Occasionally, a business comes along that generates cash like an engine, enabling its owners to grow it freely and achieve their wildest plans – product diversification, geographical expansion, or a stock market float – without the aid of money from external investors. But these firms are increasingly rare. Even the most successful Silicon Valley cash cows, Google, Facebook and Amazon among them, all received funding from business angels and institutions on their way to initial public offering (IPO).
So, the chances are that your business will require a cash injection at some point during the various stages of its growth. When that time comes, you will be faced with a lot of confusing jargon relating to the type of funding you require. Seed, Series A, and IPO all mean different things and – although in some cases the difference between them is subjective – you’ll be expected to understand the basic principles that underpin each (at the very least).
To help, here’s our breakdown of the main start-up funding rounds that you can expect to go through on your way to business success.
What are the different stages of start-up funding?
It might seem like splitting hairs, but some analysts point to the existence of a funding round that pre-dates the seed stage. ‘Pre-seed’, as the term suggests, comes at the very beginning of your busines journey and generally applies to people unable to fund the earliest costs of starting a business by themselves.
These are costs including incorporating your business, researching the market, developing the concept, travel, meetings and perhaps a few discretionary purchases along the way.
At this stage, your business is little more than an idea floating around in your brain, so it’s unlikely that angel investors or institutions will back you. In fact, most people skip this funding step altogether, and instead draw down savings or siphon off part of their salary into the research phase before they quit to become an entrepreneur.
For the small group requiring outside investment at this stage, the primary sources are usually friends and family: people who believe in you and don’t need to see an airtight business plan in order to offer you some financial support.
Seed funding is widely considered the first round of ‘real’ investment. As the name suggests, it generally happens when companies are very small and require money to move into an initial phase of fast growth.
Companies going after seed funding will have laid down the foundations of their business (team, product, operations), but are yet to make a sale.
At this stage, you should have a proof of concept and a minimum viable product, a launch team incorporating the founders plus, perhaps, any key employees, and a marketing strategy to achieve the growth the funding will help you achieve.
There are no hard and fast limits on how much businesses can raise during the seed round, but generally speaking the range might be between £10,000 and £1 million. Because the investments are smaller and higher risk, investors will usually be business angels (high net worth individuals) and people using crowdfunding platforms, rather than institutions.
In the UK, popular angel groups include private investor clubs like Angels’ Den, fintech businesses connecting investors to scale-up companies like Envestors and tech mentorship organisations, including Nova.
Some start-ups try their luck in the crowdfunding market, by pitching their business to large groups of everyday investors. This can yield a better deal, but creating the marketing materials (videos, images, descriptions, updates, and inducements) can take time and effort.
It pays to shop around at this stage, in particular, because every investor has a different view of your product, its potential and their desired return or outcome. The perceived value of your business will vary from person to person; as will the experience and expertise of the investor – as well as the time they are prepared to commit to supporting your business beyond the money in their pocket.
Your business is a high risk prospect because it has yet to prove itself in the market, so expect to relinquish a sizeable chunk of equity; anything from 10-50% is normal, but it’s important to retain as much of the pie as possible, especially if you are planning future funding rounds which will dilute your shareholding further.
Series A to C
Beyond seed funding are the alphabet rounds: A, B, C and so on. These letters represent successive rounds of funding that are stepping stones to ever-greater scale. As you would expect, a Series C round is usually a more valuable investment in bigger businesses than Series A.
Theoretically, there is no limit to the number of these rounds a business can apply for, but at some point – perhaps from D onwards – investors might become sceptical as to whether the business will ever be able to stand on its own two feet without outside funding. This will inevitably cause a few question marks over its viability in the market.
One thing these funding rounds have in common is the profile of participating investors: generally larger institutions involved in venture capital, banking and private equity. As the amounts grow, the capacity for private individuals to get involved ebbs away.
With the introduction of professional investors comes a more structured approach. Institutions employ teams of analysts who will compare your business to industry key performance indicators (KPIs), profit margins, customer base, market penetration, risk factors and so on.
They want an advanced level of insight backed up by proofs. Most will conduct some level of due diligence, a process which involves accessing company records and other data to better understand the opportunity on offer as well as any potential banana skins.
While there is no hard and fast distinction between series A and B, or B and C, the following provides the basic premise of each stage:
Series A funding
- Your business will have developed a base of customers and be able to demonstrate increasing reach – almost always revenue too.
- You have a business model/plan for long-term growth and profitability.
- The average amounts raised varies hugely – anywhere from £1 million to £30 million depending on the need and the market potential.
- At this stage, investors are looking beyond ideas and assessing performance.
