How Do Startups Raise Funds || mPokket
Got a great idea for a start-up? Put your thinking cap on and head towards the garage!
To get any venture off the ground, you need money. Initially, most startups afford their shoe-string budget on the generosity of their family and friends. Often, the founders sponsor their ideas themselves.
As the enterprise matures, it attracts investors. Wealthy individuals and institutions gauge the success probability of the venture and decide if it’s worth funding.
Over time, the enterprise becomes profitable, gains a customer base, and explores other more lucrative avenues such as mergers, IPOs, etc.
What are the different kinds of funding?
Thanks to the attractive business model that comes with investing in brilliant ideas, there exists an established practice when pouring capital into nascent startups.
- Pre-seed Funding: This is the earliest stage of funding – so much so that it is not even considered as a stage. This is when the founders primarily invest themselves in their ideas, along with the help of their loved ones.
An important distinction between pre-seed and the subsequent stages of funding is that individuals who invest during this stage do so without any equity in exchange.
- Seed Funding: This is the first time that formal investors – incubators, venture capitalists, and angel investors get involved in the funding process.
This type of funding gets its name from the tree analogy. Potential investors look upon a new startup as a seed. With enough nourishment in the form of capital, these nascent organizations can successfully germinate into giant trees.
Typically, a seed funding round can raise anywhere between USD 10,000 to 2 million. Companies that participate in seed funding are valued anywhere between USD 3 million to 6 million.
- Series A Funding: This stage of funding occurs when a startup has already garnered some salient key performance indicators (KPIs) – month-on-month revenue, a unique user base, etc.
In a series A round, startups raise anywhere between USD 2 million to 15 million. Thanks to the high valuations that the tech industry often enjoys, these figures can go even higher. During a Series A funding, startups can no longer raise capital on the sole basis of their ideas. In addition to killer ideas, investors are also looking for sound strategies that will carry the ideas to fruition.
Some of the top venture capital firms that participate in Series A funding include Accel Partners, Greylock, Benchmark Capital, and Sequoia Capital.
- Series B Funding: This is a stage at which the startups, by virtue of developing a loyal user base, have proven to their investors the viability of their venture. Series B funding is used to boost vital functions like business development, support, tech, advertising, and sales.
According to fundz.net, the average capital raised in a typical Series B round is USD 58 million.
- Series C Funding: Series C funding is undertaken by organizations that are already proven successful businesses. These are companies that are seeking funds in order to acquire other ventures, explore new markets, and develop new products.
More often than not, companies end their equity funding rounds with Series C. However, organizations have been known to undergo Series D and even Series E funding rounds.
What is Bootstrapping?
When an organization is built by an entrepreneur with nothing but personal savings, it is called Bootstrapping.
In the early 19th century, “pulling up one’s own bootstraps” was an expression. It was used to describe what was an impossible feat. Bootstrapping originated from this expression and is used to denote success that was achieved with little to no assistance.
As is self-evident, bootstrapping is not for the fainthearted. The complete financial onus falls on the founder.
If the resources are limited, it could compromise the integrity and quality of the service or product being offered. It could also hamper promotion and stifle growth.
On the plus side, the owner has total control over the business and its decision-making processes. Furthermore, precious time is not wasted trying to fend for investment and pitching to potential lenders.
With Bootstrapping, you are unlikely to experience profit early on. By and large, entrepreneurs bring in revenue in a gradual manner and create assets. These assets are then re-invested into the business to fuel its growth.
How do investors earn money?
Investors recover their investments in myriad ways.
For example, Venture Capitalists (VCs) make money in one of the 2 following ways.
The management company that runs the VC fund is paid an annual management fee. It is used to cover fund and organizational expenses. It is also paid as a form of salary.
The fees are calculated as a percentage of the fund capital commitments. Typically, that ranges anywhere between 2 to 2.5 percent.
Carry refers to the share of the profits resulting from a successful investment. For Venture Capitalists, that is usually anywhere between 20 to 25 percent.
Angel investors make money the same way that Venture Capitalists do with one important distinction. There are no middlemen or intermediaries involved who have to be employed to manage the portfolio.
No financial intermediaries, money managers, or brokers are involved. This saves up to 1 to 2 percent in fees and investment commissions.
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