For a founder planning to raise pre-Series A funding, one of the most critical priorities while creating and running a startup is obtaining capital that will enable continued growth and development. This is called early-stage funding and is for conceptualising, incubating, experimenting, market research, product development, finding product market fit, attracting talent until a scalable/repeatable business model is established. Raising funds at the early stage for your startup can be stressful and time-consuming. However, if you successfully get a windfall that fits your business, it could be the first move toward realising your entrepreneurial aspirations.
Early-stage funding in India has been taking the spotlight since 2021. An analysis states that an exceptional funding boom in 2021 led to a 63% increase in capital flowing into startups across various stages compared to 2020. The sixth edition of ‘Early-Stage Investment Insights Report 2022’ revealed that while the number of agreements increased by 30%, the average deal size increased by 20%.
You will require cash before progressing to the next stage of growth. By this phase, the startup has demonstrated excellent development potential and has passed significant milestones to scale further. The startup can receive money at the Series A funding stage to continue building the firm. While growth trajectories could be different based on various industries, a startup needs to pay attention to branding and marketing, human resources and technology.
How can you secure early-stage funding?
The following factors can help you secure early-stage funding:
- The team: The management team needs credibility, experience and domain expertise, and must have a strong understanding of the market.
- Vision: Every entrepreneur seeking early-stage funding requires a well-thought-out plan for success.
- Product or Service: A startup with a working prototype has a higher probability of securing venture funding. A founder must create a prototype that integrates the value proposition and is refined based on customer feedback.
- A scalable model: High potential ventures can maximise profit margins, making it easier for SaaS-based and IT startups to find investors.
- Solutions to existing problems: Your startup should be able to provide solutions based on a robust, globally defensible IP that should be a PMF or product-market fit.
Finally, the founders’ devotion to realising their vision can enable continuous, if not rapid, growth of their company and eliminate existing pain points.
How much money should be raised in early-stage funding?
The amount of initial money required varies depending on a startup’s ambition. Before pitching to investors, do a comprehensive evaluation of your seed capital needs. During the presentation, keep the following aspects in mind:
- The first point should be the product and revenue milestones the startup needs to achieve for the next round of funding. The quantum of funding sought should be enough to reach these milestones and still have enough cash to continue for at least 6-9 months post the milestone, to close the next funding round.
- Key milestones for
- A pre-product startup could be having a working prototype ready or a MVP or having the first paying client.
- A pre-revenue startup, could be having a certain number of paid customers by geography or sector, and having a monthly revenue target to establish product acceptability. For a revenue earning startup, the milestone could be finding the Product Market Fit by establishing a repeatable sales process, returning customer ratio, winning clients in a large addressable market segment.
- Before proceeding with the presentation, have a clear notion of the monthly budget estimate for initial expenses.
- While investors may have views that differ from yours regarding how much funding is required, you must be able to defend your ideas. You should be able to clarify your financial requirements while discussing them with your investors. The most efficient way to do this is to have credible data validating the assumptions that go into the business model.
- Define and estimate the major milestones or timelines in detail. It will give entrepreneurs a clear financial roadmap and make it simpler for funders to engage in the company’s goal.
- Don’t be too stiff and demonstrate limited flexibility; if the presentation appears to be non-negotiable, it won’t be very effective. However, avoid being extremely flexible, which may result in underfunding.
Depending on their requirements, founders should aim to have a runway of anywhere between 18-24 months. The requirement, however, varies depending on which industry your startup is part of or the stage of your startup.
Many tradeoffs and considerations determine the amount of early-stage funding needed to achieve the next milestone. These include investor trust, duration of capital requirement, company size, and development plans.
When should early-stage funding be raised?
Having a reputation and a story is enough for some entrepreneurs to convince investors. However, you need to have a compelling idea, and your product/service must be gaining traction. As a founder, you should be raising early-stage funding only when:
- You have identified your target consumers and how they will benefit from your offering. Utilise market segments for identifying your ideal target persona, then create customer profiles for those consumers.
- Having a MVP (Minimum Viable Product) would allow you to engage early-adopter clients and ratify a product concept in the early development cycle. In industries like software, the MVP can assist the product team in receiving customer input as rapidly as possible to iterate and improve the offering.
- You need to identify essential data points which will aid in performance tracking. Determine your TAM (Total Addressable Market) or the number of individuals who can benefit from your product or service.
The various levels of early-stage funding for startups
There are different levels of startup investments. Entrepreneurs should be aware of the funding rounds they can go through, which are often based on the company’s present maturity and development. These included friends and family, crowdfunding, grants, incubation funds, acceleration funding, angel funding, or a first round of institutional funding such as pre-Series A (the focus at YourNest). Normally, the funding rounds are up to US$ 2 mn with the median being US$ 1 mn.
In the first quarter of FY 2022-23, 272 early stage Indian startups received funding worth US$ 1.3 bn.
Here’s a rundown of the various stages post Pre-Series A-funding:
1. Series-A Funding
Series-A is the next step in the startup funding process. This is when the company (having completed its early-stage development, has traction, revenue and users, and can scale) invites additional funding. Series-A funding is typically substantially larger than early stage funding, with capital around US$ 5-10 mn (sometimes lower or higher, depending on the industry) being obtained in most cases. In India, for example, Series-A funding usually exceeds US$ 5 mn. At this stage, capital is frequently obtained to assist validation of a startup’s business model.
2. Series-B Funding
Series-B finance comes after a firm has demonstrated repeatability in the sales cycle and now requires capital for additional expansion, be it new geographies, segments or product enhancements.
A company seeking Series-B capital will have already demonstrated its market viability and will have many active management and user engagements. This new funding can be utilised to expand functions such as marketing, sales, development, product design and research. The goal is to build a prosperous and long-term business.
3. Series-C Funding
Established businesses looking to hyperscale are better positioned to raise for Series-C capital. Companies who have previously achieved success and demonstrated their ability to grow and gain market share and start focusing on unit economics seek Series-C capital. This round’s funds are usually used to gain significant market share, make acquisitions and expand.
To wrap it up
Even as the larger startup ecosystem begins to talk about a slowdown in dealmaking due to macroeconomic challenges, Indian startups have raised more than US$ 17 bn during the first six months of 2022 of which US$ 2.8 bn was raised by 596 early stage startups. FinTech startups have been the most active segment regarding deals, with 139 startups. Next on the list were SaaS, D2C brands and Healthtech.
A startup must determine why cash is required and the appropriate quantity to raise. Creating milestone-based strategies with timetables is a great way for startups to have visibility on their two, five, or ten-year goals. A business plan is a meticulously produced projection of a company’s growth over a certain period that considers predicted and achievable sales data and factors such as market variables. Production, research, prototype development, manufacturing, and other costs must be calculated carefully.