If you don’t understand how the funding chain works investors will see you as little more than a time-waster.
A Typical Financing: How it Really Works
Let’s look at the typical stages in a successful company’s financings. We’ll start with the last and work backwards to the first. Although there are rare exceptions to this sequence, in most cases it looks like this:
This is the big pay-off at the end of years of hard work. It means liquid stock selling at, hopefully, a high P/E multiple. (The second best alternative is to be acquired by a large company such as a member of the Fortune 1000.)
-Venture Capital C-Round
The IPO is now in sight and the C-round is used to “fatten the pig” as much as possible in addition to preparing the company for it. Often this preparation includes replacing management with C-level officers who are known to and respected by Wall Street.
-Venture Capital B-Round
Wall Street is starting to take notice of the company. Therefore, the VCs inject additional capital into it in order to maximize its forward momentum.
-Venture Capital A-Round
VCs step in when the business looks like it has potential for an IPO or acquisition a few years down the road.
Angels come in with money after you have started selling. They jump aboard because you now have tangible proof of concept. You’re finally walking your talk. It’s no longer all just hot air coming from the founder. Be honest, talk is cheap.
At this stage you have no more than an idea and a business plan. You are going to build the next Facebook, or Google, or Apple…only it will take a year or two of work before there is anything that can be sold. Or maybe it’s a dull little business which excites only you?
So, who comes in at the seed stage if you should be lucky enough to attract any money? The answer is the “3Fs”, otherwise known as Family, Friends, and Fools. Yes, this means your parents and rich frat buddies from your days at Harvard or Yale. What’s that? Your family is not wealthy and you didn’t attend an Ivy League college? In that case, you are going to have to finance your seed stage the most common way: with a day job.
Welcome to Planet Earth. That’s how 99% of startups get through the seed stage.
I am providing this information because so many people here requests for funding to cover 2 to 3 years of coding or R&D. Then when they are ignored, they get angry. They accuse investors of being stupid.
If you are realistic about what types of scenarios attract investors, you won’t get angry. Instead you will work to create an opportunity that will be attractive to investors at every stage.
If you think that you are going to attract money to cover your living expenses and provide a bit of fun money while you code or do R&D for 2 or 3 years, you are in for nothing but frustration.
Financing as a Relay Race
Ever watch a four-person relay race at a track & field meet or at the Olympics? Think of funders as the runners who carry the baton and your company as the baton. The first runner will either be yourself (by funding with your own cash) or a member of the 3Fs. The second runner will be an angel investor. The third will be the venture capitalist who takes your company from the angel investor(s). The fourth runner will be the investment bank that takes your company public.
It’s very difficult to leap-frog any of these four steps as each one represents a test of both you and your company. Want more money? Then show that you can pass the tests. However, you will hear people talk about leap-frogging a step or two. Rest assured that any investors hearing them will conclude that they are ignorant about how the financing system works. And no one wants to waste time with an ignoramus.
Outstandingly excellent advice.