- They may also work together on investments, meaning you receive money from more than one venture capital firm, individual and banking partner.
- In a growing number of cases, companies will use crowdfunding platforms and business angels as part of the funding round.
- Venture capital companies operating in the UK at the Series A level include: Fuel Ventures, Accel, Index Ventures and Albion Capital.
Series B funding
- Companies looking for Series B funding are established and focused on market growth as well as geographical expansion.
- Other reasons for securing Series B funding include investing in infrastructure and personnel to meet demand for a product or service.
- You may also need to spend money on marketing, business development capacity and bigger premises costs, for example.
- Series B are a step up in value from Series A, with most companies hoping to raise between £20 million and £50 million.
- As in the case of Series A, in many cases funding rounds will be led by an ‘anchor investor’ who attracts other entities to join the round.
- Expect to deal with later-stage growth investors, including private equity firms and bigger institutions, with the likes of: Long Ridge Equity Partners, Deutsche Bank, BGF and Eurazeo Growth.
- Even at this level, many companies choose to go the crowdfunding route if their funding target is at the smaller end of the scale. In September 2020 fintech company Chip raised £10.7 million Series B funding on Crowdcube.
Series C funding
- Businesses entering a Series C funding round will have a strong track record of growth and, almost always, a series number of sales in their market.
- They have probably established a national base and expanded into new territories.
- Often the funding will be required to launch a new product or service or change direction to take advantage of an emerging trend or opportunity.
- It might also be needed to acquire a rival business.
- Because Series C companies are larger and more established, their risk profile is lower and they will attract large banking, hedge fund and private equity institutions.
- These include retail banks like Lloyds, Barclays and HSBC as well as Evolution Equity, Novo Holdings and FTV Capital.
- Some companies go on to raise Series D funding and beyond, but a more popular way to attract investors at this stage is to list your business on the stock market with an IPO.
An initial public offering, or IPO, is the name given to the moment a company debuts on a stock market, allowing investors from all over the world to buy shares in the company.
These can be private individuals, banks or institutions like pension funds, insurance companies and even large corporate businesses not in the finance industry but which have developed their own investment arm.
Companies that list on the stock market are typically large and complex, although their exist markets for smaller businesses – such as the Alternative Investment Market (AIM) – that want the benefits of an IPO before they reach full scale.
The influx of cash that comes with an IPO can go towards growth, acquisition or simply paying off debt. Once they have floated, companies can offer their shares as an incentive to attract senior recruits or as a part-payment method for companies they want to buy.
This is one stage where the earlier investors, as well as the founders and shareholding employees, can see a return on their investment. Investors buy shares at IPO in the hope that their value will increase quickly and some of their money will go towards inflating the bank accounts of the top team.
There are downsides to an IPO, however. One is that it’s an arduous process filled with due diligence and compliance measures that inevitably distract the top team from core business needs.
Another is that they will have to accept new board members who collectively have the power to fire bosses they believe are not serving shareholders’ interests.
There are ongoing compliance measures and legal responsibilities which listed firms must follow. Directors can face criminal investigations if they fail to do so. In fact, the operational requirements of the business change dramatically once it is listed and some founders regret their decision to go public.
For teams who still want to press on with an IPO, there are a few steps to take care of before you float:
Broker and corporate finance team
A banking partner is required to sell your shares to other investors and financial institutions. They charge a percentage of the IPO’s value as a fee.
This will involve rounds of due diligence and the filing of legal papers by your corporate solicitor. The process is necessary to prevent fraud and to protect money invested by individuals against exaggerated claims by the business intending to IPO.
Pricing your shares is an essential step in the listing process. If the valuation of your business is inflated, your IPO will fall flat due to a lack of demand; but price too low and you’ll miss out on a valuable influx of cash, which will instead slip into the pockets of IPO investors.
People need to know about your intention to float on the stock market, so businesses undertake a ‘roadshow’ circuit of potential investors to promote the event. The plan is to drum up enthusiasm for your stock and ensure a busy first day on the market.
At the moment a business floats, people can start trading its shares. This is a nail-biting period for everyone concerned because no one is completely sure what will happen to share price on day one. In 2019, Saudi state oil company Aramco’s share price lifted 10% on its first day; but the year before, music platform Spotify lost 10.2% during the same timeframe.
Financing your business can be a tricky process, especially when you’re seeking the support of an investor. Whatever stage you’re at in terms of funding rounds and your business’ growth, our team of solicitors specialise in supporting start-ups and scale-ups in all aspects of their legal requirements, from writing investment agreements to advice on stakeholder split, to intellectual property rights, commercial contracts, employment law and beyond.