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Stages of Venture Capital Funding, Explained

Stages of Venture Capital Funding, Explained
on June 15, 2023
Stages of Venture Capital Funding, Explained

Launching a new product or innovative solution takes more than just vision and brainpower. For many startups, partnering with a venture capital (VC) firm is a fundamental part of their startup journey, and a key to bringing new solutions to market.

That’s because VCs bring the market knowledge and—most importantly—access to funding and capital that founders need to fuel their R&D and activate their product roadmap. By pooling money sourced from multiple investors, VC firms help fund organizations that demonstrate high growth potential in exchange for an ownership or equity stake in the business. 

This is the exchange that makes many startup-VC engagements a “win-win” for founders and investors alike. You may be a founder with no previous experience operating a business, for instance, but you have an idea or innovation that could disrupt markets. A VC may be willing to risk their money and that of their investment partners on funding your mission in exchange for a share of any profits down the line. 

Making the case for your business and clearly communicating your market potential is therefore a key Step One in any VC scoping mission. While VCs are characteristically specialized based on industries and markets, they’re generally considering the following criteria when vetting your startup for investment:

  • Do the numbers add up? (ie. Is there real growth potential for your product?)
  • Is your leadership strong? (ie. Does your management team click?)
  • Is your new product or service unique? (ie. Are you serving a market need, or solving a unique problem?)

While not necessarily a requirement, these VC qualifiers align pretty closely with the criteria for the Scientific Research & Experimental Design (SR&ED) tax credit in Canada and the R&D tax credits (IRC Section 41) offered in the United States. To claim either, your business must demonstrate you’re performing due diligence in executing R&D according to scientific best practices, while also actually addressing Technological Uncertainty, if not explicitly working toward Technological Advancement

As a result, having a successful SR&ED or R&D tax credit study completed (along with cashing in on government-granted non-dilutive funding) may be attractive to some investors.

These are the five stages of VC funding that most startups can expect to engage with, along with guidance for working with investors before and after the VC lifecycle. 

Pre-seed:

Sources of funding:

  • Self or startup founder
  • Friends and family
  • Angel syndicate or super angels
  • Early-stage funds (pre-seedVCs)
  • Crowdfunding 
  • Pre-sales 

The pre-seed stage of your company generally aligns with the Prototype stage of your product development. At this phase, you’re still likely exploring your ideas and concepts with your original founding team, while just starting to assess the product-market fit for potential customers. 

You’re also still largely building your case for VCs during the pre-seed period, and are instead sourcing guidance from fellow founders or entrepreneurs on how to finalize a business plan while pulling together a minimum viable product (MVP). As such, this is when you’re probably still largely self funded, but pulling together the infrastructure you need to start preparing your case to investors—all the while creating referenceable tax studies detailing your R&D to help claim non-dilutive government funding. 

Numerous startups also manage to self-fund (or bootstrap) their growth through early-stage revenue gained from pre-sales—if not tapping into their own founders’ savings. In this scenario, founders often combine their own revenue with other sources of funding (ie. non-dilutive government grants and tax credits, pre-sales), enabling them to diversify their financial support and mitigate risks before entering the next phase of growth.

Seed stage

Sources of funding:

  • Self or startup founder
  • Friends and family
  • Angel investors
  • Seed round VC

For your business to graduate to the Seed stage—the first official round of VC engagement—you must have successfully pulled together a track record that demonstrates your company’s growth potential. This includes (but is not limited to) having a beta or MVP of your product, and a solid pitch deck drafted that outlines your growth milestones and the actual capital needed, so that you can market to potential investors with confidence. 

While you’re entering a new phase of business maturity, seed-stage startups are still looking for funding that can help accelerate market research, expand the company’s management team and ensure product development runway.

It’s important to remember at this stage that founders often need to be aggressive in their funding goals, as their ability to secure capital will demonstrate to current and future investors that they “have what it takes” to grow and scale for the long term. As such, many founding teams will have to hand over greater equity shares to investors at this stage than at any other to help assure the risk that VC partners are taking on. 

Series A

Sources of funding:

  • Accelerators or Incubators
  • Angel investors
  • Venture capitalists/Corporate VC firms
  • Family offices
  • Revenue-Based Lenders 
  • Venture Debt 

At Series A, your business plan is coming together, you’re exploring a customer base, and you’re exploring product marketing as your business inches closer to consistent revenue flow and growth. Key metrics to consider at this phase include: Has the team found a somewhat proven Go-To-Market strategy with a known customer acquisition cost (CAC)? Alongside that, what are the top line revenue growth, net revenue return (NRR), and overall churn rates?

This last point is key, as it’s not just about how many users you have engaging with your product that VCs and other sources of funding will be interested in. It’s at this point that founders must show that they can monetize their solution for the long haul.

