Types of Funding - A to Z of Funding for Businesses specially Startups | Starting a Startup - Entrepreneurship PDF Download

REVENUE

The most common source of financing for a new venture comes in the form of revenue from the business itself, whatever that business may be. In the case of revenue funding, a startup offers some service or product, receives money for that service or product, and uses that money to finance subsequent provision of the service or production of the product. This sort of financing has been described by terms such as: internal financing, self-funding, or even bootstrapping (the subject of a blurb in this section).

Recognizing that the daily financial dealings of a startup are one of the sources of financing is more important than it may seem.  Each and every dollar that flows into the venture through the business operations arrives with a decision: Should this dollar be used to pay salaries, buy supplies or equipment, pay dividends to the owners, invest in new opportunities, or something else?

Directing monies away from salaries, or profits, or operations, and towards new opportunities is a choice that has consequences.  It is also the sort of choice for which the terms are not altogether clear.  Nonetheless, the great majority of startups in any year find their growth capital through the daily business of the venture, rather than through outside sources.

BOOTSTRAP

Okay, I realize this isn’t actually “fundraising,” but sometimes the best funding option is not to seek funding at all, but rather to cut corners wherever you can and work on building your company from your personal savings. Besides saving you money, bootstrapping also helps you to focus on execution and build traction without outside interference. It’s also a means for avoiding dilution and yielding larger profit margins.

EQUITY

Series Seed: Figuring out the product and getting to user/product fit.

• Purpose: The purpose of the series seed is for the company to figure out the product it is building, the market it is in, and the user base. Typically, a seed round helps the company scale to a few employees past the founders and to build and launch an early product. As the product starts to get more and more users, a company will then raise a series A.
• Amounts: Typically the range is $250K-$2 million (median today of probably $750K to $1million). The high end of this range used to be more typically $1million, but we are in the inflationary period of a venture cycle, and this number may move up into the millions of dollars before we have a correction.
• Who invests: Angels, SuperAngels, and early stage VCs all invest in seed rounds.

Series A: Scaling the product and getting to a business model. (AKA getting to true product/market fit)

• Purpose: With a series A you typically have figured out your product/userbase, and need capital to:
  • Figure out or scale distribution. Your users may love your product, but you have not yet optimized all the ways to build a userbase.
  • Scale geographically or across verticals. You have a product that works in one market (e.g. it works in the Bay Area), and you want to adapt it to other markets (lets launch it across the US or globally).
  • Figure out a business model. If you are a consumer internet company, you may be getting lots of users, but may not have a clear business model that is working at this point (see e.g. Instagram).
• Amounts: Used to be $2m-$15million with a median of $3-$7 million.  Series A amounts have gone up dramatically recently to more of a $7-15million raise being typical.
• Recent examples: Uber(cab) raising from Benchmark, Instagram's raise from Benchmark
• Who invests: Your traditional venture funds (Sequoia, A16Z, Benchmark, Accel, Greylock, Battery, CRV, Matrix etc etc.). lead these rounds, leading to a pretty different dynamic relative to a seed round (more on this in another post).  Angels may co-invest with VCs in the A, but they have no power to set the pricing or impact any aspect of the round.

Series B: Scaling the business.

• Purpose:  The Series B is typically all about scaling. You have traction with users, and typically you also have a business model that has come together. If your user traction is out of control, sometimes you can raise a Series B without an existing business model, as most VCs assume you can eventually monetize large #s of eyeballs.
  • Scale your business model. You need to hire a bunch of ads sales people, enterprise sales people, or the like
  • Scale your userbase. You have a great business in the US and want to go after Europe.
  • Make acquisitions. Sometimes a Series B is raised to buy other companies.
• Amounts: Anywhere from seven million to tens of millions.
• Recent Examples: Although it was called a “series A” in the press (and probably on the financing docs), Angry Birds recent $40 million funding by Accel was more similar to a series B or C financing. The company already had great user traction and was making lots of money. For the company to scale its existing business, as well as move into new lines of business, additional capital was needed.
• Who invests:  Some series B are led by the same folks as your Series A (e.g. Square and Sequoia), but also some additional firms who specialize in later stage deals such as IVP, GVVC, Meritech, DAG, etc. start to get involved at the Series B stage.

