Financing Cycles For Start-Ups
In March of this year (2014), I had the opportunity to talk to the San Diego Princeton Alumni group about Financing Cycles for Start-ups. In preparing my presentation I was reminded why I love the start up world. It’s exciting and rewarding to create a product or service from scratch and bring order to the chaos of ideas and out of that burst of creativity, launch a business.
Most of my presentation appears here. I began by asking the group to consider how they would answer this question. What are you passionate about?
Since the interests and experience of those present were varied but all were interested in start-ups, I presented the cycles from the foundation up. I identified the prospective sources of funding for a company by setting out the stage of its development, identifying the product/service status, anticipated revenues and use of proceeds. Knowing the company‘s financing cycle helps you to determine which direction to head as you prepare to knock on doors in search of funding. You can figure out who is most likely to be willing to fund you at that point in time.
That said, here are the Financing Cycles.
- The Seed stage: If your product or service is still at a prototype phase, you may need capital to finance its early development, establish a proof-of-concept, do some market research or cover administrative costs which may include your paycheck. This is known as the seed stage because of its seminal nature. So who are your main contributors at this point? Most likely it will be YOU, your savings account, your friends, your family, your friend’s family, your personal network, and angel investors.
- Start-up stage: At this point, you have been running your business for a short period of time. Although you have already tested the market, your company is making few or no sales. You will need the capital at this stage to further product development, jump start marketing and cover overhead expenses. At this point, it may be possible to obtain venture capital. Venture capital generally comes in the form of money (but can also include managerial and technical expertise) from investors if they perceive long-term growth potential. These investors accept the high risk associated with the startup because they feel that above-average returns are possible. In exchange, the venture capitalist gets some equity in your and often have the right to be involved in management decisions. As well, your venture partner is going to expect a minimum return. Keep in mind that VC firms generally specialize by industry (technology, health care, etc.) so you want to do some research to identify the firms that are the best match for your company.
- Early stage: Now you have been running the business for several years. You have a management team in place and are “out of the garage” and are operating commercially. Funding at this stage is often required to cover cash flow requirements. Your capital pool continues to include friends and family, angels and venture firms and institutions.
- Second stage: Here you may have been selling your products or services for some time but your business is not yet profitable. At this stage you most likely are in need of financing to expand engineering, technology platforms, sales, marketing, and manufacturing capabilities. It’s also likely you need to boost working capital, cover overhead, and purchase inventory. If you’ve already received venture funding and are seeking another infusion of cash, you may go back to the venture capital market for another tier of funding.
- Third stage: You have been operating for three to five years now and your company is at or near break even or is actually profitable. You are poised to sell products on a very large scale. At this point, you are seeking funding to help you expand operations, facilities and marketing programs. Your sources for funding are the same as in prior stages.
- Mezzanine Financing Phase: This phase is also referred to as “late stage financing.” At this point, sales are strong. You need funds to finance a major expansion. You’ll either be taking on debt or giving up more equity. The price tag isn’t as high as it was in earlier stages because your venture isn’t as risky. So, in addition to VC funds, you can pitch your opportunity to institutional investors and banks.
- Bridge Financing Phase: If you have reached the point where you are seeking bridge financing you are in one of two positions. And hopefully, it’s this first one. Your company is thriving, fully developed and profitable; it has gone from a seedling to a tree in full bloom. You are enjoying the proverbial fruits of your expansion labor. Your mantra now is IPO. You are seeking a short-term loan to cover the cost of an Initial Public Offering. Now I mentioned that you could be in another position that is not so enviable. Tour company is in distress. You are looking for bridge financing to supplement short-term cash needs while you are strategically searching for a merger or acquisition partner.
And here I ended my presentation by coming back to the question I’d raised at the beginning of my presentation – what are you passionate about?
The start-up world is STRESSFUL and will consume you, your family and the many people who will be supporting you. Have passion for your business and what it will be doing. Your passion is what will see you and your team through the down times and will propel you forward and up. I believe that passion play a huge part in enabling you and your entrepreneurial team, to “ring the bell.”