So what are the different stages of funding now that we know why a startup needs the money in the first place?
The first and probably most important stage of funding any startup is bootstrapping. This is when the founders invest their own money in the startup. It’s the risk and the bet that they are taking for the startup to take off. The reason this is so very important is because it sets the tone about how serious the founders are about the business and also that they are willing to put their money where their mouth is. It shows that they have skin in the game, and it’s definitely one of the questions any investor will ask when evaluating a startup.
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Next there is the pre-seed round. This is the first round where external investors get involved. In this round, the company may or may not have a proof of concept (POC), and is generally pre-revenue. Usually the company would stick to issuing common equity in this round, but it is not uncommon to also see compulsorily convertible preference shares (CCPS) due to the high level of risk involved in this round. One might also come across instruments such as compulsorily convertible debentures (CCDs) which need to get converted to equity shares in the next round of funding at a certain cap and floor.
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It is usually around the pre-seed stage that people ask their friends and family to participate just to help them get going in setting a valuation for the startup.
The round after this is the seed round. This is the first round in which startups actually have revenues and have achieved a product-market-fit (PMF). Every round after this is simply growth capital and used for helping the company scale and achieve it’s various goals.
Many times, companies have not achieved what they want to achieve for which they have raised the funds in that given round, but they run out of runway, or are close to running out of runway. As a result of this, they decide to raise what is called a bridge round. This gives them an extension on the runway, will they do what they set out to do in that round of funding, and to then go on to raise funds at a higher value.
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Some subsequent rounds are pre-series A, Series A, Series B, and so on. There is no limit to the number of letters that can be used. If they run out, it could hypothetically even be Series Z1, Series Z2, and so on. Although the aim is to make it big enough in the first few letters itself and then get acquired or to IPO. It is in these rounds that you will see instruments such as Ordinarily Convertible and Redeemable Preferred Shares (OCRPS).
