Raising Capital for Startups

There is one inevitable truth about starting and growing a business. 

You need money.

That's why entrepreneurs spend much of their time looking for investors, and why venture capitalists have assumed an increasingly influential role in business. According to the accounting firm Ernst & Young, the amount of money venture capitalists invested in companies rose from $24.5 billion in 2009 to $72.3 billion in 2015. Separate surveys by the Center for Venture Research at the University of New Hampshire found angel investments in the U.S. rose from $17.6 billion to $24 billion over roughly the same period. Angel investments serve as the initial funding for many start-ups. 

With the occasional blip, those totals are likely to continue rising as venture capitalists and other investment groups look for the next Apple or Facebook. 

Below you'll find a summary of different stages of funding a business. They start with the pre-seed capital and extend to later-stage capital infusions that enable firms to make the final push before they become publicly traded companies. 

1. Pre-Seed Capital Stage

Typically, pre-seed capital may be provided by family and friends who know and want to support the entrepreneur.

Since very little is known about the product at this high-risk stage, pre-seed investors tend to fund smart, unique ideas. These are not the only resources available to entrepreneurs at this initial stage. So-called seed accelerators offer services such as mentorship, office spaces, and programs that help entrepreneurs refine pitches to investors.

Top U.S. accelerators in 2015 include Y Combinator, Angel Pad, Mucker Lab and Tech Stars.

A full 95% of entrepreneurs surveyed in 2014 said that the pre-seed programs they attended were worth the equity stake they gave up. However, some observers of entrepreneurship argue that looking for excessive funding at this stage may kill credibility with bigger investors in the near future, making funding difficult at later stages.

2. Seed-Capital Stage

Investors use seed stage capital to expand their businesses from the launch stage. They are turning increasingly to a growing number of so-called micro-venture capital firms for this level of funding -- generally smaller amounts than appear at later venture capital stages. 

According to a 2015 article by Samir Kaji, a senior managing director at First Republic Bank, there are more than 200 micro-venture capital firms. Kaji expects the number to rise to about 350 over the next few years. Examples of these micro-venture capital firms are AngelList and FundersClub.

Regulated Crowd Funding under Title III of the Jumpstart Our Business Startups Act (JOBS) allows start-ups to acquire funding in an inexpensive way through online portals from unaccredited investors. Among other things, an entrepreneur must lay out the unique features of the product, target a market audience and how much capital is needed.

Rewards-based crowdfunding outfits such as Kickstarter and Indiegogo offer benefits to contributors in proportion to their donations. Such offerings could be current or future goods and services.

Charity crowdfunding platforms such as gofundme and Youcaring are channeled toward charitable contributions.

Equity crowdfunding from Onevest or Crowdfunder allows funding companies to hold portions in a start-up. That makes them shareholders of any future profits in the company.

Super angels fund a pool of startups by investing their own money multiple times. In installments, these angels provide funds at earlier phases than traditional VCs.

Sometimes angels jointly invest in start-ups selected by an experienced investor. Such syndicate investing funds include Syndicate Room and the Cambridge Capital Group. Other avenues for seed-capital include corporate seed funds that are part of mature companies such as Alphabet'sGoogle (Google Ventures) and Intel (Intel Capital). This sort of funding mostly leads to an acquisition later where the start-up becomes an extended arm of the established firm.

3. Growth Stage

Series A funding requires a sound business plan that focuses on the introduction and scaling of a product across different markets, progress reports and the creation of a larger user base. This round of capital is mostly received through venture capitalists who are allotted preferred shares to retain long-term control over the company.

For a Series A round of financing, the product needs to show how much it has grown through seed capital financing.

Series B funding is required when the company needs to scale up its product after it has an established customer base and an applicable business plan.

4. Mezzanine Stage

Series C and later stages occur once a company has proven that it has a robust business model. Examples of companies at this stage include Airbnb, Grab, Unity, Hike, etc. Investors at this stage finance the steps of going public and bridge the gap between expansion and going public. Leading investors in this round consist of investment banks, private equity firms, and large venture capital firms.

Many tech firms like Facebook, Twitter and Yelp used VC funding on their way to going public.

Even companies that succeed in raising money often fail. According to CB Insights, which tracks venture capital activity, many start-ups fail 20 months after raising capital. Many of them fail to find an audience. Others struggle with management issues or a fundamentally flawed business model. Yet there is also no shortage of companies in recent years that navigated the various funding stages capably and have thrived as publicly traded companies. 

Originally Published on TheStreet.com by Deena Zaidi