Way back in the wild Internet gold rush leading up to the dot.com crash of 2001, a newly minted venture capitalist told me: “The rules of cash are simple. A) More cash is better than less cash; B) Cash now is better than cash later. C) Never run out of cash. Those rules are simple, but take a look at any startup that has crashed and I guarantee that they have disregarded one of those three rules.”
Of course, it’s not that simple anymore, if it ever really was, but there is an important lesson hidden here if you are patient enough to dig down into it. Understanding the essential trade-offs in your chosen funding source is the key to getting innovations to market under the most favorable conditions. If you need examples, Fast Company has assembled a list of 92 companies that raised over $100 million but still went out of business due to poor money management. Details mean everything in funding and a bad deal can sink even the world’s smartest innovation.
A great deal of what you read about funding is targeted at would-be founders and beginning entrepreneurs in search of seed or pre-Series A funding. Today, we’d like to open up your field of view to the bigger picture of how funding works.
First, let’s define some terms. The biggest difference among the funding rounds is determined by the maturity of the underlying business and the type of investor that you bring to the table.
Mid-sized companies are normally well beyond the seed stage, but individual projects within an enterprise innovation incubator might prompt the company to go out looking for seed funding from their partners and their wider networks. Pre-seed funding can involve something as simple as a pair of entrepreneurs who have identified a problem but not a solution. Seed funding covers just about everything before there is a solid understanding of product-market fit. See our earlier blog on Making Dreams Real, Part I for details on what this involves. Seed capital usually pays for market research, app development teams, MVP prototypes and anything else that is required to prove out the business model. Typical seed rounds average between $500,000 to $2 million. This is the realm of angels, informal investors and risk-takers.
Venture capital firms normally start to pay attention after you can prove that the business concept is bringing back positive cash flow, an enthusiastic customer base and plenty of room for growth. Series A is meant for expansion into new markets, optimization of processes and large scale development. You’ll need a well-prepared business plan and a narrowly defined financial presentation. You can expect the Series A funding round to generate deals in the $2 - $15 million range, though individual Series A deals have grown much larger depending on the goals of the business. This can be a very painful process, as TruStory founder Preethi Kasireddy experienced it. Like many others before her, she felt the crush of disappointment and self-doubt that comes with denials. She found that, “nothing about fundraising is easy. It’s filled with painful no’s: No’s that take your breath away in how quickly and rudely they’re delivered; no’s that are tied up in pretty little ribbons and disguised as ‘let’s keep in touch’; no’s that come in the form of deafening silence after a series of promising meetings. Especially in the beginning, each one of those no’s will weigh on you heavier than you ever could have imagined.”
Even to reach this round of funding is a triumph in one sense. Research by TechCrunch suggested that 60 percent of startups fail before they get to Series A and nearly 80 percent fail before reaching Series B rounds. Their data showed the biggest jump in companies that ended up exiting through acquisition happened after the Series B funding round. Just of 8 percent of companies were acquired after Series A and that number increased by 50 percent (up to 12 percent acquisition rate) after Series B. Whether or not an exit as an acquisition is a goal of your company is another question entirely. In any case, a Series B will open a new chapter in the life of your business. Mid-sized companies frequently find it more difficult to raise funding at this stage, even if they have been extremely successful. One reason is that the amount of investment is typically still in the same range as Series A – around $10 - $20 million -- but now there are hard numbers to work with instead of (optimistic) projections. There are many venture capital firms that specialize in Series B and late stage investing only.
While a small number of companies go on to raise Series C,D,E,F rounds and more, they are have normally grown well beyond mid-sized companies by that point. When an enterprise is ready to go global or start franchising on a massive scale, they need serious up-front capital on much better terms. Along those lines, plans for mergers and acquisitions often kick off discussions about a new round of funding. Series C rounds are often in the $100 million or larger range. The types of investors you will be dealing with at this stage are more commonly private equity firms, investment banks and hedge funds.
In our next blog we will dive into the most common hurdles at each of these stages and offer some tips on how to sail over them.
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