June 29, 2022
The idea of “bootstrapping” one’s way to success is built into the American ethos. But the myth of the plucky entrepreneur who grows their early-stage startup into an IPO-primed unicorn entirely through blood, sweat, and self-funding is just that—largely a myth. A startup can have the best business idea in the world and still fall flat on its face if it doesn’t have the capital needed to get that idea off the ground. And most startups burn through a ton of capital before reaching profitability, so they’ll most likely need to raise money in not one, but several subsequent funding rounds.
If you suspect that your startup will need external funds sooner rather than later, it’s a good time to learn about startup funding rounds—what they are, how they work, and how many you may need to go through to grow your company to its maximum potential. In this guide, we’ll walk through the A-B-Cs of funding rounds, beginning with seed fundraising and ending with the final infusion of capital that precedes an initial public offering (IPO).
Let’s get started, because that money isn’t going to raise itself.
What is a funding round?
A funding round is an event in which external investors give a startup money that enables it to continue growing. In exchange for the money they put up, investors receive equity, or an ownership stake in the company.
Why would an investor exchange cold, hard cash for something as unpredictable as an ownership stake in a not-yet-successful startup? Investors typically see something they like in the startup, and their bet is that investing in it at its current stage will net them a profit as its valuation grows. As the company’s overall valuation grows, so does the value of their equity.
Funding a young startup does come with risk, however, which is why many startups depend on fundraising rounds in the first place. They may have difficulty obtaining bank loans or other debt instruments sometimes used to raise capital (or paying back any interest that accrues on those debts).
Typically, the kinds of investors who participate in startup funding rounds have a greater appetite for risk than traditional institutions like banks. They also understand that higher risks can come with higher rewards—but they don’t bet on just any old horses. In attracting new investors for a funding round, it helps to have a solid business model, a proof of concept, and a charismatic founder to make the pitch.
How startup funding rounds work
Assuming a steady rate of growth and success, a typical startup’s journey involves several investment rounds. Each of these rounds takes place at a different point of the startup’s lifecycle, and collectively they can serve as important milestones in charting the course of the startup’s growth.
We’ll dive deeper into the various types of funding rounds shortly, but let’s start with an overview of the funding stages in consecutive order:
- Pre-seed funding
- Seed funding
- Series A
- Series B
- Series C, etc.
There may be additional funding rounds between Series C and IPO, depending on a company’s goals and valuation heading into an IPO. These rounds are called Series D, Series E, and so on.
The types of investors who participate in funding rounds
So, who exactly are these investors who participate in startup funding rounds? Many of them are private equity investors or private equity firms, meaning that they invest private money into private companies.
One type of private equity you may have heard of is venture capital. Venture capitalists and venture capital firms specialize in funding startups, so they typically care less about a proven track record and more about the potential for future growth.
Many VC firms have different criteria than other types of private equity firms. For example, they may place more emphasis on a visionary founder or founding team versus a proven business model. Since VC firms tend to hitch their wagon to founders, they typically allow those founders to retain the largest equity stake in the company as an incentive to stick around.
Other types of investors take part in startup funding rounds, too. Angel investors, or seed investors, also play an important role in early-stage startup funding. These are usually high-net-worth individuals who invest their own money into startups. This differs from a typical VC or private equity firm, which raises a pool of money from a group of limited partners.
At later-stage funding rounds—usually Series C and onwards—these investors may be joined by more traditional institutions such as investment banks, hedge funds, and private equity firms that don’t focus exclusively on venture capital.
Pre-seed funding is where the word “bootstrapping” can actually mean something. Though it’s not always considered an official round of financing, pre-seed funding is arguably just as important as any other round.
This is where a founder or group of founders pours in their own hard-earned money to get an idea off the ground. The startup may have no track record or proof of concept to speak of, but hey—every idea has to start somewhere. A pre-seed funding round may also include money from friends, parents, and other family members, or even money obtained via a crowdfunding campaign.
