What differentiates a startup that fails from one that succeeds? There can be several things.
The leadership effectiveness, business acumen, and operational efficiency of the person in charge (and the people working with them) play a role. The business model and corporate structuring are certainly factors. The product or service itself – is it good and unique, and does it provide value? – matters and can determine business success outcomes, too.
However, lack of cash is one of the primary reasons startups fail. This is why fundraising (and fundraising strategy) can be vital to a startup’s viability.
If you’re a startup or planning to set up one, you should seriously consider your funding strategy. Consult a business consultant if you have no idea what this is. To succeed, you need funds to spend on operations, expansion, and other expenses until your business can sustain itself.
Why Startups Need to Raise Capital?
When CB Insights analyzed their post-mortem data of startup failures, they found that cash, or the lack thereof, is the top reason startups fail. According to their data, 38% of the failed startups in their study ran out of cash or could not raise new capital.
Think of a startup like a car in an endurance race like Le Mans. To even have a chance at winning, it has to cover as much distance as it can for 24 hours. If it runs out of fuel, it will grind to a halt.
Likewise, a startup must endure to gain customers, outcompete competitors and dominate the market. Meanwhile, it has to burn cash on capital and operational expenses, including salaries and utilities. It’s likely not making enough revenue to support operations and expansion. Therefore, if it doesn’t get a capital infusion, it will run out of money. When that happens, it can’t keep the lights on.
The Funding Rounds
When startups need money, they go through funding rounds. It would help you plan your funding strategy to know what these rounds are, what they are for, and what they entail.
Pre-Seed Funding: Faith in an Idea
Pre-seed funding is the earliest funding round or stage. At this stage, all you probably have is an idea and many plans, like:
- A mockup of your minimum viable product
- What problem your product solves
- Who your market is
- How your product is unique
- How you will earn money
- How you will grow the business
At this juncture, the focus is squarely on validating your core business idea, developing a prototype and conducting market research.
Some don’t deem pre-seed funding an actual funding stage. Family members, friends, and organizations that channel money into startups to promote entrepreneurship typically comprise the pool of pre-seed investors. There may be one or two angel investors in there, but they’re investing not in the business but in the founder.
Additionally, pre-seed capital is nothing ground-breaking. Ranging from fair to middling, it won’t get a business off the ground. That said, it can give it legs to stand on or get the figurative ball rolling.
The pre-seed round is not about scaling but about getting started. More importantly, successfully raising pre-seed capital represents faith in the potential of an idea and the startup founder.
The pre-seed round typically enables the following:
- Idea validation: Ensuring that the concept addresses a real problem and has a potential market
- Prototype development: Creating a basic version of the product to demonstrate its feasibility
- Market research: Gathering insights about potential customers, competitors, and the overall market landscape
Additionally, the pre-seed round can become the benchmark for future rounds. What if a startup founder gets pre-seed capital and utilizes it well and cost-effectively to accomplish the purpose of the funding round? That will provide verifiable proof of the startup’s viability and the founder’s abilities, engendering trust that can be valuable in the next funding round.
Seed Round: A Hope to Become Better
You can think of seed capital as a business growth fund. It is for you if your business is at this stage:
- Product: You have more than an idea and a mockup but an actual, functional product.
- Customers: You must have customers, preferably paying ones. If yours is an app, you must have a user base. This proves people find your product useful, and you have the potential to expand that with some marketing.
- Social proof: Preferably, you have followers on social media and people who like your product so much they’re like brand ambassadors.
- People: You may have key employees in critical roles.
- Roadmap: You must have a clear growth plan.
At this stage, your startup may or may not have revenue – preferably the former. Revenue demonstrates how people are willing to pay for your product and can give investors confidence in your startup.
The funds raised during the seed stage are primarily allocated towards the following:
- Product development
- Market research
- Fine-tuning the team
- Customer acquisition
Investors in the seed stage are usually angel investors, early-stage venture capitalists, and specialized seed funds. They are willing to take on higher risk in exchange for a bigger share of equity.
The seed capital will go to refining your product for better market fit and to attract more customers or users. Your goal at this stage is to get the funds to establish your business.
Series Rounds: To Expand and Scale
Once your business is established – has a robust customer/user base and generates revenue – you can raise capital to scale up operations. To do this, you go into the series funding rounds. These are:
- Series A: Capital to maximize growth momentum
- Series B: Capital for expansion, say, a private jet charter flight app venturing into operator-to-operator dry leasing to directly offer flights
- Series C: Capital for strategic acquisition, research and development, geographical expansion, or initial public offering (IPO) preparation
Some startups have Series D and E rounds, but they’re rare. Series C is typically the last funding round before a startup considers raising capital through an initial public offering (IPO). Business founders may also choose to exit at this stage if another entity acquires their interest in the business.
You Need a Fundraising Strategy
The funding rounds are for different stages in a startup’s journey. Navigating them requires a strategic approach, a solid understanding of where the business is and where it is going, and expert advice from capital fundraising strategy experts.
AUTHOR BIO
Jinky Elizan is a content writer for SEO Sherpa. She has more than 17 years of experience in producing content for SEO, inbound marketing and link building as well as in creating copy for web pages and social media. She also develops WordPress websites.
