A Venture Company’s Funding Lifecycle
The funding lifecycle refers to the recurring iterations of funding that venture companies go through as they grow. Money comes from different sources at different times during the development of the company. The “normal” path for a company through the funding lifecycle is not set in stone. The path changes with trends and the economy, and is variable because of other factors like geography.
The basic pathway follows this order:
BootstrappingFriends and familyAngel capitalVenture capital
Some companies skip a step in the funding lifecycle, but rarely (or never) do companies go backward (that is, a company that has gotten to venture capital funding generally would not go back to friends and family).
The concept stage — bootstrapping
In the concept stage, companies don’t have a product or customers, and they’ve not made significant gains toward product development or R&D. In this stage, companies often have to come up with cash through bootstrapping, in which the founders use their own money to get the company off the ground. (The term suggests that you’re pulling yourself up by your bootstraps).
Bootstrapping is always a good thing for a company. The founders have equity in their company, and they are responsible for its early growth. If the initial founders don’t have enough of their own money, they often seek an additional founder who can bring capital to the company. A bootstrapped company is attractive to investors for three major reasons:
Commitment: The founders are putting not only their blood, sweat, and tears into the company; they’re also putting their money in, too.
Belief: The founders truly believe in their product or technology.
Leadership: The founders are especially leading the way for investors by putting their own money behind their company.
The early start-up stage — friends and family
You can raise money from friends and family when your company becomes established enough to prove to them that you’re serious about your business endeavors. Depending on who you know, you can raise quite a bit of money this way.
Taking money from people you know can really help you grow the company. However, you have to be careful that you only take money from people who can stand to lose it. Also, you want to treat friends and family investors like any other investors.
Because these investments seem informal, they may not be as well structured as formal investments. To protect both you and your family from misunderstandings, regardless of whether things go well for your company, do the following:
Issue stock or promissory notes with very clear terms. Family members tend to come down with sudden amnesia about the original terms when they want to cause a ruckus at the Christmas dinner table.
Have a clear buyout plan for friends and family. That way, if later-stage investments require cleaning up your capitalization table, you’ll have a pre-arranged and agreed-upon mechanism for doing so. This is especially important if some of your friends and family are non-accredited investors with a net worth under $1 million or income under $200,000 per year.
Be clear about the future. Friends and family need to understand that they will be minority investors in your company as soon as you start working with angels or VCs.
Your capitalization table is a list of all the people who have invested in your company, how many shares each person owns, and the terms of the investment. Friends and family rounds can complicate your capitalization table (read, there are people involved in the deal that could be a liability in the future).
The traction start-up stage — angel capital
At the traction start-up stage, companies have proven traction, either by finishing their product development to at least a minimum viable product (MVP) stage, or they may even be selling their product. Companies at this stage have likely attracted five to ten people to the team, including those on an advisory board.
When your company is selling a product or is about to sell a product, you can raise money with angel investors. Angels are high-wealth individuals who invest in the companies owned by people they don’t know personally.
Angel investments are great for raising between $200,000 and $2 million and can help companies get through 6 to 18 months of development, after which the company will be poised to attract VCs for subsequent rounds of financing.
You have to be careful working with angel investors. They’re not trained investors, and they may be naïve in their negotiations. Some angels may negotiate odd or restrictive terms in the deal. Work with a good securities attorney to ensure that your angel term sheet doesn’t kill the deal in later rounds.
The growth stage — venture capital
By the time a company is ready for venture capital, it is fairly established, may have a product available to consumers, and is ready to have unusually fast growth over the next five years. If your company has made revenues of $1,000,000 a year from selling an excellent product in a high growth market with a rock star team, then you may be ready to consider venture capital.
VCs are all different and have different criteria, but most VC deals involve investing sums between $2 to $20 million or more.