Seed funding is generally considered to be the earliest stage of venture funding. In any case, it’s typically the first time that a startup sees a meaningful infusion of cash from external investors.
The seed funding round is where the aforementioned angel investors and venture capitalists enter the mix—though they may be joined by friends and family members with deeper pockets. Every seed round looks different, and the specific amount of money a company needs to get off the ground can vary depending on a number of factors.
If you’re looking for an example range of seed capital, consider Y Combinator, the startup accelerator that invests $500,000 per company across a large number of startups. But don’t read too much into that figure. A seed funding round can include as little as $20,000 and as much as $2 million—whatever it takes to get the company off the ground.
Investors who participate in seed funding rounds may do so via SAFEs, or Simple Agreements for Equity Funding. To learn more about SAFEs, see our guide to pre-money SAFEs vs. post-money SAFEs.
Series A funding rounds
The Series A round is an important milestone in a startup’s growth trajectory, as it typically comes after the startup has developed a proof of concept and begun to expand its operations or user base. Series A funds allow for a startup to continue investing in crucial areas such as staffing and product development.
As with seed funding, the size of a typical Series A funding round can vary pretty drastically. One constant is that it has grown steadily over time—an Inc. article from 2013 cites a typical range of a few million to $15 million, while Crunchbase data from 2021 shows an increase from $6 million to more than $18 million over the past decade.
Investors who typically participate in Series A funding rounds include venture capital firms and angel investors, though the former tends to outweigh the latter.
Series B funding rounds
Series B funding is where the juices really start to flow, i.e. where a business begins to leave behind the “early-stage startup” category behind and look more like a significant industry player.
The Series B round bears many similarities to the Series A round, though the numbers tend to be larger and more investors tend to be seated at the table. The average deal size in a Series B round can vary greatly depending on the industry, the startup, and the investors involved, but it’s not uncommon for a Series B round to weigh in at anywhere from $20 million to the low six figures. Crunchbase notes that the average size of a Series B round across every industry they tracked in a recent data study was $44 million, with healthcare startups attracting the most funding on average.
Investors in a typical Series B round include the usual suspects, i.e. venture capital firms. But some newer venture capital and private equity firms may join the mix here, as well. These tend to be firms that specialize in funding later-stage startups on the path toward IPO.
Series C funding rounds
Not every startup gets to a Series C round (or a Series A or B round, for that matter). Those that do are generally quite successful and already have a proven track record of using funds to grow their business operations and product offerings. They have also validated the faith of those early investors who took a risk at the seed and Series A funding stages—and may soon be considering an exit with a handsome profit.
A Series C round can easily encompass more than $100 million in funding. This funding is oftentimes seen as the final influx of capital needed to prepare the company for IPO, and it may be put toward anything from globalizing operations to expanding product offerings.
For many companies, Series C is the end of the road in terms of private funding rounds, but this isn’t always the case.
While not as common as the earlier rounds of funding, Series D, E, F, and even G funding rounds do exist. They generally get less and less common the deeper you get into the alphabet, as a company that reaches Series C funding may already be close to preparing for an eventual IPO.
Funding rounds beyond Series C
These later stages of funding may be necessary for additional capital, but they are not always strictly desirable, as they can result in further dilution of equity for the founder and existing investors. Remember: every time a new investor or group of investors comes on board, those who already have equity may be diluted. This doesn’t always happen equally to every stakeholder, so as a founder, it’s helpful to know how to model dilution.
Things to consider as a startup founder
If you’ve arrived at this point, congratulations! You’ve made it through every startup funding round there is. Now the trick is to do it in real life. Should be easy, right?
In all seriousness, it’s important for a founder to understand the basics of fundraising—if only to avoid the most common mistakes. The unfortunate truth is that the investors almost always have the upper hand when it comes to fundraising negotiations. After all, this is their literal full-time job. Your job is to run a business and keep everything together, not to memorize equity terms.
If you want to learn more about the various fundraising stages and even model what your fundraising can look like, schedule a call with Pulley today. We can help you avoid costly cap table mistakes and make the most of your next funding round.