That being the case, a startup needs to comprehensively conceptualize how its MVP will work. This can then be presented to investors as part of the reason that additional funding is required.
Imminent Scaling – Use the S-Curve:
The scaling of your business has already been touched on as a major reason to begin raising funds. The fact is, when you feel in a strong position to scale your business upwards this is a really good time to contact investors.
When looking to measure scalable success startups should use the proven S-Curve (Sigmoidal Curve) model. This is a theoretical mathematical function that shows the dynamics of change and will help a startup realize when they are nearing their scaling point.
The results will suggest that when your venture has grown in solutions and product development you are ready for expansion and increased business success.
Increased client interest:
Scaling up your products or services goes hand in glove with an increase in your client base. The more customers you bring on board, the greater the demand for your resources. This increased demand will be seen through the need to increase product availability and to ensure you have the staff to cope with services offered in an efficient and timely manner.
The good news here is that this increase in existing and potential new business highlights that your evolving business model is proving to be successful. This is a positive time to look at fundraising because it will show investors that money is required to maximize your business potential.
When Should You Consider Fundraising?
This will vary depending on such things as your type of business, target audience, and available resources. However, in the majority of cases, a startup will not be ready to look at fundraising for its first two years of existence.
Of course, this is not set in stone and there will always be exceptions. Some startups have been very successful within 1 year of creation while others who have been around for 5 years do not necessarily qualify as investment-ready.
Having said that, the longer a startup has been in existence the more difficult it becomes to show an appropriate growth curve. This is a factor that could prevent investors from offering to fund. As has already been mentioned, timing is key. Get that right and your bid for successful fundraising stands a far greater chance of being realized.
How Much Capital Should You Raise?
This is a question that needs serious thought and must be backed up by sensible projections. The valuation of your company needs a subjective assessment and must take into account two important factors.
First is the amount of money you intend to raise. Second is the amount of equity you need to give up to raise the required amount.
The majority of founders will be prepared to give around 20% of their equity at the seed funding stage and another 20% if they progress to the Series A round of funding.
Based on the above percentage, let’s give an example:
Once you have defined your set milestones and have estimated ongoing monthly operating costs, let’s say this results in the need to raise $1 million at your seed funding round stage.
Based on the fact that you are prepared to give up 20% of your personal equity you will need to set a negotiated valuation of $5 million (20% of $5 million = $1 million). This figure will give you the required capital to reach your next set of goals without having diluted too much of your equity.
It is important to always bear in mind that valuations are fluid. This means the focus must be to negotiate your ideal valuation with the goal being to raise enough money to reach the next growth phase.
Two other factors also need to be taken into account. The amount you are looking to raise must satisfy investors that their funding is a worthwhile investment and from your perspective that you maintain an acceptable ownership percentage of the venture you have started.
Deciding on the most appropriate time to begin your fundraising activity is a crucial time for startups. This needs careful consideration to ensure you maximize the amount of funding required.
In that respect WOWS Global is ready to assist. We have in-depth experience and intimate knowledge of the challenges that your new venture will face. This is from the beginning of your journey right through to the most advantageous ways to grow your company into an entity that spells success.
By getting in touch with our highly experienced team we will offer guidance and support that can effectively create and organize fundraising and access liquidity channels. Our ability to connect investors and startups alike is second to none.