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Investing
Andrius Ziuznys
October 04, 2022
From the very beginning, a startup company with ambitious objectives and solid business ideas wants to conquer the market.
However, to achieve those goals, the founders require capital to develop a product, present it to the market, and build a consumer base.
In this article, you will learn about the 4 funding stages that startups usually go through before reaching an initial public offering (IPO).
What is a funding round?
A funding round is a stage at which businesses raise capital.
There are different levels of funding rounds: pre-seed funding, seed funding, series A funding, series B funding, series C funding, and sometimes startups proceed with series D and E rounds of funding.
The seed funding round, and series A, B, and C are considered to be the 4 official stages of funding.
All these stages raise progressively more money. However, less than 10% of startups that receive seed funding go on to raise capital in series A funding.
Investors participating in different funding rounds
The most significant difference is between pre-seed funding and seed funding rounds.
Pre-seed funding
The pre-seed funding stage is generally not included in the number of official funding rounds and the main investors during this stage are the founders themselves, their friends, family, and supporters.
Outside investors rarely, if ever, fund a pre-seed stage startup. Only an angel investor may be interested in funding pre-seed round companies. Angel investors are private investors that focus on funding small businesses for equity. An angel round funding amount may be from $100,000 to $250,000.
Seed funding
Seed funding is the first stage of the official funding process. In this stage, the startup founder and family members may still be among the main investors; however, angel investors and venture capital firms join the equation, too.
| Pre-seed funding investors | Seed funding investors |
|---|---|
| Founders | Founders |
| Family | Family |
| Friends | Angel investors |
| Supporters | Venture capital |
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Main types of funding rounds
As mentioned before, there are 4 official funding stages: seed, series A, series B, and series C. In this section, we will discuss each of them in more detail.
Seed funding round
The seed round is the first step of external equity funding.
Venture capitalists, or, most commonly, angel investors, help the company establish a fundamental ground for running a business. With seed capital, startups can perform market research and develop their product.
External investments help build a successful business strategy, determine the target market, and pave the way to receive additional funding in the next startup funding stage.
The money raised from seed investors can vary significantly. For example, depending on the startup, the range can be between $500,000 and $2 million. And the companies that try to raise funds at the seed stage are valued between $3 million to $6 million.
Some companies don't pursue further funding rounds after receiving the seed financing. They raise capital required to get the operations going and then grow the business through their own revenue streams.
Series A funding
For the next stage, series A funding, the startup must have a business plan to develop a business model directed at a long-term profit. Once a customer base has been generated, a company has to figure out a way to monetize the startup idea in the long run.
The series A stage usually involves typical investors from venture capital firms such as Sequoia Capital, Google Ventures, and other investors. Angel investors also take part in this stage, but they usually have less impact than in the seed stage.
In this type of funding, potential investors look for companies that have a solid strategy for monetizing the business and a proven track record.
The financial resources for series A funding averaged $23 million in 2022 and the seed-funded companies proceeding with series A round are expected to have a pre-money valuation of around $24 million.
Series B funding
The third round mostly goes to companies that are well-established, have a successful business model, and are ready to scale their business to reach the next level. It's used to expand market reach and meet the raised demands.
Meeting the new demands requires more people to work toward the goal. As a result, the additional capital usually goes to developing a stronger team of professionals.
The investors interested in series B funding are similar to the ones in the previous round. The only addition is venture capital firms that specialize in startups of later stages.
The average funding amount for the series B stage was $33 million in 2020 and the median pre-money startup valuation was around $40 million.
Series C funding
The companies that are interested in series C funding are usually the ones that are looking to develop new products, conquer new markets, or acquire competitor companies in other regions. Also, it could be used to support the startup for an initial public offering.
In this stage, hedge funds, private equity investors, investment banks, and some other investors join the list of existing investors. During the series C round, investors provide additional funding in hopes to get at least double the amount back.
One of the reasons for this influx of investors is that, for example, private equity firms are usually interested in already established and successful companies with a proven business model rather than early-stage startups.
These institutional investors fund the company with large amounts of money, expecting to secure their positions as business leaders and not miss out on good business opportunities.
The average amount of money raised in series C funding was $59 million in 2020 and the average pre-money valuation of a startup was around $68 million in 2022.
| Funding amount | Startup valuation | |
|---|---|---|
| Seed | $500,000 - $2,000,000 | $3,000,000 - $6,000,000 |
| Series A | ~$23,000,000 | ~$24,000,000 |
| Series B | ~$33,000,000 | ~$40,000,000 |
| Series C | ~$59,000,000 | ~$68,000,000 |
Initial public offering (IPO)
Initial public offering refers to a private company's shares going public in the stock market. That way, any investor can buy shares and contribute to raising money for the company.
Usually, startups go through 3 seed funding rounds before completing an IPO.
Most companies finish their journey to IPO on the series C funding round, but some companies proceed to series D, E, F funding and more to grow further. Series D funding is a continuation of series C that entails more money. The same applies to series E, F, and others.
Other startup funding types
Other startup funding types include crowdfunding and loans.
Crowdfunding mostly refers to the collective fundraising of family, friends, customers, and supporters. This method is primarily done via social media. It's generally used when the startup struggles to raise money from other institutional investors.
Loans mostly refer to bank loans. However, it's not as attractive to founders because a bank loan must be returned no matter the fate of the startup.
For example, if you're funded by a VC firm, you won't have the obligation to return the money if the business fails. Instead, you'll be giving up some of the equity in case of success.
Startup funding sources
To sum up, here is a list of startup funding sources:
- Own money;
- Angel investors;
- Venture capital firms;
- Private equity investors;
- Hedge funds;
- Investment banks;
- Crowdfunding;
- Loans.
Summary
Startup companies go through 4 main funding rounds: seed, series A, series B, and series C. After that, they can reach an IPO and be listed on the public stock exchange so any investors can contribute to raising capital.
Each round comes with progressively more money. In the early stages of a startup, angel investors may fund the company, and in the later stages, venture capital firms, private equity investors, and other financial institutions may join the list of investors.
Frequently asked questions
How do funding rounds work?
Funding rounds are based on the startup's funding valuation, competitive advantage, cash flow, business strategy, and other metrics. Each funding round offers progressively more money and requires a higher startup valuation.
How many rounds of funding are required before IPO?
Typically, startups undergo 4 rounds of funding: seed, series A, series B, and series C before reaching IPO. However, companies can seek further funding of series D, series E, and so on.
How many rounds of funding can a startup take?
A startup can take unlimited funding rounds.
How many rounds of funding is normal?
The standard number of funding rounds is 4: seed, series A, series B, and series C.
What is a SAFE investment round?
SAFE investments refer to guaranteeing a proportionate amount of company equity in exchange for funding.
