Startups are often in a capital raising mode, maybe every year or two, and sometimes more often. There are a number of different paths available, each with distinct trade-offs. Funding requirements, cost, and timing can all drive the capital raising decisions. What are the different options and which ones make the most sense? How should an executive team or owner evaluate the various opportunities?
There are generally four types of capital available to startups: angel investors; venture capital; venture debt; and in certain situations, private equity.
Angel Investors. Companies that finalized the initial business concept and products, and are pre-revenue with test customers, are often targeting a seed round of funding from angel investors. The typical investment can range from $25k – $100k per individual. Angel investors will often join together in a syndicate to fund a round, increasing the proceeds for the company while diversifying the risk for the individual investors. A total round in this example can range from $100k up to $2-3 million. While every situation is different, angel investors are often looking for 10-25% ownership of the company.
Venture Capital. Once a business is scaling its products, services, customers, and revenue, and before it is profitable, it may make sense to access venture capital. While angel funding is provided by individual investors, VCs raise institutional funds and allocate the capital to a series of prioritized investments. The amount raised and deployed is significantly higher than the seed round. The Series A, B, and C rounds are typically $5m, $10m, and $15-20m, respectively, buy can vary based on the company and the opportunity. In terms of ownership provided to investors, Series A round participants may receive 25-50% of the company and approximately one third can go to the Series B round investors. Venture Capital firms typically require board seats and structure the investment as a preferred stock with accrued dividends and with a priority over the existing common shares.
Venture Debt. Traditional bank debt is not available to most startups due to the lack of tangible assets and cash flow. However, venture debt is often an option that companies can access between Series A, B, and C rounds. Venture debt extends the cash runway of prior equity rounds in order to complete additional milestones, such as launching new products or upgrading and scaling internal systems. By completing these additional milestones, it allows the company to issue the next round of equity at a higher valuation, and a lower cost to existing owners. Venture debt is generally non-dilutive, or lightly dilutive through the issue of warrants. Structures vary from a term loan, to a revolver, to a repayment schedule that is a fixed percentage of each month’s revenue. Proceeds can range from $100k to the low millions and are often sized as a percentage (25% – 50%) of the most recently completed equity round.
Private Equity. Traditionally, private equity firms take control positions in mid to late-stage profitable companies. While PE investors can provide an alternative exit route for venture capital investors, we also see private equity investors making minority investments in early to mid-stage technology companies. This can be a good fit for owners and management teams that want to add credibility by having an established investor in their capital structure. Companies may benefit from a partnership that can help scale the business, while at the same time maintaining overall control of the company. If a management team is interested in raising $2 – $5m in a single round and focusing on profitable growth over a longer time horizon, while retaining a higher ownership of the company, then certain PE investors may be a good fit.
Raising capital can be a challenge for early stage companies. Finding the right investor based on the required amount of capital, stage of the company, and ownership objectives, can have a significant impact on the future success of the company. Understanding where the business is in the capital raising lifecycle, and the management team’s specific financing goals, can lead to a great fit between the company and investors, and a positive trajectory for the future of the business.
About the Author: Jeff O’Brien is President and Founder of Fusion Finance. The company provides corporate finance advisory services to clients in the technology, media and telecommunications sectors. Learn more at fusionfinance.com.