Quick Guide to Tech Funding
Over the past few years I have raised millions of pounds of investment for my startup Lutebox through VCs, private equity, angels, incubators and grants, and have advised other startup founders on fundraising. I am writing this short guide to help new founders navigate through the often overlapping and confusing stages of funding and understand how much to raise at each stage.
Stage 1: Seed
Stage 1 can be referred to as bootstrapping, seed round, angel round
The traction required to get to each stage will differ vastly from situation to situation, startup to startup, but usually at seed stage you would need a demo/prototype with solid business plan/deck, or early traction with customers showing some product/market fit, or if you’re a successful serial entrepreneur, a good idea on the back of a napkin.
Do not raise money from external people, try and launch something as cheaply as possible and accelerate revenue to ramen profitability so it can be self sustainable as soon as possible. No dilution of equity, founder retains control.
Raise small amounts (subjective as can be between £5,000 and £500,000, but not usually more unless very sophisticated Angel operating as a venture fund). Give up between 5% and 40% stake (but median range will be around 15%-25%). Do not give up control as no board seat given, usually common stock given, but in many cases can give preferred stock, but either way no voting control given up.
1c) Incubator/Accelerator/Seed Fund
Programmes with highly scripted methodology to help get startups fundable. Take small equity (usually 3%-7.5%) in exchange for small amounts of capital and/or advice/office space/connections. Usually last 2–5 months ending in a demo day which aims to get in front of as many investors/corporates as possible. No real control given up, but will dilute early on.
1d) Seed competition/Grant funding
In both cases funding will be via an application made for funding, usually a very detailed business plan and financial projections/budget. No control given up, usually no equity given up. Money can range from few £1,000s to £50k at most.
1e) Equity Crowdfunding
Raise money from the crowd. Let hundreds (or thousands) of people invest tiny amounts into your startup. You can dictate terms which gives you more control and crowd may become customers/users of your product but be warned you will have many unsophisticated investors as shareholders in your startup. (I’m personally not a fan, so try and avoid if possible. See my article on reasons not to crowdfund: http://techcitynews.com/.../crowdfunding-your-tech.../)
Stage 2: Venture
Stage 2 can be a Bridge round, Series A round
To get to venture stage, usually need to show traction by way of revenue, early growth, repeatable metrics, product/market fit, a solid team starting to get in place.
2a) Angel Group/Network
Professional groups of angels invest together between £500k and £2m. Common in US to do convertible notes (not that common here in the UK). Often times preferred stock given, in some cases board seat given, loss of some control/voting. Will aim to take between 15% and 35%. Typical post money valuations range between £0.5m and £10m.
2b) Venture Capital Firm
Professional investors managing funds to invest in startups between £500k and £6m (in some rare cases startups with very solid founder can raise more at this stage but not that common). Rule of thumb is they want 1/3 of the company. Usually will take board seat and voting shares and/or preferred stock. Will try and get additional preferential terms (remember, if you’re a founder never give anti-dilution to anyone!).
2c) Small private equity fund
Very similar to venture capital firms in most regards. May differ by creating a new entity which will be the shareholder in your company rather than investing directly. Terms/numbers similar as above.
2d) Corporate Strategic Investment
Again similar terms to venture capital firms. May be more willing to give you a better valuation at this stage by taking a smaller stake and taking lesser control.
Stage 3: Growth
Stage 3 can be a Series B round, Series C round, etc.
To get to growth stage, usually need to show profitability (or close to), highly scalable metrics, hockey stick growth, or large and engaged customer base.
3a) Venture Capital Firm
Growth capital of £10m+. Will take around 10–15% or less based on situation. Further dilution and potential loss of control for founder. Founder may be able to take money off the table.
3b) Private Equity Fund
Growth capital of £10m+. May look to restructure company, add board seats etc. Significant loss of control for founder. Sometimes founder can take money off table in this round.
3c) Sovereign Wealth Fund ;)
If you were to be so lucky.
Thoughts on convertible notes:
Startups can use debt financing such as bank loans or debt to fund their business, this can be at any stage, however at the early stage funding via bank loans or debt tends to be very difficult to obtain. However one common funding type for tech startups (especially in the US, and getting used more often in the UK) are convertible notes. Convertible notes are loans that convert into equity at the next funding round, at a pre-agreed discount and with a valuation cap in place. They allow for much faster investments (less paperwork and negotiation) and almost always convert into equity so don’t end up as debt. Good way to close a seed/angel round quickly without having to agree a valuation at such an early stage. A newer derivative of a note agreement is now being used more often called the YC SAFE (Y Combinator’s simple agreement for future equity) which is just like a convertible note but without the debt aspect.