Who, When, and How Much? A Quick Introduction to Startup Financing
For a first time entrepreneur trying to figure out the arcane world of startup financing, it can be very confusing to understand the roles that different types of investors play in funding promising companies, as well as the point in a company’s life at which they enter the stage. It is not unusual to hear people refer to “angels-and-vcs” in a single breath, even though those are two very distinct groups with different attributes. If a company is appropriate for angel financing, for example, it is highly unlikely that it would also be in a position to raise venture capital, and vice versa. Putting all the players in the context of both the size and timing of their likely investments (and with the caveat that there are always exceptions), in very, VERY rough ranges the world of early stage financing looks something like this:
From $0 – $25,000 you will likely be investing your own cash out of your own pocket, otherwise no one else will be comfortable investing at all. Once in, this money stays in, and is part of what makes up your Founder’s Equity (along with your work and your intellectual property.)
From $25,000 – $150,000 you will likely be rounding up friends and family to put in the first outside cash on top of yours. This will usually be documented as either a straight sale of Common Stock (which is most typical) or else as Convertible Note which converts into the same security as the next professional round, but at a discount (which is actually better for everyone).
From $150,000 to $1.5m, you are in angel territory, either by lucking into one really rich and generous angel investor, or (more likely) by pulling together either a bunch of individual angels (at $10,000 – $100,000 each), or one or more organized angel groups, or one or more micro-VCs (colloquially known as ‘super angels’). Depending on the circumstances, they will invest either in the form of a Convertible Note (but with a cap on valuation), or else in a Series Seed or Series A Convertible Preferred stock round, using similar documentation to that used by VCs.
From +/- $1.5m up to, say, $10m, you’re looking at early stage venture capital funds, which will almost certainly be using something very much like the National Venture Capital Association’s Model Series A documents. They will likely make their first investment about half of what they’re prepared to put in, with the rest coming in one or more follow-on rounds if you execute successfully on your plan.
Finally, north of, say, $10m – $20m, you’d be getting money from a later stage venture capital fund, whose paperwork will be similar to the earlier VCs. They will put in much larger amounts of cash, but your valuation will be much higher, so they may end up with a smaller stake than the earlier investors (who would likely have continued to invest in each round in order to maintain their percentage ownership.)
Although this is the canonical progression, keep in mind that the number of companies that get all the way through it is very, very, VERY small. A majority of companies that are started in the US begin and end with the first stage: the founders’ own money. The number of companies that are able to get outside funding then begins to drop by orders of magnitude: the percentages (again, very, rough) are that 25% of startups will get friends & family money; 2.5% will get angel money; 0.25% will get early stage VC money; and probably 0.025% will make it to later stage VCs.
This article is intended for informational purposes only, and doesn't constitute tax, accounting, or legal advice. Everyone's situation is different! For advice in light of your unique circumstances, consult a tax advisor, accountant, or lawyer.