By Cameron Chell CEO, Podium Ventures
When it comes to investing in startups, understanding the difference in rounds can be a daunting task. With public market financing, it’s easy to understand exactly what is happening and what each raise of money signifies.
Money isn’t all the same when it comes to private investing. The earlier an investor comes to the table, the higher their risk and therefore the more substantial their stake relative to their investment. Those who join the party at a later stage, after a startup has grown and matured and has the potential to move towards an exit or acquisition will see very different investment terms being offered.
The pre-seed stage of investing is generally considered the land of family, friends, and either the very brave or foolish. This is the stage of a startup’s life where the company is generally still conceptualizing the true nature of the business venture.
For investors who aren’t adverse to risk, it’s where a lot of real money can be made … and lost. Startups at this stage aren’t commonly looking for an overly large amount of money. Entrepreneurs will be more interested in keeping control of the company while at the same time having some cash flow to begin operations. In a pre-seed operation, investors typically see a customer hypothesis being developed and entered in to the initial stages of conception. The end result of a pre-seed company is commonly some determination of whether their initial concept has value and some level of validation. At this level, while risk is extremely high but so can the rewards gained.
The seed stage of startups is more often than not the time when everything begins to get exciting. The company goes through a series of pivots and begins working towards getting a working product to the marketplace. The goal of this stage in a startup’s lifecycle is to get a product finished, no matter how barebones, and get it out to the marketplace. A majority of the financing that is done at this stage is centered around testing, validation, and creation. If startups aren’t doing that then they aren’t a seed stage company or are likely to have some serious problems moving forward.
Taking the hypothesis created and data collected in their pre-seed development, a seed stage startup should be meticulously refining their product. The number one question that an investor needs answered at this stage of a startup’s life is whether this is a solution looking for a problem, or the solution to a legitimate pain point?
When startups hit the growth stage of their lifecycle, they are more or less entering into a time where multiple financial raises may occur. At this stage of the lifecycle, investors should be looking for scaling patterns in how the startup operates. Has operational management been hired? Are senior positions being filled with experts in market segments? Are funds being allocated to new hires? What are the customer acquisition and growth strategies?
If a startup reaches the growth pattern, this is where many new investors are going to be looking to come on board. It’s not late stage yet, but it is rapidly approaching the borderline. The growth stage of a company is the area where rigorous due diligence is going to come into play for the first time for entrepreneurs. Investors need to be asking the tough questions now that the company is moving forward, gaining customers and earning revenue.
This is where there should be a series of checkboxes beside the startup company’s name. Validated customer hypothesis? Check. Product(s) operating in the marketplace? Check. Clear and defined path to growth and scaling underway? Check. Revenue? Check.
With all those checkboxes in place, an investor should be able to recognize the opportunity they have in front of them. This is the time for startups to begin looking at their liquidity strategies for themselves and their early investors. Whether that is through an acquisition, or looking to float on the public markets. The exit phase of a startup is when investors can reference the same decision making process they might have for investing in already public companies. Although these startups aren’t there yet, they are close enough where the similarities and reporting structure should start to blend together.