What Are the Stages of Venture Capital Financing for Startups? What Are the Stages of Venture Capital Financing for Startups?
Venture capital is a primary fundraising tool entrepreneurs and startup companies use to achieve their growth goals. Venture capital firms are comprised of investors known as Limited Partners who contribute money that their fund manager, or General Partner, uses to invest in different businesses with high growth potential. Startups generally exchange some portion of equity for VC funding, which has the potential to provide a positive return on investments for VC investors if the company becomes successful.
Key Takeaways:
- Each stage corresponds to different growth goals for startups and generally involves different funding sources.
- VC investors usually come into play for startups no earlier than the seed funding or Series A funding rounds.
- Companies that reach Series B and Series C rounds of funding have proven success and have an established customer base.
- Typically VCs will hope for the founder to grow their company to the point of selling for a liquidity event or, much more rarely, going public through an IPO. This allows founders to continue to grow their company while generating return on investment for themselves and other early investors.
While this is broadly how the VC funding process works, there are several funding stages that startups go through that involve VC investors to different extents. Each stage corresponds to different growth goals for startups and generally involve different funding sources. In addition, it is important to understand that VC funding is not the only way for a company to raise funds. For example, at any point, a company may decide to take a business loan instead of seeking VC funding. Having said that, however, today, we are exploring the stages of the venture capital funding rounds for startups.
What Is Pre-Seed Funding?
The pre-seed funding stage, also known as the bootstrapping stage, is often undertaken before startups even begin reaching out to venture capital firms. This part of the startup journey is usually when founders are still developing their product or service and generally exploring the avenues for success. During this phase of startup funding, businesses will also be doing legal due diligence like exploring copyright or trademark opportunities as well as hashing out any partnership agreements.
As such, the pre-seed funding stage rarely involves VC funding with most financing being contributed by the founders themselves and contributed by friends and family. The exception to this would be any angel investors, who themselves might be looking for nascent businesses to invest in at the ground floor. In most cases, it's unlikely that equity is being exchanged for funding during the pre-seed phase.
What Is Seed Funding?
Seed funding is generally the first official equity funding stage for startups and is usually when startups begin working with venture capitalists to secure funding. During the seed funding phase, startups will prepare a pitch deck to show potential VC investors how they plan to achieve profitability with their product or service.
If a startup is able to successfully pitch their business and secure VC funding during the seed stage, they will be able to pay for additional market research, hiring a management team to lead the company through future growth, the development and execution of a business plan, and further product development. Essentially, money raised during the seed funding stage is primarily used to nurture enough growth to prove to investors that the business is scalable and worth supporting through future rounds of investment. Often, startups will be pitching investors on future funding rounds (more on those below) during the seed funding phase.
Common sources of funding for startups during the seed phase are the founder, their family and friends, close contacts, angel investors, and early venture capitalists. It's worth noting that because seed funding takes place very early on, any VC investors will be taking on a considerable amount of risk, and as such startups will likely have to give up equity and potentially board seats during this phase. VCs will typically agree to accept either a SAFE note or a convertible note. Reference our previous article to learn more about the differences.
What Is the Series A Funding Stage?
The Series A round funding comes after a startup has an established business plan and vision, a pitch deck to show potential investors how the product or service fits into the market, an understanding of their customer base, and reliable revenue flow. Potential Series A venture capital investors are looking for a startup that has a strong business plan with a solid strategy for turning a profit over the long term.
Series A funding comes from more established VC firms, corporate VCs, angel investors, startup accelerators, and family trust offices, and is usually received in exchange for preferred stock in the company. Startups may find that once they've secured investment from one firm as part of their Series A funding round, also known as an anchor investor, others will show interest in turn. While angel investors do sometimes participate in Series A funding, they will generally be less influential in this round than during seed funding.
Additional funding raised during the Series A phase is used by startups to accomplish a range of business goals including growing their workforce, continuing market research and product development, and executing their business plan in order to attract investors for future rounds of funding.
What Is the Series B Stage of Funding?
If a startup has made it through the seed and Series A phases of fundraising, it has already experienced a level of success that the majority of businesses will never reach. Startups that have reached the Series B phase have made it past the initial development stage, have proven there is a market for their product, have generated revenue, and are ready to scale. These types of performance milestones are what potential investors look for when considering whether to take part in a startup's Series B funding round.
Series B funding provides capital investment that is primarily used to help startups achieve growth milestones and will support manufacturing, marketing, advertising, and general operations. Series B fundraising can come from a variety of sources including venture capital firms, corporate VCs, and family offices. One of the notable differences between Series A and B fundraising is that Series B usually involves venture capital firms that specialize in investing in later-stage startups. Series B funding also involves the exchange of stock for capital investment.
What Is the Series C or Later Stage of Funding?
Startups that are lucky enough to reach the Series C or later round of fundraising are officially on an exponential growth trajectory with a proven track record of profitability and an established customer base. Companies that are initiating a Series C round of funding are often looking to develop new products, expand into new markets, or acquire another startup to either expand market share or product offerings.
The Series C phase is most commonly funded by hedge funds, private equity firms, late-stage VC firms, corporate VC firms, and family trust offices. Because most businesses initiating a Series C round of funding are well-established with a proven track record of success, investors take on much less risk during this stage of funding than the previous phases. Generally, Series C funding is the final round of external equity funding for startups.
What Is the Bridge Stage?
Many startups proceed directly from their Series C or later funding round to IPO. As mentioned above, a startup that has reached Series C fundraising is a successful business with a track record of profitability, and as such some of their investors may choose to sell their equity in the company to get a return on their investment.
This makes it possible for new, late-stage investors to provide capital investment for further pre-IPO expansion and growth.
What is IPO or Going Public?
Once a startup has gone through some or all of the funding rounds outlined above they may consider initiating the process of taking their business public by offering shares on the stock market through an initial public offering, or IPO. Going public is an avenue for founders to continue to grow their company by raising significant capital on the public markets while also generating a return on investment for themselves and other early investors. However, the process is an extensive use of time a company resources, and public companies have to comply with a raft of regulatory requirements, which can significantly impact a company’s decision to go public.
Businesses that go public can continue to raise capital through secondary offerings which can be used to stimulate future growth as well as to pay off early investors and any members of the leadership team. Public stock is also a benefit companies can use to attract top talent to their team.
Still have questions? Leader Bank's Venture Capital and Private Equity Banking team is here to help with an invaluable knowledge base, personalized relationship banking services, and flexible solutions for both emerging and established funds.
