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Funding 101: Prep

 

The Evolution of Investment

While it would be great to launch your new company with a mountain of freshly injected cash, that's rarely how companies get started. Sure, you read about companies in popular magazines getting millions to launch some newfangled idea, but you rarely read about what it took to get there.

The reality is that most companies go through a basic evolution in both the state of the company and the availability of capital. As the company transforms from an idea to an operational business, the check sizes and deal terms become much more attractive.

In the early stages where you probably are now, the number of options available to you may be a little more limited. Here are the four typical stages of a startup company and the capital that tends to be available:

Idea Stage

Capital Types: Credit, Savings, Friends and Family
Revenue: None

From the point at which you wake up at three in the morning with a brilliant idea to the point where you're building something meaningful, the idea stage is where all your thoughts start to form the foundation of a company.

At this point you're starting to put together what will eventually be your business plan. You're spending time on a whiteboard or doing research on the Web trying to figure out whether your idea has merit.

This isn't a capital intensive part of the process and therefore shouldn't require much cash. 

This is usually the stage where you're moonlighting to pay the bills and using your savings to cover small expenses.

Sometimes you may need to invest a small amount doing research, travel or some prototyping. This is usually the stage where you're moonlighting to pay the bills and using your savings to cover small expenses. It's probably a little too soon to be looking for capital because you're basically just funding early research.

Formation Stage

Capital Types: Small Business Loans, Angel Investors
Revenue: Less than $500,000

So you've figured out what you want to bring to market and you're ready to start building a company. Now you're on to incorporating the business, setting up your office, and getting ready to make your product available to customers.

This is the most popular stage at which entrepreneurs raise capital because the costs start becoming significant and few entrepreneurs have enough capital saved up to do this alone.

There are quite a few capital sources that specialize in this stage of starting a company, from SBA Bank Loans to private Angel Investors. You'll want to tap these sources for your first $25,000 - $500,000 worth of capital to get the business launched.

What you'll be selling to funding sources at this stage is still the potential of the idea, not the actual performance, since it's likely very early in the evolution of the company. Investors will be investing in the idea and in you personally, more than anything.

Traction Stage

Capital Types: Lines of Credit, Factoring, Venture Capital
Revenue: Over $500,000

The Traction Stage of the business assumes you have already gone to market and your business is ready for more capital. Ideally it's because your business is growing so quickly that you need to add more resources to grow even faster.

Just as often, it's because the business is consuming far more cash than its providing and you need more capital just to stay afloat.

 

The capital game changes quite a bit in the Foundation Stage. Instead of selling the dream, you're now selling the performance of the company, which may be good or bad.

The capital game changes quite a bit in the Foundation Stage. Instead of selling the dream, you're now selling the performance of the company, which may be good or bad.

At this point your existing revenues and cash flow will start to matter. You're less of a startup and more of a small business that wants to be much bigger. Your sources of capital - Banks, Factoring Companies, and Venture Capitalists will be far more diligent about investigating the inner workings of your company and taking you to task on the accuracy of your financials.

Growth Stage

Capital Types: Venture Capital, Private Equity, Commercial Loans
Revenue: Over $3 million

As the business starts to generate real revenues an entirely new class of investment capital becomes available, all focused on fueling the growth of existing companies versus incubating ideas.

Think of these investors like the major leagues versus the farm teams. When your company has performed well enough to be eligible for large sums of investment capital it usually means you have proven to be a bankable athlete that is ready for prime time.

You are now considered a Growth Stage company.

The firms you are talking to now are looking to put much larger sums of capital to work, usually in the millions, and are looking for businesses that have a very real track record of success and growth.

At this point the company is rarely still pitching the big idea and usually has some real performance to back it up (although not always tied to revenue).

Investors at this stage are looking for high growth companies that they can latch onto and grow with. Think of these investors like the major leagues versus the farm teams. When your company has performed well enough to be eligible for large sums of investment capital it usually means you have proven to be a bankable athlete that is ready for prime time.

Summary

The point of grouping companies into specific stages is to allow them to understand what capital types are most appropriate. There are always outside cases where a company will get Venture Capital funding with just an idea on a napkin, but those aren't realistic paths to follow.

Aside from knowing what types of capital you should be targeting, understanding the evolutionary milestones helps you to determine what your next goals should be in order to move the company into a more fundable state.