Like kindling to a campfire, most startup businesses need capital in order to grow. This capital comes in two main forms: debt and equity. Debt is self-explanatory: This is money that’s borrowed from a lender or raised from a bond issuance that must be repaid with interest.
Meanwhile, there are two different kinds of equity: private equity (PE) and venture capital (VC). There are important differences between them that you should understand before seeking equity financing for your company.
VCs Invest in Growth Companies
To understand these differences, you must first understand the different objectives of PE and VC investors. In short, private equity investors want to invest in businesses that are profitable, while venture capital investors want to invest in businesses that are going to grow. There’s a big difference between the two.
Right now you might be thinking: “But doesn’t every business want to be profitable?” Yes, but profitability isn’t always the main objective, especially during the early stages of a startup company. Technology giants like Amazon and Google are good examples of companies that operated at a loss for years so they could invest all of their cash back into the business in order to grow.
These companies and their investors were taking the long view: They weren’t worried about becoming profitable right out of the gate. Instead, they wanted to grow as much and as fast as possible so they could eventually dominate their industries. They knew that if they could become the dominant online retailer and search engine, profits would soon follow. Of course, this strategy worked well for both of them.
Also, market capitalization — which is a main focus for VC investors — is calculated as a multiple of revenue, not earnings. So the faster a company grows, the higher its sales and market cap will be.
Stages of VC Financing
Venture capital is usually raised in stages because successful growth companies always need more money in order to keep growing. Think of it like pouring gasoline on a fire: The more capital a business has, the more salespeople it can hire and the more it can invest in technology, research and development, and new product development to spur growth.
Pre-Seed:
The first stage is called the pre-seed stage. Here, there may not even be a real business yet — it might just still be an idea or concept in an entrepreneur’s mind. Funding at this stage usually comes mainly from family and friends or out of an entrepreneur’s own pocket, not from venture capital investors.
Seed:
The next stage, or the seed stage, is the first stage where venture capitalists might get involved. There still might not be a lot of revenue but there’s strong evidence that the seeds of a successful business have been planted. Real (not prototype) products and services are being delivered to the marketplace and a management team is in place that’s capable of executing the business plan.
Series A:
The next stage of funding is called Series A. At this stage, VC investors want to see a real, operating business with repeatable sales and marketing processes that can acquire customers on a consistent basis. The business should be utilizing financial modeling and long-range planning and have adequate internal controls, along with a fundraising project plan and investor presentation
Beyond Series A:
Subsequent funding stages after Series A are called Series B, Series C and so forth for as long as the business needs to raise capital. Venture capital investors will have specific expectations at each funding stage.
Always Be Funding Ready
The biggest thing to keep in mind when it comes to venture capital financing is the importance of being “funding-ready” at all times. Remember that as long as you intend to keep growing, you will always need more capital — so you should always be ready to proceed to the next stage of funding.
Unfortunately, four out of five companies that receive pre-seed and seed funding never make it to Series A. And nine out of 10 companies that receive pre-seed and seed funding don’t achieve a successful exit.
Building a strong finance and accounting team is critical to maintaining funding readiness This can be done internally or on an outsourced basis, which tends to be more common among pre-seed and seed startups.
Consero can help you build the efficient and scalable finance and accounting function you need to stay funding ready throughout each financing stage. Request a complimentary consultation today.
