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The path for each startup is somewhat different, as is the timeline for funding. Many businesses spend months or even years in search of funding, while others (particularly those with ideas seen as truly revolutionary or those attached to individuals with a proven track record of success) may bypass some of the rounds of funding and move through the process of building capital more quickly.
Before exploring how a round of funding works, it's necessary to identify the different participants. Once you understand the distinction between these rounds, it will be easier to analyze headlines regarding the startup and investing world, by grasping the context of what exactly a round means for the prospects and direction of a company.
First, there are the individuals hoping to gain funding for their company. As the business becomes increasingly mature, it tends to advance through the funding rounds; it's common for a company to begin with a seed round and continue with A, B, and then C funding rounds. On the other side are potential investors. While investors wish for businesses to succeed because they support entrepreneurship and believe in the aims and causes of those businesses, they also hope to gain something back from their investment. For this reason, nearly all investments made during one or another stage of developmental funding is arranged such that the investor or investing company retains partial ownership of the company. If the company grows and earns a profit, the investor will be rewarded commensurate with the investment made. Before any round of funding begins, analysts undertake a valuation of the company in question. Valuations are derived from many different factors, including management, proven track record, market size, and risk. One of the key distinctions between funding rounds has to do with the valuation of the business, as well as its maturity level and growth prospects. In turn, these factors impact the types of investors likely to get involved and the reasons why the company may be seeking new capital. Pre-Seed Funding
The earliest stage of funding a new company comes so early in the process that it is not generally included in the rounds of funding at all. Known as "pre-seed" funding, this stage typically refers to the period in which a company's founders are first getting their operations off the ground. The most common "pre-seed" funders are the founders themselves, as well as close friends, supporters, and family. Depending upon the nature of the company and the initial costs set up with developing the business idea, this funding stage can happen very quickly or may take a long time. It's also likely that investors at this stage are not making an investment in exchange for equity in the company. In most cases, the investors in a pre-seed funding situation are the company founders themselves. Seed Funding
Seed funding is the first official equity funding stage. It typically represents the first official money that a business venture or enterprise raises. Some companies never extend beyond seed funding into Series A rounds or beyond.
You can think of the "seed" funding as part of an analogy for planting a tree. This early financial support is ideally the "seed" that will help to grow the business. Given enough revenue and a successful business strategy, as well as the perseverance and dedication of investors, the company will hopefully eventually grow into a "tree." Seed funding helps a company to finance its first steps, including things like market research and product development. With seed funding, a company has assistance in determining what its final products will be and who its target demographic is. Seed funding is used to employ a founding team to complete these tasks. There are many potential investors in a seed funding situation: founders, friends, family, incubators, venture capital companies, and more. One of the most common types of investors participating in seed funding is a so-called "angel investor." Angel investors tend to appreciate riskier ventures (such as startups with little by way of a proven track record so far) and expect an equity stake in the company in exchange for their investment.
While seed funding rounds vary significantly in terms of the amount of capital they generate for a new company, it's not uncommon for these rounds to produce anywhere from $10,000 up to $2 million for the startup in question. For some startups, a seed funding round is all that the founders feel is necessary in order to successfully get their company off the ground; these companies may never engage in a Series A round of funding. Most companies raising seed funding are valued at somewhere between $3 million and $6 million. The Bottom Line
Understanding the distinction between these rounds of raising capital will help you decipher startup news and evaluate entrepreneurial prospects. The different rounds of funding operate in essentially the same basic manner; investors offer cash in return for an equity stake in the business. Between the rounds, investors make slightly different demands on the startup.
Company profiles differ with each case study but generally possess different risk profiles and maturity levels at each funding stage. Nevertheless, seed investors and Series A, B, and C investors all help ideas come to fruition. Series funding enables investors to support entrepreneurs with the proper funds to carry out their dreams, perhaps cashing out together down the line in an IPO.
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