If you have or intend to found a startup for the first time, you need to pay close attention to how, when, and why you raise funding. Your financial needs will differ significantly from other new, small businesses.
Small businesses are those that utilize a well-known business model and seek long-term profitability. Small businesses can generate profit from day one, according to Forbes. Startups differ in that you attempt to use a new business model and disrupt an industry. A startup will not be profitable right away, which is why it needs multiple injections of capital over time. By seeking additional investments during your business’ early years, you gain the financial resources you need to hire more employees, purchase more inventory, upgrade or expand your equipment, reach additional markets, and much more. Every round of financing has the potential to help your startup grow exponentially.
When you consider founding a startup, or you’ve already gotten started based on seed money, you need to find an experienced attorney to work with. There are many business and transactional attorneys who focus on startups. “Entrepreneurs, it’s been my experience, typically don’t have a very good understanding of the federal and state securities laws,” says J. Fred Kingren, a Business and Finance attorney at Hand Arendall. “Securities laws are pretty complex and the repercussions of non-compliance are pretty serious and they could even include rescission of the deal, which of course would be pretty extensive and devastating to a startup.” They can ensure you follow all federal regulations in relation to your finances. They also can offer you business advice and insights derived from their years of experience.
Your first investment is your seed money, which could be your savings, gifts or loans from family and friends, or more formal loans or investments. Some startups intentionally raise seed money from high-net-worth investors, according to Justin Kan, entrepreneur and founder of Twitch. The amount of seed money can range drastically from several thousand to millions of dollars, depending on your business idea and your business’s potential value. Ryan Law, editor of the SaaS Growth Blog, writes that there are huge variances in seed funding, though the average funding amount was $1.7 million in 2015 by angel investors, early state venture capitalist funds, and startup accelerators.
This seed money is intended to get your business off the ground. You have your idea, and now you have a bit of money to start making that idea a reality. Your seed money helps you solidify your product or service, create a strong business plan, form your founding team (whether that is with cofounders or early employees), figure out your target demographic, research your market, and create a product or service if needed and enter the market. In reality, it may be what enables you to quit your day job and focus on starting this new venture.
Series A Investment
Within a few months or a year, you should have more than a general idea. You should have a product or service, a defined goal, and market and demographic knowledge. You may have already begun to sell your product or service or have developed a strong plan for how you will enter the market and reach your target audience.
Kan advises you are ready for Series A funding when:
- You have a strong team in place
- Your business has strong metrics and is growing rapidly
- You are in an industry/sector that can support a company worth millions
Series A investments, which may be your first round of investments if your seed money was your own, help you make more of your product or offer more of your service, become more efficient, cover unforeseen expenses, hire more people, and improve your market reach or enter new markets.
Series A is a formal investment round since you are looking to raise millions of dollars. According to Kan, a typical venture capitalist-led Series A is for five to 10 million. You also may pursue financial backing through loans, grants, angel investors, and/or crowdfunding, though Law states venture capitalists dominate Series A investing.
Series B Investment
Once your startup is truly up and running—which means your product or service is out there, you have strong marketing efforts, and people are buying what you’re selling—then it is time to consider what you could do with more money. Series B investments usually occur when your business is turning a profit, has a high valuation, and can attract venture capitalists and private equity investors to raise additional millions. In 2015, the average Series B funding amount was $24.9 million, and business values were typically between $30 and $60 million, Law reported.
Series B is all about scaling up. You may need to build an even larger and better team. By gaining more investments, you can offer strong compensation packages and hire additional developers, account managers, marketers, and customer service professionals. Additional capital can help you reach more markets. For instance, if your startup’s service launched in Denver, you may wish to expand to other cities, like Seattle, Portland, Los Angeles, or San Francisco. In some situations, Series B investments are used to purchased other businesses. By gaining the other business’s employees, inventory, processes, or intellectual property, your startup may gain a competitive advantage.
Additional Rounds of Investments
You can theoretically have as many rounds of investments as you want, however it is rare to go beyond Series C, which is often used for significant expansions or acquisitions. Too many rounds of investments can look like you aren’t managing your money well or the business isn’t profitable. At a certain point, the business should make money and stand on its own feet.
Whether you’re interested in founding a new business or have begun, always work with an experienced attorney. There are many federal regulations you must follow in regard to financing a startup, including the Securities Act, Regulation D, Regulation A, and more. An experienced lawyer will ensure you avoid violating federal law. A startup attorney can also guide you in forming your company and negotiating contracts with co-founders and employees.