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I have worked closely with startup founders and entrepreneurs alike — here are the main steps in the startup funding stages. Whether you a seasoned entrepreneur or an inspired side hustler, there is something to be learned about how startups get funded here.
5 Stages of Startup Funding in 2020
Need help understanding differences in startup financing stages? These are the 5 startup funding stages required for a startup to become an established business.
1) Seed Capital
|Be in the Know: What is Seed Capital? Seed capital is the initial funding used to begin creating a business or a new product. Obtaining seed capital is the first funding stage required for a startup to become an established business (Investopedia).|
If you have a killer business idea or want to develop a product or service — what do you need? Well first the idea, but then money to fund your idea.
There are different routes used to get the cash required:
- Personal Loans
- Cash Advances
- SBA Loans
- Crowdsourcing platforms
- Personal Savings
- Liquidating Retirement Accounts
- Acquaintances (Friends and Family)
The most obvious one is taking a business loan or a personal loan. Typically you won't qualify for a business loan because most lenders require at least 1 year in experience and positive business financial bank statements. Many people resort to taking out small personal loans up to 100K to fund their idea. Here are some of the most popular lenders for 2020:
|$1,000 to $100,000||4.99% to 35.99%|
|$1,000 to $50,000||3.99% - 35.99%|
|$1,000 to $50,000||7.99% - 35.89%|
|$1,000 to $100,000||3.84% - 35.99%|
|$2,000 to $40,000||6.95% - 35.99%|
Also, seed capital can be received as a loan on in exchange for common stock for your startup.
2) Angel Investor Funding
Since seed capital is sometimes limited, it is often necessary for you to reach out (or mingle) with individuals who may be able to invest in your idea — this is often called an “Angel” investor.
According to Ralph Kroman of WeirFoulds LLP, the typical angel investor:
- Has an income that exceeds $100K
- Is 40 – 60 years old
- Has a net worth in excess of $1,000,000
- Has previous successful entrepreneurial experience
- Expects to hold on the investment for up to five to seven years (although some angels wish to “cash out” after only a few years)
- Enjoys advising the entrepreneur and likes to be part of the action
- Invests up to $150,000 but may participate in a syndicate of other angel investors bringing the total investment to multiples of individual investments
- Refers deals to other private investors even if the angel has chosen not to invest
- Likes to invest in an industry with which the angel is familiar
- Sources deals through referrals
But how can you find an angel investor? This can be done numerous ways, some ideas that I would recommend are using Linkedin, going to various business and trade organizations, check out local startup Facebook groups, and plain old networking. Get out of your house and get active, shake as many hands as you can and make sure you have your business cards handy.
If you happen to find an angel investor who is in love with your idea — they have the option of providing you with a loan that is convertible to preferred stock. Note, I mention that it was convertible, when can it convert?
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Usually, it converts to the Series A round of stock which we will discuss next.
Friends and Family investors sometimes choose to participate in this “Angel Round” of financing.
3) Venture Capital Financing (Series A, Series B, Series C Rounds, etc.)
Have you seen Sharktank episodes where Marc Cuban brings up terms like Series A, Series B, etc?
They are referring to different rounds of Venture capital (VC) funding and each round is given a letter of the alphabet (A, then B, then C, etc.)
According to Startsups.com, “Venture capital is a great option for startups that are looking to scale big — and quickly. Because the investments are fairly large, your startup has to be prepared to take that money and grow.”
However, you can use VC funding even if your company isn't profitable — usually to offset negative cash flow issues.
These funding rounds of Series A, Series B, Series C and so on provide outside investors the opportunity to invest cash in a growing company in exchange for equity, or partial ownership of that company.
In the case of Shark Tank, when the sharks invest they can also offer much more than money — such as resources, connections, and much more to help increase sales and marketing efforts.
4) Mezzanine Financing & Business Loans
At this stage in the startup funding stages — your company may be interested in acquiring additional funds for further growth.
This can be done by offering an IPO (initial public offering), a management buyout, business loans, or an acquisition of a competitor.
Mezzanine financing is a hybrid of debt and equity financing that gives the lender the right to convert to an equity interest in the company in case of default, generally, after venture capital companies and other senior lenders are paid (Investopedia).
A business loan is a loan specifically intended for business purposes. As with all loans, it involves the creation of a debt, which will be repaid with added interest. Business loans have a lot of positive aspects. Here are the pros of business loans for your startup.
Multiple options: Business loans have a lot of options for different types of borrowers to meet different business needs. Business loans can be secured, unsecured, payday, SBA loans and of many other types. Also, business loans can be commercial and non-commercial. As a borrower, you have a variety of choices to take on business loans that suit your needs.
Low-interest rates: Business loans generally offer lower interest rates. Though business loans vary from each other, you will be able to secure a higher loan amount with lower interest rates if you have a good personal credit score, positive cash flow in your business, and have positive trade account lines.
Tax-deductible: One of the best reasons for taking a business loan is it is you are able to take tax deductions from it. If you make the repayment timely and accordingly then you can deduct this on your taxes.
However, business loans do also have some downsides. Here you get to know the cons of business loans for your startup.
The lengthy application process: While applying for a business loan, you may face a lot of hiccups in the process because lenders sometimes can require a lengthy process filled with paperwork. This is common though — and there are some lenders that expedite the process and can fund your business loan in 1 to 2 days. Each business lender has its own requirements so it's important to shop around for the best small business loans.
Qualifying for a business loan: It can be difficult to qualify for a business loan. The banks require a lot of things to lend you a business loan. You will have to submit papers of income, job, credit report and other papers to the bank and if the bank is satisfied with the qualifications of yours, you will get the loan, otherwise not.
Risk: Taking a business loan is sometimes risky. You may lose your assets if you fail to repay the loans. In fact, you may lose your business and even file bankruptcy in cases of failure of the repayment.
Collateral: Business loans generally require collateral as security. And you may have lost the asset if you are in a problem in times of repayment. If you fail to pay back a business loan you are at risk of losing your business, home, assets and even may have to file for bankruptcy. So, you have to be very careful when applying for a business loan.
Overall, if you are applying for a small business line of credit, most lenders will evaluate your business bank statements, business credit reports, and personal credit reports. If you are applying for a line of credit over 100K, then you should know the basic financials about your company. If your company isn't profitable or does not have a strong bank statement then this would lessen your chances of approval.
Additionally, if you have a poor personal credit history, that is something that would really be taken into consideration. Just know that even if your small business did poorly in during the financial crisis or you have had a bankruptcy in the past, you can still get extended a small business line of credit. Overall, it's important that your recent statements and credit history are positive.
5) IPO (Initial Public Offering)
If your company gets to the point where an Initial public offering or stock market launch is necessary then that's a great sign of tremendous growth. An IPO is a type of public offering in which shares of a company are sold to institutional investors and usually also retail investors; an IPO is underwritten by one or more investment banks, who also arrange for the shares to be listed on one or more stock exchanges.
Once the stock is out, it is traded through the stock exchange and can be purchased by the public. Companies can offer more of their stock through additional offerings as well.