How Do Startup Funding Rounds Work?

Most brick-and-mortar businesses secure bank loans to cover real estate, equipment, inventory, and other costs. While banks will gladly hand out loans against hard assets, many startups spend money on hiring people rather than acquiring hard assets. As a result, they typically sell equity to investors rather than borrowing money from banks.

Let's look at how startup funding works from pre-seed to initial public offering (IPO), as well as some pitfalls that founders should watch out for during the process.

Startups often need to raise significant amounts of capital to finance their growth—here's the trajectory that they usually follow.

How The Funding Process Works

Many startup founders begin by tapping into their savings or raising capital from family and friends. These pre-seed funding rounds provide the capital founders need to incorporate the business and develop a minimum viable product (MVP). With an early product in hand, it's much easier to raise money from non-personal connections.

The next step is securing seed funding from angel investors. At this stage, startups usually raise between $500,000 and $2 million to hire a small team and find a product-market fit. Many seed investors are former startup founders or incubators, like YCombinator, Techstars, or 500 Startups, that provide founders with hands-on support.

After the startup finds product-market fit and starts to see traction, founders may raise a Series A round to supercharge growth. These investments of $3 million or more typically come from venture capitalists. Unlike angel investors, these institutional investors require robust data, existing traction, and growth potential.

Series B and Series C investments provide additional funding of $10+ million and $100+ million, respectively. While they're called "startups," businesses raising these amounts are usually large private companies gearing up to go public. And when they do go public, investors from the pre-seed to the Series C level get liquid stock they can sell.

Pre-Seed & Seed Funding

The pre-seed and seed funding rounds are the riskiest for founders and investors. Investors provide between $10,000 and $2 million in capital to founders that must bring their vision to life. Many companies at these stages are valued at between $3 million and $6 million, although these valuations are little more than guesswork.

Most seed funding comes via convertible notes or Simple Agreements for Future Equity (SAFEs). Rather than negotiating a valuation upfront—which is challenging for startups without products or revenue—these instruments defer valuation conversations. In other words, the startup gets money now at terms it negotiates with other investors later.

Founders that don't have experience with a past startup may want to consider a startup accelerator that offers pre-seed funding. For example, YCombinator invests $125,000 in a post-money SAFE in return for 7% of your business, along with $375,000 in an uncapped SAFE with a Most Favored Nation provision, for a total of $500,000.

Series A Funding

Startups with a track record and product-market fit move on to raise Series A rounds from venture capital firms. In general, startups at these stages raise $2 million to $15 million, depending on their requirements. These funds should be sufficient for the business to continue product development and hire employees for six months to two years.

While founders and employees own common stock, Series A is preferred stock that constitutes 10% to 30% of the business. The idea is that these shares would receive liquidation preference if the startup goes under—ahead of the founders' common stock. However, these shares are convertible to common stock if and when the startup IPOs.

In some cases, companies become acquisition targets following their Series A round. Many startups already have product-market fit and Series A funding helps accelerate growth, making them potentially attractive to industry peers. In these instances, pre-seed, seed, and Series A investors would get paid off during the acquisition.

A single VC often acts as an anchor that leads the funding round and helps recruit other investors in a more politicized process than seed rounds. However, startup founders can also use platforms like SeedInvest to raise Series A funding from a pool of investors. Ultimately, the right choice depends on the terms and desire for mentorship.

Series B & C Funding

Series B and C funding rounds are for startups that have commercial success. Series B rounds typically raise $10 million or more, helping the business scale up its team and expand into new markets. Meanwhile, Series C rounds are a final round of fundraising to supercharge growth before listing on a public stock exchange.

Like Series A, Series B and C rounds consist of preferred stock. But unlike Series A, there are only a handful of investors with deep enough liquidity to serve these markets. Some of the most prominent investors include Sequoia Capital, Insight Venture Capital, and Accel. In some cases, industry peers may become large investors at these levels.

Investors at these levels are ultimately seeking an initial public offering. When companies are listed on the NASDAQ or NYSE, the Series A-C shares become liquid common stock. Investors can choose to sell the stock as part of the initial public offering or wait until after the offering and sell their stake in the secondary market.

The Bottom Line

Startup founders often raise equity capital to finance their business development and growth. However, unlike brick-and-mortar businesses, they usually reinvest in growth rather than seeking profitability. As a result, they typically raise capital in tranches as they progress, including seed, Series A, Series B, and Series C funding rounds.

While outside funding is a common path for startups, there are plenty of startups that bootstrap their way to success. MailChimp, SparkFun, Lynda, Braintree, and countless other companies successfully grew from zero to IPO without taking in outside capital. By not raising capital, these startups retained more value for their founders and employees.

If you're a startup founder looking for product-market fit, Intent can help you with everything from customer development to creating a lean minimum viable product (MVP). We specialize in working with all kinds of tech startups, including connected devices.

Contact us to schedule a free consultation and learn more!