Startup technology companies face many operational, sales and financial challenges as they attempt to grow and scale the organization. Often, one of the most challenging and confusing aspects of growth is the fundraising process. However, understanding the different stages of fundraising, the sources of those funds and the uses of the funds is critical to both the short- and long-term survival. Below are the stages of fundraising a typical technology company will navigate throughout its life cycle.
At this stage, the company is seeking the basic funding to develop the initial business concept or prototypes of its product or service. The company is not generating revenue; the focus is entirely on product and service development. Pre-seed capital may come from bootstrapping, friends and family, angel investors or startup accelerator programs.
Friends and family contribute approximately $60 billion to early stage companies each year, or three times more than venture capital, state economic development funds and angels combined according to the Angel Capital Education Foundation.
Angels are accredited investors who have created personal wealth in their business affairs and have a level of sophistication and experience with start-up technology companies to understand and accept the associated risks.
Accelerator programs often provide capital, mentorship and space for the company to develop its products and services.
Companies at this early stage must explore many potential sources of funding to provide adequate capital.
Once a company has obtained pre-seed capital to develop the initial product or service, additional seed capital is required to more fully develop the product, identify the appropriate markets, execute initial customer acquisition strategies and attract the talent necessary to execute these initiatives. Seed capital is generally provided by angel investors, super angels, angel groups and early stage venture capital firms.
Super angels are accredited investors who may invest relatively large amounts in a technology start-up, generally $500,000 to $1 million.
Angel groups are comprised of large numbers of angel investors who function similar to a venture capital fund by providing professional management in the investment process. These groups create deal flow and due diligence committees. They also provide investors with the ability to analyze a larger number of potential investment opportunities and spread the investment risk across the entire group or a subset of the group. These groups also provide early stage technology companies with exposure to a larger number of investors, which reduces the difficult and time-consuming task of finding individual angel investors.
Early stage venture capital firms represent a segment of the venture capital funds who function like angel investors and provide venture capital funding at lower amounts within the venture capital spectrum.
Once a company has figured out its product or service, researched the size of the market, identified potential opportunities to scale, and is ready to develop distribution systems and sales and marketing strategies, it’s time to seek more significant sources of capital to fuel these initiatives. This is the point where the company needs to engage with venture capital firms to provide the first institutional round of growth funding, known as a Series A.
Finding the appropriate venture capital firm entails a painstaking process to identify firms that understand a company’s particular product or service, and are interested in making investments in specific industries or technologies. These firms should have the background and experience to assist management with the variety of issues that come with growth and scale. They also should be able to facilitate introductions to others within their network that can help the company grow.
Typical Series A funding rounds usually take the form of preferred stock or units and may range from several million dollars to $10 million. In return, the venture capital firm may own 15% to 30% of the company’s stock or units. The terms of a Series A round can be complex and the negotiation of a term sheet must involve the services of legal and accounting advisors who have the depth of experience to guide the entrepreneur through this process.
Often referred to as the Series B stage, companies are more mature — having fully developed their products and services and established customer relationships and revenue streams. Companies at this stage have solidified their product and customer acquisition costs and now require capital to fuel the explosive growth that can lead them to an exit event.
Often, the venture firms that participate in the Series A round are also participants in the Series B round, but may or may not lead that round. In many cases, this may be the last round of funding required before a company positions itself for a potential exit or liquidity event. As with Series A funding, the terms of a Series B funding can be complex as the company’s capitalization table includes multiple types of investors, each with different rights and privileges associated with their stock ownership.
Capital fundraising for early stage technology companies is a highly complex process that requires significant time investments and rigorous planning. Collaborate early with your experienced legal and accounting professionals to help guide you to and through successful funding events.
Contact Dennis Grady at dgrady@cohencpa.com, Kaitlin Mansfield at kmansfield@cohencpa.com or a member of your service team to discuss this topic further.
Cohen & Company is not rendering legal, accounting or other professional advice. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts and circumstances.