Angel investors and traditional VCs do the bulk of the funding at this phase, though businesses can also explore Accelerators or even corporate VC funds—caveat being that these stakeholders emphasize a strong business plan (read: path to profitability) on the part of founders to minimize investment risk. 

Series B

Sources of funding:

  • Venture capitalists/Corporate VC firms
  • Family offices
  • Late-stage venture capitalists
  • Venture Debt 
  • Revenue-Based Lenders 

You’ve acquired Series B status once your startup is ready to scale, including the launch of actual manufacturing, marketing and sales operations. Supporting all of this calls for another round of funding and likely a much larger capital investment from existing and potential partners. 

Key metrics that VCs and founders need to bear in mind here include: EBITDA, NRR, Year-over-Year Growth and new opportunities (vertical, market, upsell). 

While you were tasked with demonstrating your product’s potential during the Series A phase of funding, Series B calls for moving well beyond your MVP and demonstrating the actual commercial viability of your new solution. This means gathering and presenting performance metrics that show your on a success trajectory, demonstrating material market momentum (not just potential) that will help ensure returns on investment. 

At Series B, you’re likely engaging with VC firms and inventors that specialize in bringing well-established startups to larger markets. So along with more funding, founders can expect firmer guidance from investors on how to more successfully compete and deliver on customer needs at a much larger scale than previously required. Founders can also expect strategic investors to make new introductions and broker new deals to help the business take advantage of growth opportunities.

As a result, founders may have less implicit control over the direction of the business as they enter Series B, but they’ll be partnering with equity stakeholders who have experience (and vested interest) in driving the success of similar products. 

Series C (and beyond)

Sources of funding:

  • Late-stage VCs/corporate VC firms 
  • Private equity firms
  • Hedge funds
  • Banks
  • Family offices 
  • Venture Debt 
  • Revenue-Based Lenders 

At this phase, your original product has found its market fit and is returning a profit, opening your business up for growth in the forms of new products, new markets or even an acquisition. Historically, businesses at this stage have been working at it for at least 2-3 years and are demonstrating consistent profitability while still maintaining huge growth potential.

Businesses at this phase also need to be poised for global growth. Because these kinds of companies must demonstrate a stable revenue stream and history of growth, there’s less risk from investors at this phase, which makes the potential available pool of capital that founders can access a lot larger. As such, hedge funds, investment banks and private equity firms are much more willing to invest in businesses at this phase because returns are more assured. 

Mezzanine

Also known as the “bridge” stage or “pre-public” stage, your business is in the Mezzanine phase of VC engagement once the company is firmly established and no longer a fledgling operation. You’ve got a long-term, viable business plan, a mature and successful leadership team, and a wealth of options for your business going forward, either in the form of an initial public offering (IPO) or even through M&A. 

In the context of VC, ‘mezzanine financing’ generally refers to a later-stage round of financing right before the company goes public, although it can also refer to any form of subordinated debt or preferred equity (meaning it gets paid out after senior debt). It often has an equity component, such as warrants or conversion rights into equity, as well as higher interest rates than senior debt (reflecting the increased risk). 

Mezzanine financing usually is a part of the borrowed funds and sits between the senior debt and equity in terms of payout priority. Because of its position in the capital stack, it can provide significant returns if the company does well.

It’s at this point that investors who helped fuel product growth on the way to profitability will “cash out” and sell their shares to reap their reward on investing in your business. It might become a bit of a sliding-door scenario, as new late-stage investors might take the place of original partners in the hopes of gaining from an IPO or sale. 

Still, it’s at this phase that you can confidently view your whole mission—from ideation to profitability—as a success (and you and your inventors can start enjoying the fruits of your labors). 

Exit

Taking the business ‘public’ via an IPO—which involves offering corporate shares on the open market—offers an opportunity to reward founders and early investors by generating additional funds from the business. While there is a lot of work that goes into creating an IPO (including significant regulatory wrangling that calls for deep legal expertise), it’ll be critical at this Exit phase that you have all financial documentation related to the efficacy of your business clean and readily auditable. 

A third-party will then review all of your financial statements to help assign value to your public offering. While this audit will largely be focused on assessing your company’s future viability, any past validation—including successful R&D studies that have resulted in tax credits or grant claims—into the quality of your product and team will only work in favor of a higher valuation. 

At Boast AI, we’ve worked with hundreds of startups across North America to help organize and optimize their R&D, while streamlining their access to non-dilutive government funding. By giving teams a means to view their financial, technical and product data holistically through a single platform of intelligence, businesses can better navigate any fundraising journey—VC or otherwise—to bring their innovations to market. 

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