We constantly get the question, “when is a venture ready for first funding?” Approximately 90% of startups will seek venture-style capital. And, it is common for a high-growth company to go through three or more rounds of capital. When you seek your first capital defines many things for your company: your capitalization table, what strings are attached to your company by investors, your ability to operate without supervision, etc.
Typical stages of company growth and capital a company can command for a typical science/tech/software venture:
- What: Founding of the company with a substantially inwardly focused team
- Actions: Company formation, market research, filing patents, customer discovery, business plan development
- Investors: Accelerators, product-based Crowd (Kickstarter, Indiegogo, etc.), and FFF (Friends/Family/Fools)
- Amount of capital: $15k – $100k, typically funded by Founders
- Valuations: $250k – $500k
- What: Team turns outward to accelerate customer discovery and begin product development
- Actions: Product prototype, beta testing, additional IP filings, premarketing/acquisition of early adopters
- Investors: Accelerators, product and equity-based Crowd (AngelList, OurCrowd, SeedInvest, CircleUp, CrowdFunder, EquityNet,etc.), Angels, and Angel Groups
- Amount of capital: $250k – $1M
- Valuations: $1.5M – $2.5M
- What: Team focuses on market launch and gaining traction
- Actions: Final product development, launch, marketing, sales, prove your business model
- Investors: Angels, Angel Groups, the equity-based Crowd, early stage Venture Capital (which is very rare!)
- Amount of capital: $1M – $2.0M
- Valuations: $2.5M – $6M
- What: Team focuses on marketing, sales, and product evolution
- Actions: Market traction, market traction, market traction – prove your business model is repeatable!
- Investors: Angel groups (as a follow-on investment), Venture Capital, equity-based Crowd (RegA+!)
- Amount of capital: $3M – $5M
- Valuations: $10M – $20M
- What: The team focuses almost exclusively on market traction
- Actions: Prove you can scale your business model, identify potential acquirers
- Investors: Mezzanine and late stage venture capital and possibly Private Equity
- Amount of Capital: $15M – $50M+
- Valuations: $50M – $100M+
- Declaration of victory by the noncombatants
These are approximated stages and capital investment for the vast majority of the country. Clearly, there are areas of the country where these do not apply, such as the Silicon Valley, Boston, New York, etc. I am not saying higher valuations are good or bad, these areas have a demonstrably higher cost of living too. I am saying that we tend to find the same great tech and teams in the heartland at more rational valuations that are far less prone to “bubbles.” Finally, these norms don’t apply to biotech companies, especially those requiring Food and Drug Administration (FDA) clearance. That is an entirely different story and driven by regulation, not market forces.
In general, you should expect to give up 20% – 40% of your company for each round of funding. The implication, by extrapolation, is the Founders and Option holders typically will control between 10% (common) and 40% (uncommon) of the company at the time of exit. Alternatively, the longer you go on Founder funding, the less dilution the team will endure. It is critical for entrepreneurs to understand that investors expect a premium for the risk they are taking by investing in startups. This is why venture debt (non-convertible) is almost nonexistent.
The answer to the question of when is a venture fundable is, it is up to you and the investors you approach. Each investor is going to have a set of criteria to qualify for investment. Find out where an investor invests in the market before approaching them with a full-court-press. Most professional angel investors won’t entertain a company prior to late seed stage, and many won’t consider earlier than the startup stage. We invest no earlier than the late seed stage and not later than the early growth stage. Most professional VC investors won’t consider a deal any earlier than the late growth stage at this time in the market.
When you seek funding is directly related to the point in your business that you believe adding capital will expedite the growth of the business sufficient to justify the pain of dealing with the funding process, giving up ownership in your business, and accepting the inevitable strings that come attached. In other words, when you believe you are creating more value than you are giving up, then you are ready to seek funding. One caveat…..make sure you see this point six months before it occurs. The reason is simple. It can take that long to capture the resources you seek, and you never want to seek capital from a point desperation!
I don’t mean to sound as if dealing with investors is a bad experience. We are very rational. We know what it takes to be successful. And, we can be very helpful to your business working alongside to create life-changing wealth for you and your investors. Additionally, we are seeing studies saying that increasingly VC’s are looking for companies that have previously been backed by professional angel groups. That means we can be instrumental in your success.
The bigger question, and the one that does not get asked enough, is: “is my venture fundable?”
Copyright Eric L. Dobson, 2016