Series C onwards: More capital to scale.

• Purpose: The Series C is often used by a company to accelerate what it is doing beyond the Series B. This may include:
  • Continue to grow fast. You know where the profits are, but you are making the tradeoff of losing money in order to win the market.
  • Go international.  Launch your business in other markets.
  • Make acquisitions. Some people raise big war chests to buy a number of other companies.
• Amounts: This can range from tens to hundreds of millions.
• Who invests: This can be driven by the folks mentioned for Series A or B (see e.g. all the early stage guys who just funded GroupOn), but often other sources of capital may invest in later rounds such as private equity firms, hedge funds, the mezzanine or late stage arms of Goldman Sachs, Morgan Stanley and other investment banks, or big secondary market firms such as DST or Tiger.

DEBT FUNDING

Debt funding is also a viable funding option. With debt funding, you borrow cash that you will have to pay back, regardless of whether or not your company is making a profit. While you may choose to incur debt (i.e. borrow cash) from friends and family, there are other kinds of debt funding you could also pursue. The most common are:

• Venture debt. In some ways this kind of debt feels a lot like equity—at least in the short term. The difference comes in the long term: at some point, you will have to repay this debt, regardless of company performance. For term loans, typically repayment terms are multi-year (with three years being the most common). Non-formula lines of credit usually have a shorter term of just one year.
• AR line (accounts receivable-based credit lines). If your company has accounts receivable (in other words, you are already generating revenue), this can be a great funding option—cheaper and less risky than other forms of venture debt. There are many lenders who are willing to finance accounts receivable. If you are experiencing a working capital gap between the time it takes to collect payments and make payments, you can leverage your billed accounts receivable at a significantly discounted rate. In other words, you’re essentially taking out a loan on payments yet to be paid. Most of what we see with our clients in terms of debt funding is venture debt and/or AR lines.
• Asset loan. This is essentially a loan that is collateralized by equipment. If you need a significant amount of capital equipment, you can finance these purchases. This kind of loan doesn’t always require that the equipment you are purchasing is specifically tied to the funding you receive. Sometimes you can even use this loan to fund growth in other areas. This kind of debt is pretty hard to get so we don’t see it too often, but it’s worth seeking out if you have equipment needs.

BUSINESS LOAN

Oftentimes the first place that entrepreneurs go when thinking about funding is the bank. There are many specialized options available for situations like small business ownership (such as microloans), but your obstacle here is finding your way through such a tough lending period. When you go into the bank, you have to have to be able to present how every penny of the loan will be spent, and even then sometimes a first-time business owner seems too risky to the bank and you won't get the loan. If this is the case, you may also want to consider a small business loan alternative from a provider like Express Capital where they specialize in these specific types of financing.

CREDIT CARDS

If you have an excellent credit history, you may be able to use that to help you use a line of credit to fund your startup. There are specific credit cards designed for entrepreneurs, so visit your bank and talk about some of your options. This is definitely the riskiest option on the list, but if you can make it work, it can likely offer you the best results from the perspective of having --full control and full ownership of your company.

GRANTS

Grants involve the exchange of something for impact.  That something that is exchanged is usually money, but you could imagine grants involving products, assets (e.g., paintings donated to a museum), or even services (e.g., volunteer work).  What separates grants from equity or debt is that the exchange does not result in (a) a claim on the assets of the firm, or (b) an obligation that if left unmet results in claims on collateral or other assets.  Grants can and often do expect accountability, however, as would other obligations of and claims on the firm.

Importantly, grants are not “free money.”  In fact, grants can be harder to come by than equity or debt in many cases.