New Early Stage Financing Options for Entrepreneurs

Martin Zwilling , Founder and CEO , Startup Professionals

9 Jul 2012

If you are new to the entrepreneurial world of startups, you are likely confused by the terminology of seed-stage, lean startups, micro-VCs, and Super Angels. Don’t be embarrassed, since even professional investors are often confused these days by the new terms, as well as old terms used with new meanings. In any case, it’s time to look again at the options you really have.

A while back I heard a talk by Dave McClure, a long-time angel investor, who also proclaims to be one of the “new breed” of venture capitalists in Silicon Valley, as CEO of 500Startups, which is either a micro-VC seed fund, or a startup incubator, or both. He is going gangbusters, and is now targeting a $50M second round of funding. The good news is that he is all about helping early-stage startups. The hard part for entrepreneurs is figuring out what it takes to play.

Here is just a sampling of the latest terminology and lingo that I gleaned from Dave, and from some additional research on the Internet, that I think every entrepreneur should know, who may be looking for funding now, or down the road:

• Micro-VCs. These are emerging group of professional investors (venture capitalists, ala VCs), who are investing from a fund of other people’s money, with a particular focus on seed-stage startup opportunities. Seed-stage means promising companies that don’t yet have a revenue stream, and may not yet have a proof of concept.
• Super Angels.These are angel counterparts to VCs, who traditionally only invested their own money, but now have begun raising funds from outside investors, to do more than a few deals per year. Like most angels and micro-VCs, however, they still start with relatively small sums of money, often investing only $10,000 to $50,000 in the first increment.
• Series-seed round. Since the economic downturn started, neither angels nor VCs have given much attention to startups without a product and a revenue stream. That was left to the realm of friends and family. In the last year, there has been a resurgence of interest, some say a bubble, by both angels and VCs, in a pre-Series A kicker to identify promising startups with seed funding, before major equity has been given away.
• Early-stage startup.Every startup is early-stage to someone. For a startup founder, this stage is when the “big idea” has become a passion for him, but he hasn’t written anything down yet. For angel investors, early-stage means there is a good business plan and maybe a prototype, but no customer revenue. For VCs, early-stage means customer revenue is less than $10M. Thus the more precise term these days for early startups is “seed stage.”
• Business accelerator. This term is replacing “startup incubator,” which is a facility provided by an individual, university, or local community for any new startups to congregate for almost no cost, with the hope of learning from each other. The business accelerator model is YCombinator and TechStars, who select only the best applicants, have a demanding process, provide experienced coaching/mentoring, some seed funding, with a required exit in about six months. Incremental investment may follow.
• Lean startup. This is a concept coined (and trademarked) by Eric Ries a few years ago, primarily for software and web applications. Lean startups operate on minimal money, an open source environment, and assume multiple iterations, with customer feedback, to get it right. A popular phrase heard in this environment is “rinse and repeat.” Today, if you do well in this mode, you will get funded if and when you need it.
• Crowd funding.The recently passed JOBS bill now allows even non-accredited investors to contribute small amounts to new startups through “crowd-sourcing” sites, like Kickstarter and Crowdtilt. While the exact rules are still being set, suggested limits for a given startup will likely be a maximum of $1M, with each investor limited to an amount equal to the lesser of $10K or 10% of their annual income.

Overall, the biggest issue for early-stage startups still is funding – how much should you expect, who provides it, and how much of your future company should you give up to get it? The trend for investors, including micro-VCs and Super Angels, is to place “lots of little bets,” ($10K to $50K) with milestones applied, which can then lead to incremental and larger funding checks.

Pundits call this the “spray and pray” approach to funding. Even though significant deal vetting and filtering is performed by the investor teams running these seed programs, in effect, they spray little bits of capital onto as many good ideas as possible, help them along, and pray some eventually strike it big.

Despite these pundits, I sense a fundamental change in the early-stage financing eco-system. With the Internet and other powerful but inexpensive business tools, the cost of development and rollout of new startups is lower than ever before, so the “big bang” theory of funding no longer makes sense. This should be a wake-up call for traditional entrepreneurs and investors alike.

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