Is your startup ‘investor ready’? (Part 1/3): The stages of development

So you reckon your startup is ready for external capital? Let’s find out.

In this series of three blogs, I’ve tried to distill  my experience in acting for venture capital fund managers, angel syndicates, crowdfunding platforms, corporate venturing arms and emerging technology companies on their early stage funding transactions, to provide an overview of the capital raising process and address some frequently asked questions to help founders become investor ready.

First things first: where are you in the development cycle?

In this first blog, I explain the stages of development of a typical startup, what milestones it should expect to have achieved at each stage and the funding options that are available to it given its traction.

Development reduces risk and increases funding options

Startup companies generally go through predictable development stages.

The earlier the stage of development, the greater the commercialisation risk and therefore the more challenging it is to attract external investment. As a startup progresses through the stages of development and de-risks its business by validating its product, securing paying customers and beginning to scale, the more investable the business becomes and the higher the potential valuation the founders may expect to secure.

Seed stage – from idea to product

At the seed stage, the founders will generally be developing the business idea based around a number of assumptions about the market and the opportunity. During this stage, the founders will be focused on developing a proof of concept product or service that can be tested in the market and the business will generally be pre-revenue.

This stage can continue for one to three years, depending on the type of product.

The founders should also be considering how to structure their business (usually in a company) and how they will hold shares in the company. They should also consider intellectual property issues, including patents and trademarks, at this stage.

Seed stage funding requirements vary depending on the sector. These early funds generally come from the founders’ personal savings, credit cards, and investment by family, friends and possibly angel investors within the founders’ own networks. Crowdfunding platforms can be a helpful way of structuring small fundraising rounds from family and friends. Companies at this stage are often undertaking research & development and therefore may be eligible to receive tax incentives (including cash refunds) as a result of the R&D tax incentive program.

This funding enables the founders to develop the product or service to the point where they can launch the business and start acquiring customers.

This is also the stage at which a company could be suited for participation in an accelerator program, which also attracts a small amount of funding.

Startup stage – technical & consumer validation

At the startup stage, the founders should have built an early prototype product and have documented plans for the growth of the business, but will usually have no, or very few, customers. During this stage the founders will be focused on testing the beta product on early customers. From early customers, the founders obtain valuable feedback about the assumptions upon which the idea was built, allowing the founders to alter the product, the pricing and the marketing accordingly if required.

This stage generally continues for approximately one year.

Startup stage funding will generally range from $100,000 to $500,000. These funds generally come from the founders, government grants, angel investors, equity crowdfunding platforms and micro venture capital funds.

This funding enables the founders to develop and refine their beta product (technical validation) and secure early customers (consumer validation). During this phase the founders should have tested early assumptions (and made any necessary changes to the business model or product), developed a clearer understanding of the consumer problem or market opportunity, and developed a customer acquisition strategy and resourcing plan that they are ready to implement in order to scale the business.

It is toward the end of this stage that startups are ready to consider implementing an expansion strategy to increase customer acquisition and scale the business.

Expansion stage – customer acquisition & scale

During the expansion stage, a company will start to formalize business processes, escalate marketing efforts and scale up customer acquisition. It will also continue developing and making improvements to its product or service.

The early expansion stage generally continues for approximately one to two years. Later stage expansion, which includes developing profitable growth companies, can continue indefinitely.

Early expansion stage funding will generally be $1-5 million. These funds generally come from venture capital firms, strategic corporate venturing divisions, family offices and angel syndicates, with equity crowdfunding platforms participating to fast track the closing of the round.

The first round of funding at the expansion stage is generally referred to as Series A funding. Additional rounds of funding for a company continuing to expand are referred to as Series B, Series C and so on.

This funding enables the founders to recruit key team members, undertake further development of the product or service and execute a more comprehensive sales and marketing campaign designed to scale up customer acquisition, brand awareness and revenue.

Conclusion

Generally, investors do not fund ‘ideas’, they fund businesses. This reality is not limited to Australian investors. So before early stage company founders go to the market pitching for external capital, it will be important to have achieved both technical validation (even at a beta stage) and some level of consumer validation (even if the business is not yet profitable).

In the next article, we look at the importance of preparation in the capital raising process and detail the key corporate, legal, tax and financial hygiene matters that founders should address in order to position themselves for a successful capital raise.

Steven Maarbani

Acknowledgements: I’d like to thank Tank Stream Ventures, Reinventure, Blackbird, M.H.Carnegie & Co,VentureCrowd, Artesian Venture Partners, Telstra Ventures, Fishburners, SCALE,  Tyro Fintech Hub, NICTA, iAccelerate, & muru:D for their feedback and contributions to this series of blogs.

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