What are the different types of funding rounds?
Finance is essential to the success of a new company. But if you are unfamiliar with words like seed, pre-seed, and series funding, it can be a confusing topic.
Once you know the basics of the different types of funding rounds, it's much easier to decide which stage your business is at. That way, you can understand which round of funding you need and how to start raising it.
It's also good to have an overall idea of what kind of startup funding rounds you will use in the future, so that you can ensure to keep close control of how much equity you sell off to investors.
Finance can come from anywhere at any time — if your business is going well, don't be surprised to receive expressions of interest from investors who want a piece of it.
You don't have to accept those offers. Still, it's worth considering every offer you receive, as you could gain the expertise of an experienced investor in your chosen industry in return for an equity stake.
At other times, you might want to raise funds with new investors to help get your business model past a specific stage in its development.
This is where rounds of funding are used, and depending on what stage your business is at, the main types of funding rounds are slightly different.
Pre-seed funding is one of the first financing options startup companies use to start developing ideas into saleable products. It doesn't have to come from institutional investors, such as venture capital firms.
In many cases, pre-seed funding comes from friends and family who want to support an early-stage business ambition.
One example of this is the $1,000 loaned by Peter Buck to Fred DeLuca in 1965, to set up what would eventually become the restaurant chain Subway.
To this day, Subway's parent company is named Doctor's Associates Inc. in reference to Buck's work as a nuclear physicist.
Over 50 years later, there are several different places to find pre-seed funding, ranging from new business startup accelerators to peer-to-peer lending platforms.
Pre-seed funding is usually for a smaller amount of money, and the loan might be relatively short-term if you plan to spend it on setup costs and turn enough profit to pay it back within a year or less.
Seed funding is usually the next stage after pre-seed funding. If you paid your first costs out of personal savings, seed funding might be the first time you look for finance from external investors.
At this stage, you are usually looking to scale up to full market production and product development will be complete. You might have previously had a prototype or a limited manufacturing run as proof of concept.
By the time you hold a seed funding round, your concept should be ready to go. The funding might be to cover larger costs, like a full-scale manufacturing run, to meet a large order you have received.
Seed capital is more likely to come from institutional investors rather than from friends and family.
The loans may last longer — well over a year in some cases — and larger amounts of equity can change hands too.
You might be looking to raise hundreds of thousands of dollars, depending on the valuation of your company and the costs you need to cover.
Find out more here: What's the difference between pre-seed and seed funding rounds?
Moving on to series funding means you are preparing for large scale growth. Investors at this stage will usually expect to start seeing a return quite quickly, often within a year.
Seed funding is about setting up, but series funding is about scaling up. You should have already worked over the kinks and solved any teething problems your business might have.
By this stage, all market research should be completed, and you should have a finished product or service should be ready for public sale.
Series funding is used to cover the costs of growth. That can include marketing your product to a wider customer base, moving into new territories, and even to launch internationally.
You are not limited to one round of series funding. It's common to offer up to three rounds of investment, and sometimes a fourth and fifth round too.
Rounds of series funding
The first round of series funding is Series A. This might even be the first time you take external investment into your business if you put up the seed finance from your own money.
Venture capitalists who invest at this stage will expect to receive Series A preferred stock or equivalent, giving them a preferred equity stake in return for their support.
Series B round and Series C funding rounds are common to raise more money later on. These again might be to cover specific costs such as launching a second product for the first time or expanding into new markets.
Although Series D and Series E funding rounds sometimes take place, they are less common. By this stage, if your business is successful, it should be well established and raising finance in this way is usually not necessary.
Which funding round is best for my business?
Deciding which round of financing you want to start with can make a big difference in the early days of a new business plan or venture.
If all you have is a good idea, pre-seed funding is the way to cover those initial setup costs, proof of concept, and hiring a team to make your concept into a reality.
If you already have a prototype that could be mass-produced, seed funding could be a better option. You'll need to present a strong business case to your investors, but it's a way to get off the ground if you're ready to begin.
Jumping straight to Series A funding is a big commitment. The money involved is larger, and investors will expect more return in the short term.
Let your business valuation guide you and make the most of any expertise on offer from experienced investors, who can help you to build your business so that everybody's equity rises in value.
Learn out more about Startup Valuations from Brex's CFO Michael Tannenbaum in Episode 15 of Brex in the Black.