We have the opportunity to meet a lot of entrepreneurs at different funding stages in their life cycle. One thing that I’ve found is that it is important that you communicate to investors which stage you’re in and, if possible, how many rounds of funding you anticipate before exit.
You can bet the investor will form their own opinions, but it is important that you, as an entrepreneur, give this serious consideration and show the investor that you have done so. It will go a long way in establishing credibility.
The first stage of funding, called seed funding is at or very near the beginning of the timeline. This is when money is spent on activities such as technical development, market research or in securing intellectual property rights. Basically, it is money spent evaluating potential viability and preparing for the commencement of operations. Most of the time this money comes from the entrepreneur’s own personal savings or from family or close friends. Institutional investors such as venture capital firms or angel investors usually see this stage of development as too risky.
The next stage of investment comes when the company needs money to get operations off the ground. This is known as start-up funding. The start-up financing stage is usually characterized by the business’ first revenues that fall short of supporting positive cash flow, hence the need for a capital infusion to fund operations until revenues are sufficient to sustain operations on their own. Sometimes start-up financing is dubbed series A funding, referring to the first outside capital brought into the company.
Once the business is on firm footing, there will come a time when more money is needed to support continue growth. This money may be used for things such as refining marketing efforts, hiring additional management and staff or new product launches. This round of financing is called growth or series B funding.
Sometimes companies have a seed round of funding followed by series A and series B rounds of funding then proceed to a sale or public offering.
The last stage of financing with the general purpose of preparing the company for a profitable sale or IPO is called mezzanine funding. Mezzanine financing is generally some combination of debt and equity than can lower a company’s overall cost of capital.
Funding stages can take on many different forms depending on the business and market in which it participates. At some point when cashflow is positive companies may elect to take bank loan, to support operations or some companies may choose to move on to subsequent rounds of series C and D funding before exit.
Whatever your funding strategy, remember that each stage will require a valuation of your company and that too much funding will lead to dilution of the founder’s stake.