Startup Financing Lifecycle
The startup financing lifecycle can be separated in four stages. Founders’ equity claim and control rights are diluted at each stage:
- Startups begin in the pre-seed stage, with founders contributing initial capital, known as sweat equity. They are issued common stock, which has the lowest liquidation priority but full voting rights.
- Optionally, startups in the early stages may rely on incubators, which offer resources such as workspace and support for idea validation, but do not provide capital. Nonprofits do not take equity, whereas for-profits may request a stake.
- As startups build their product and test market fit, seed funding through angel investors and accelerators is done to obtain a larger initial investment. These agents pre-purchase Series A equity with a built-in discount through convertible securities due to the unknown valuation of the company. Employees and prospects are incentivized by stock options (in this and all subsequent stages), and a stock option pool (usually of equity) is reserved for them.
- Angel investors are accredited investors who provide mentorship and connections, and invest (usually \leq \1\text{M}$) in exchange for equity.
- Accelerators are organizations that support startups with a viable MVP (minimum viable product) that generates some revenue, providing both a workspace, mentorship and capital (\25K-$150K5%-10%$ equity.
When startups validate and perfect their business plan, Series A funding (usually after of seed investment) is the first external capital raised from angel investors or VCs. It is often the first priced round, where the company’s valuation is formally negotiated and set. Series A investors are provided Series A preferred stock.
Subsequent raises (i.e., Series B, C, …) may occur given that the startup achieves certain growth milestones and no down-rounds (lower valuation at a subsequent raise).
Financing Only Applicable for Unicorns unicorns, which are extremely high-growth potential startups. Unless a startup is a unicorn, it will not get such treatment and should look at other means of financing, such as
All of the above investment mediums are on the lookout for
- Bootstrapping, where the startup relies solely on its own savings for growth.
- Revenue-Based Financing, where the startup relies on a revenue-based payment model (i.e., a fixed percentage of future revenues over a fixed period of time).
- Traditional Loans, provided by banks, and often backed by the U.S. Small Business Administration (SBA).