ALL YOU NEED TO KNOW ABOUT FUNDING ROUNDS FOR STARTUPS

INTRODUCTION

Amongst other concerns associated with starting and running a business, fundraising is one of them. There are several fund raising options to consider to consider which we shared in our previous article you may read it HERE. There are primarily two ways in which startups could fund their businesses;

1. Equity financing; in which a portion of ownership of the business is given up in exchange for investment.

2. Debt financing; which involves borrowing of money from creditors with the stipulation of repaying the borrowed money plus interest at a specific future time.

Funding rounds are a form of equity financing where investors are provided with the opportunity to invest cash in a growing company in exchange for equity or partial ownership of that company. The more investment made by investors, the higher the chances at growth for the company and the ownership status of the founder(s) reduces. In most cases, startups go through several rounds of valuation which increases as a startup proves its increasing probability of success, customer base growth, and proof of concept.

TYPES OF FUNDING ROUNDS

The different funding rounds series are:                                                   

1. The seed funding – This is the first investment a startup receives in exchange for a stake in the company. Under this stage there is no real company, or products yet. All what is available here is just an idea which turns out to be a good one. Funds derived at this phase helps get a startup off the ground and into the phase of the business when an idea has materialized. Under this first stage, new startups mostly are in need of an investment to cover the cost needed to run daily operations before a significant cash flow enters the company. With seed funding, business can prove that their concepts or idea works. Focusing on research and or launching an initial product is the deal here. What the investors require here is a well detailed and strong business plan and their ownership stake in your business

2. Series A – This stage of funding is obtained after a Startup has established a strong business model with huge growth potential. Funds gotten at this stage are aimed at expanding operations and achieving its long term goals. Professional investors are usually involved at this stage and what they are looking for are startups with a great monetization plan, a solid strategy for turning their investment into long time growth that will ultimately give them good returns.

3. Series B – Startups at this round have gone past development phase, have an established client base, have higher valuation and are ready for market expansion. Funds gotten at this stage are deployed towards meeting the demands of a larger market. This round of funding is usually provided by private equity investors and venture capitalists.

4. Series C – Ideally, this is considered the last stage. But some startups may opt for more rounds   such as; D, E etc. Companies at this phase have attained a great level of profit/revenue and on-demand market base. They however, need funds to either develop a new product, expand their market base or acquire other company(ies). In addition to Angel investors and VC firms, other investors such as Hedge funds, Investment Banks, Private Equity firms participate at this phase.

5. Initial Public Offering (IPO) – At this phase, a company has acquired public status and it can offer shares and debentures to the public and as a result of this, it makes it easier to access funds from the capital market when it is listed in the stock exchange.

Regardless of the funding round, one essential requirement is that both the business and the investor come to an agreement regarding how much is to be invested and on what terms.  Each round is designed to raise enough capital to grow further and can take as long as 6 (six) months to 1 (one) year.

While there is the option of raising funds through either equity or debt instruments, earliest stage startups prefer equity financing because it puts less pressure on the business’ growing revenue.

CONCLUSION

Not all startups go through all phases mentioned below. Whichever round of financing a startup wishes to embark on requires a great level of housekeeping in several areas such as accounting, tax, legal and compliance, etc. Moreso, each phase of funding has implications in terms of ownership structure, in other words, the higher the round, the greater the demand for a startup to give up a significant amount of ownership as well as provide return on investment.

Negotiating funding rounds for a startup comes with a lot of technical terms particularly with regards to economics and control and if mismanaged, could greatly affect a startups subsequent funding negotiations as well as management of the startup in question. It is therefore important that startup founders work closely with business or startup lawyers who have a great deal of experience with venture funding and negotiations to enable them make the best out of funding negotiations.

If you need help in this regard, you may reach out to us HERE, and we’ll be delighted to assist you.

Cynthia Tishion
Cynthia is a lawyer and currently serves as Head of Corporate / Commercial Services at LEX – PRAXIS. With her passion for business and entrepreneurship, she is actively engaged in creating awareness on the legal aspect of businesses through various platforms such as writing, public speaking engagements.

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