Startup Funding Stages: What Every First-Time Investor Needs to Know

Posted by Adam Haider on Oct 07, 2020 08:08: AM
Adam Haider

Most--if not, all--startups would include in their credentials what funding round are they at. Unfortunately, this is something that most first-time startup investors don't understand.

In this blog post, we will explain what are the different startup funding stages and provide examples of these startups.

7 Startup Funding Stages in the UK

 

1. Pre-Seed Startup Funding Stage

This is the first round of funding every new startup goes through. It’s called ‘pre-seed’ because the funds they gathered here are those that came from the savings of the startup founders, their relatives, and even their friends.

Receiving funding from family and friends (FF) is common for those who are still starting up. This kind of financing is the most accessible form of funding since they (FF) are unlikely to question the startup’s valuation or grill the founders about the details of their business plan.

Another advantage of self-financing a business is that it gives the owner(s) much more control than other finance options. This also means that they don’t rely on outside investors, who could decide to withdraw their support anytime.

Though self-financing a startup is advantageous, it also has its risks. One of which is that family and friends (FF) initially expect a return, and the startup might haven’t even started generating revenues yet. The only way to control this risk is through clear communication and setting transparent expectations from the start.

Furthermore, the business is at a disadvantage since startups who receive outside investments also receive mentoring and networking opportunities. But to those who are bootstrapping their business, they will have to develop their own contacts and mentoring opportunities.

2. Early Stage Startup

Seed funding is the first official round of funding startup founders receive from investors.

In this startup funding stage, the founders attempt to pool, on average, £1.5M to finance their startup. It’s also called the “seed stage” because the funds used here are primarily used to primarily fund the activities associated with building and launching their startups. These include conducting market research to determine what its Minimum Viable Product (MVP) will be, and cementing their ideal customer profile.

In exchange for investing in their startup, the founders will reward startup investors with preferred stocks, convertible notes, or equity in the startup.

Seed-stage startup examples:

Insurwave

Insurwave Image

 

Insurwave, a SaaS platform for the entire insurance ecosystem, serving multinational companies with complex insurance needs. They use leading cloud and cryptography technologies to make the distance between corporate risk and insurance capital less.

It enables the elimination of tedious reconciliation, and also allows high data integrity and greater insight for insurance buyers, brokers, underwriters and reinsurers of complex risk—a startup in its early stage financing, which received £5M funding last September.

Psykhe

Psykhe Image
 
Psykhe is a fashion e-commerce platform powered by machine learning and personality science. It received about £2M last September as well.
 

Investors who invest in early-stage startups have the advantage of potential bigger returns as they get the chance to buy in early at a low price per share that has lots of opportunity for growth.

But they take on more risks, such as unproved product, market and, sometimes, team. They also take on the risk of dilution if they don’t participate in follow-on rounds - VCs can negotiate “pro rata rights” into deals, alongside board seats etc., that give them the right to invest in subsequent rounds and however, mitigate the risk.

3. Series A Startup

Suppose the startup has finally developed a track record (established user base, consistent revenue figures, or some other key performance indicator). In that case, it may proceed to Series A funding round to further optimise its user base and product offerings. In this stage, it is vital to have a plan that will undoubtedly generate long-term profit.

Typically in Series A funding, startups can raise approximately £2 Million to £12 Million, but these numbers have increased due to high-tech industry valuations. The average funding in Series A as of 2020 is £12.3 Million.

In this funding stage, investors look not just after companies with great ideas, but also, companies whose founders have well-planned strategy, knowledge and skill that will eventually turn their ideas into a thriving, money-making business.

Series A startup examples:

Spoon Guru

Spoon Gure Image
 

Spoon Guru is a London based global AI nutrition technology startup that developed a Health & Wellness platform to cater to individuals with specific dietary food requirements or health objectives.

A world-leading end-to-end solution, Spoon Guru combined AI and machine-learning with nutritional expertise to allow food retailers to deliver a personalised experience tailored to each customer, based on their distinct and unique dietary, health and wellness needs.

The platform processes billions of data points daily and studies every ingredient as well as its nutritional value to designate the appropriate dietary tags to each product or recipe, enabling large and disorganised data sets to be easily searched and accurately filtered to deliver suitable choices.

Acin

Acin Image

 

Acin is a market-defining fintech company that is on a mission to make banks more reliable and reconstruct the financial industry’s approach to non-financial risk through the use of data. And a startup in its Series A funding stage, which secured about $12M as of September 2020.

Investing in Series A is very risky since startups under this funding stage are still optimising and developing their product or service. But they have the same advantages as seed-stage startups for the investors.

