How To Raise Money II: Growth & Funding Stages
Last weekend Tim Gillette and I enjoyed lunch, where some really smart people at our table asked: “what exactly is an A-Round investment?”
Since I’ve had, depending on how you look at it, the good fortune or misfortune of raising funds for software startups as well as for a retail pet store, perhaps I can cast a little light into the mysterious cavern of professional investing. Yep; if you're starting out, this is for you.
For startup and early high-growth businesses, there are four basic rounds of investment: a seed round, an A-Round, a B-Round and, you guessed it, a C-Round. It may surprise you to learn that the rounds are not defined by specific dollar amounts, but rather by the goals of the enterprise and investors for a particular phase of growth. So, let’s describe these phases first (fortunately for this article, businesses – whether software or otherwise – go through similar basic phases).
An EARLY PHASE or EMERGING business is a "DREAM UP" -- it's researching options and throwing the clearly bad ones out, envisioning future prototypes (market-test “deliverables”), and designing and writing marketing tests.
At the end of a Dream Up phase, the business should have plans, raw pitches (usually anchored by PowerPoints), business formalities (but, not too many), and a prototype (in software, it’s usually a “demo” -- a demonstration product -- which almost never works, and so gave rise to the affectionate slur “vaporware”). These are common "Season 1" Shark Tank pitches.
In a MARKET TEST PHASE (this is also called a "STARTUP" Phase) the business is testing one or more products (which are likely alternatives of each other), and also testing a myriad of marketing approaches (called “A – B”, or “split,” testing), and the business hopes that one or more approaches strike a vein. At the end of this phase, there's a product a consumer can use. Interestingly, these are typical of Season 2 Shark Tank pitches.
The third (and final common) stage is SCALING – or a RAMPING UP phase -- taking the product that sells with a strong marketing message. This stages focusses on selling as much product as the market will allow by testing channels. On Shark Tank, these are the deals Mr. Wonderful is looking for, as well as VCs (Venture Capitalists) -- they want a plan that works on a small scale, and they want to ramp it up or to license it.
We'll skip the Private Equity and Public Market rounds for now, because very, very few businesses ever get there.
Now, here’s the trick to understanding investing: each round of investing is designed by the investor or group of investors (or as least the smart ones) to get the business through a particular phase.
So, “seed funding” is directed at Dream Ups and should get a business with the plans and structure in place for product testing/development and market testing. And, as you now know, product and market testing is the goal for a Startup and an A-Round (often, angel funding). Similarly, the B-Round should be sufficient to test product channels in a Ramp Up phase, and a C-Round should get successfully tested products to a wider market. That, my friends, is how and why hockey stick grown occurs, and, come to think of it, why every successful startup company that you've actually heard of HAD to experience the hockey stick.
Oh, in case I went over this point too quickly, an “A-Round” does not stand for “Angel Round” – Angels (which are wealthy individuals) may fund any or all of the rounds (although it’s exceedingly rare to see Angels fund a C-Round).
So, as fate would have it, the funds needed to reach these business goals are similar in size for most businesses: about $200,000 or less (much less) for seed funding, $1 – 3Millon for A-Round funding, $5 – 12Million for B-Round funding, and C-Rounds are, frankly all-over the map (PayPal’s C-Round, for example, was for around $100Million).
This causes people to ask questions such as “how much money is raised in a B-Round?” Well, outside of the context of the specific business, the question is meaningless.
If this helps, please give this a thumbs-up. If you just wasted five minutes of your life, give me a thumbs-down (or angry or whatever). And, if you’d like to learn a little more about scaling a business, why not suggest a “next topic” in the comments below?