STARTUP FUNDING 101: VENTURE CAPITAL
Venture capital is generally for early-stage startups beginning in either the Seed-Stage, or with a Series A, and into a Series B.
ENTREPRENEUR'S DUE DILIGENCE
Venture capitalists (and entrepreneurs) are very busy people. An entrepreneur seeking VC funding should research certain information about the VC first, specifically: (i) the name of the person and their title (whether they have any decision making power); (ii) the type of company/industry the firm invests in; (iii) what stage of startups they invest in; and (iv) the amount of the firm's typical deals (although this can vary widely).
This is the least amount of information a founder should know to determine how much time and energy (if any) to invest in a conversation with a VC. If an entrepreneur plans to attend an event where the VCs can be ascertained ahead of time, she/he can simply go on the VC's website and social media accounts or Crunchbase to find this information.
Regardless of whether this particular VC is a good match for their startup, founders should always strive to make a great impression (VCs talk). Asking a VC for a personal introduction to a firm that does match the startup never hurts either.
VENTURE CAPITAL FIRM STRUCTURE / HIERARCHY
VC firms all operate a little differently depending on their size, industry, and location.
Entrepreneurs should research the structure of a firm to understand what authority that person has, if any, so that time and energy can be allocated efficiently. A lot of energy can be wasted attempting to negotiate with or impress someone with no decision making power. In some cases, an entrepreneur can simply ask to speak with someone higher in the firm, and it's always best to know that person's name and title when making such request.
The managing director (MD) or general partner (GP) is the senior deal professional in the firm and will be the person(s) who make the ultimate decision as to whether not to invest in a startup and will sit on the startup's board of directors.
Persons with the labels partner, principal, or director, are generally the junior deal professionals in the firm and not the ultimate decision makers. They are generally only involved in certain aspects of the deal, such as deal sourcing. In full-stack VC firms partners, principals, and/or directors help the startup by assisting with operations, marketing, sales, recruiting, technology, etc.
Associates generally work under a senior or junior deal professional. Associates scout for new deals, conduct due diligence, and perform numerous other tasks associated with the finding and evaluating new and current investments. Founders should understand that associates are in a limited position and do not have any decision making power when considering where to allocate their time.
Analysts are generally recent college graduates who are not directly involved with deals at all. They perform tasks related to the deals, including accounting and writing memos on their findings. In some firms, associates are more like analysts.
Entrepreneurs in residence (EIRs) are experienced entrepreneurs who work at a VC firm part-time for about 3 months - 1 year. EIRs generally assist with networking, introductions, and due diligence.
Smaller firms: in smaller firms, the entrepreneur may deal directly with the MD or GP. There may also be multiple MDs who all have equal power to make investment decisions.
Larger firms: in larger firms, there may be numerous deal professionals with redundant titles. For example, there may be several MDs, and only one with an additional prefix, such as executive managing director, to denote his/her seniority over the other MDs. It's important to figure out who sits at the top and makes the actual investment decisions.
Some VCs only invest in startups in certain industries, such as technology. Some VC firms narrow that even further and only invest in specific sectors of an industry, such as biotech. Some VC firms will only invest in products (hardware), while others only invest in services (software).
There are many reasons why VC firms limiting potential investments. Generally, the industry is familiar to the funds investors or the industry happens to bring in the highest ROI at the moment. Other VC firms, however, prefer to diversify their investments across multiple industries. Each VC firm has a different investment strategy.
Founders should know whether a given firm even invests in their type of product or service before engaging a that VC. Additionally, VCs with experience and connections in the startup's core industry generally serves as better mentors for the founders.
Before the influx of money in VC it was easier to understand financing rounds. Each round was labeled alphabetically, beginning with a Series A, Series B, and so on. As more money and more players have moved into the startup investing arena, however, it has become more convoluted.
> PRE-SEED ROUND
Today, a startup may seek very early-stage initial funding called Pre-Seed Round. This is usually either funding from the founders themselves or money from their friends and family (called "Friends & Family").
After the Pre-Seed Round, if any, there may be an equity or debt round prior to a Series A called a seed round. There can be one or multiple seed rounds, sometimes themselves labeled alphabetically (Series Seed A, etc.). These very early-stage investments are generally the first round in which capital is exchanged for a percentage of ownership in the company. Seed-stage companies are usually valued between $3 million - $ 6 million.
Seed funds come from Friends & Family, Angel investors, accelerators, or very early-stage VC firms, such as mirco-VC funds or seed-stage funds. These VC firms that invest in seed rounds are often started by Angel investors who now invest other people's money alongside their own.
> VENTURE CAPITAL ROUNDS
Finally comes the Series A. This is usually the first round consisting of institutional investors and requiring much more complex deal terms. Startups in a Series A are generally still in the development stage. At this point, investors are looking for more than just a great idea. They will want the founders to have a solid plan for how the startup will generate revenue. Series A funding is usually between $2 million - $15 million, or more, and may come from numerous VC firms with a single one serving as the lead or the anchor.
Next comes the Series B funding round. This round is generally used to continue growth so that the startup can keep up with the demand for its products or services which were developed with the funds from the Series A. Series B rounds are generally between $7 million - $10 million in companies valued between $30 million - $60 million. The Series B typically involves many of the same firms as the A round and additional mid-stage VC firms.
Series C funding is reserved for successful startups that need additional outside funds to keep growing called growth equity. The money is used to expand into new markets, develop new products, or acquire other companies. Sometimes Series C funding serves to inflate the valuation of a company prior to an IPO. Startups accepting Series C funding are usually valued at $100 million or more. Funding rounds after the Series C are rare.
Note that if a subsequent round comes from the exact same investors with the exact same terms (even if different investment amount), the Series may be expanded rather than labeled as a new round. For example, an expanded Series A will be a "Series A-1" instead of moving to a Series B. There may be several expansions in a Series. Existing investors prefer this labeling because startups with Series' beyond a Series C can start to look suspicious to new investors. Not moving too far down the alphabet can keep the wariness down a notch.
> BEYOND VENTURE CAPITAL
VC firms generally invest in early-stage companies between the Series A - Series B. Mid-stage funds or growth equity is generally allocated for Series B, C or later. Series C and beyond are generally pooled from private equity funds or hedge funds, large banks, or sovereign wealth funds, and are typically the last financing before an IPO or M&A event.
None of this black and white, however. Today, it's not uncommon for a very large VC firm that typically invests in later-stage companies to create an early-stage fund. VC firm Andreesen Horowitz proclaims itself to be "stage-agnostic", investing in all stages from seed to late-stage and in both consumer and enterprise tech companies.
Typical deal amounts for a particular VC firm will generally correlate to the stage and Series that the fund focuses on. Because deal amounts can change depending on market demand and the particulars of the startup, it's best to stay up-to-date with a firm's latest investments. Sites like Crunchbase and Pitchbook are a great source of information on recent VC deals.
Before approaching VCs, founders should know the approximate amount of funds needed to make it to the next development stage and/or next funding round. This number can then be matched to VC firms that typically invest in companies at the startup's current stage and for that amount.