4. Series B Startup

Startups that have gone through from Seed to Series A funding round have already developed their substantial user bases and have already proven that they can reach success on a larger scale.

This round is about taking the startup to the next level by further developing the business, growing its advertising, sales, tech, support, and employees. Startups undergoing series B funding rounds are well-established, and it is reflected mostly in their valuation.

Series B startup example:

Checkout.com

Checkout Image

 

Checkout.com grants fintech companies with a cross-border payment solution for digital commerce. The company gives direct access to domestic acquiring across payment methods and geographies, including major debit and credit cards, online banking, PayPal, Apple Pay and other eWallets.

Achieved through a unified, integrated platform which also provides fraud management tools, analytics and comprehensive reporting features.

Motefee

Motefee Image

 

Moteefe is an eCommerce platform that allows anyone to sell customised merchandise through social media.

Moteefe provides a unique end-to-end e-commerce platform designed for merchants of all sizes – from individual entrepreneurs to larger retailers – to turn their brand and creative designs into globally available merchandise in minutes.

Series B appears to be quite similar to Series A since their processes and key players are a bit the same. Still, they differ with Series B’s addition of a new wave of venture capital firms that specialise in later-stage investing.

5. Series C Startups (and Beyond)

Startups that have made it to Series C funding are already quite successful. These companies seek additional funding to help them develop new products, expand their market, or to even acquire other businesses. In this funding round, investors provide capital to these successful businesses with the intention of receiving twice or thrice of that amount back.

Since the company has proven itself to have a successful business model, new investors will likely start coming to the table expecting to invest large sums of money as a means of helping to secure their position as business leaders.

In most cases, companies end their external equity funding with Series C. However, some might still proceed to Series D and even Series E rounds of funding as well. Generally, though, companies that gained up to hundreds of millions through Series C funding are already equipped to continue to improve on a global scale.

Companies that continue with Series D funding do so either because they are still in search of a final push before going public (IPO) or because they were not able to attain the goals they set out to achieve during Series C funding.

Investing in Series C and beyond has less risk as the company already has a tested product in the market, relatively good data to future project sales and plans on, and probably a well-rounded board and investors to support the team.

The disadvantage is that getting in later means higher valuation and share price, and less potential for the exponential growth seen in very early stages - so later stage investing typically produces lower returns.

The company will hopefully continue to grow and prosper and increase in value long after these later-stage investors get in, but will undoubtedly have a liquidity event, such as a trade sale, IPO or buyout, that will crystalise existing shareholders’ gains at a certain level.

6. Pre-IPO Startup

Pre-IPO is the stage in which a company undergoes before finally becoming open to the public. It is when a private company raises funds before going to the market and issuing the IPO itself.

The investors here are composed mainly of hedge funds and private equity investors who buy a stake in the company between 6 months to a year before it issues the IPO. In funding a pre-IPO startup, investors pay a much lower price for the company shares than an initial public offer (IPO) since investing in a private company has more significant risks than a publicly-traded company.

The biggest con in investment in pre-IPO startup stock is that it’s not typically liquid. That is, the value of a startup investment will not be convertible into cash until the company goes public.

On the more excellent side, more and more funding is being added to startups before they exit. As a company raises more funds at higher valuations, the value of the investment can multiply quickly over a few years.

7. IPO

Initial Public Offering or IPO is the process of offering private corporate shares to the general public for the first time. Startups that need capital for expansion and growth offer an IPO.

The awareness of the public about the company increases, which drives up its demand and the equity's valuation. With this, the company can raise more capital to develop its product further. Higher equity valuation also means lesser dilution for existing shareholders.

 

The stocks and shares of publicly-traded companies are highly liquid, which can help in acquisitions. It also allows founders and investors to sell their shares as and when they desire.

However, being open to the public means facing the added pressure of the market, which can cause the company to concentrate on short-term results rather than long-term growth. Going public also involves legal and disclosure obligations.

The business must make extensive disclosures to shareholders and regulatory bodies. The process costs a few money, and it is also very time consuming as complying to the Financial Conduct Authority's (FCA) rules and regulations involve going through stringent procedures.

Summary

Every company profiles differ with each case study, but they generally possess different risk profiles and maturity levels at each funding stage.

Thus, understanding the distinction between these stages of raising capital is vital to help you decipher startup news and evaluate prospects since the different stages of funding operate in the same manner. Hence, it sometimes confuses some.

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Although you now know a lot about startup funding stages, it is still always better to have someone knowledgeable to talk to.

You can schedule an appointment with us today, and someone will get in touch with you to answer all your other questions.