A few weeks ago, I wrote a post about Joining a Startup. In it, I discussed some of the important things to consider before joining a startup including responsibilities, career path, v1.0 vs the Vision, and funding. The post itself got a great response but more importantly, it generated some questions about funding. Apparently, many geeks don't know how startups are funded, so here's some perspective.
There are a variety of ways that a company can be funded. One route – bootstrapping – involves building revneues to take the next step, building those revenues to take the next step, lather, rinse, repeat. While this can work, it tends to be slow and plodding and it's not what I'm talking about here. When a company needs a certain critical mass (Eg. Ebay, Amazon, Twitter), this doesn't work very well. The alternative is Funding.
Funding can come in a variety of forms at a variety of stages. Each one means and implies different things, so here we go. There are a couple things to remember about each of these options, a) there is no set dollar amount for each of these routes and b) they're all optional. A successful early round combined with early profitability could end the external funding process right there.
Self-funding – Just about every company starts at this level. The founding members put in some of their own cash to get things rolling. If one (or many) of them are already successful, they may fund it beyond that initial seed… others will mortgage their house and max out their credit cards. The interesting thing is that whether the founder(s) put in $20k or $2M, all it does is extend the runway to becoming profitable. A Founder putting in their own money does not validate the concept because – as I noted last time around – every Founder believes in themselves. If they didn't you don't want them in charge.
This is generally not more than a few hundred thousand dollars but I know of instances where founders put in ~$1M of their own money.
Friends & Family – If a Founder doesn't have the money personally, they may have friends and/or family that does. This is where things start to get squishy. Some people will have the means and interest to put in money just to be supportive while others will want formal roles on the Board of Advisors, etc. Getting funding here could show some support/belief in the company but since it's “Friends & Family”, it could just as easily being belief in one or many of the people involved. This isn't bad, just don't expect validation of the idea.
Once again, there's no set amount for this range but is rarely gets above $250k or so. People with the means to put in more tend to gravitate towards the next level.
Angel Investors – This is when things start to get serious. Angel investors are normally people who have had success of their own and have gone on to do bigger and better things, repeat. When your group gets Angel investment, the relationship will be unique. If the Angel is from another industry, they might watch and keep an eye on things but an Angel from your own industry, it's quite a bit different. Somewhere along the way, they've been successful enough to be removed from the risk and thrill of a startup. Many will have wisdom, experience, and connections to share and will want to share in the experience and help the next generation. These are the types of Angels you want to work with. Even better at this point, there's some validation of the idea happening. Others see value enough to contribute a significant amount of money to the process. This is a good thing.
Once again, there's no set amount for this round, but the bottom seems to be around $250k with an upper limit of a few million dollars.
Venture Capital – This is a whole other beast. The people who do Venture Capital (or Venture Capitalists or VC's) are investors first and foremost. Most have never worked in your field, even fewer have ever even worked at a startup. They probably don't know your problems. Although they want your group to succeed, they're not personally invested in your success. They have a dozen other investments – some larger, some smaller – and have to keep an eye on all of them. In some cases, you'll have to beg and harass them to get their time. In other cases, they'll get involved and open doors you can't begin to dream of. While some interpret Venture Capital as complete validation of their idea, it's not. There have been some notoriously horrible ideas funded – selling pet food online anyone? – while wildly successful ideas have been passed over time and time again.
Once again, there's no set amount for a Venture Capital round, but they start in the millions of dollars and just go higher. What's unique about Venture Capital is that there can be multiple rounds, often called “series”.
Throughout all of this, there are additional ways to get funding, these just tend to be the most popular and well-known. And of course, some rounds are skipped depending on the situation. If one of your Founders has been through a few successful startups, it's entirely possible they'll start with their own funding and jump directly to a Series A. Regardless, as you're joining a startup, you should know where the organization is in this process and what their next step is believed to be.
To date, I've been through numerous Self-Fundings, one Friends & Family round, and two Angel investments in addition to giving/supporting dozens of presentations to Angels. I have yet to be involved in a successful VC round.