Understanding the entrepreneurial world: key terms in start-up funding
Funding start-ups is possibly one of the most complicated areas of the entrepreneurial world. In this guide we clarify some of the most common concepts relating to a company’s funding phases.
Photo caption: There are various stages involved in funding a start-up, and each one has its own investors.
You may have heard them a million times, but if you’re not part of the world of start-up business ventures it may not be particularly clear what all these words actually mean.
We’re talking about venture capital funds, business angels, and start-up incubators and accelerators. In this guide we’ll explain what all these terms mean and look at the differences between apparently similar concepts. So, if you get the entrepreneur bug, you’ll know exactly who you need to get on board and become your allies.
All the words you’ve read so far refer to one of the biggest challenges entrepreneurs face: how to fund their project. Having a business idea may come naturally, but turning it into a reality without sufficient resources can get complicated. And what’s more, depending on what stage of the process your idea is at, you may need some type of funding.
According to The Crowd Angel, an online investment platform for start-ups, there are five stages in funding a business. The first stage is known as pre-seed capital. This is all about taking those first steps, when entrepreneurs look at how to shape their business idea. In this first stage the main sources of funding are:
– Family, friends, and fools: people close to the project who contribute a small about of capital to help the project grow.
– Business angels: these are professional investors who contribute their own capital to projects they believe in. These tend to be people working in business, with many having set up start-ups themselves.
– Accelerators and incubators: these are specialist organisations that provide both capital and consultancy. Although they are similar types of organisation, there are some key differences.
Incubators tend to be selective, and offer an indefinite period working in a co-working space. Accelerators, on the other hand, come up with a plan that could last weeks or months, after which the business leaves the space. Incubators give entrepreneurs the chance to go to workshops or have a mentor for as long as they’re there, whereas accelerators look to give a boost to businesses that are already established.
One such example is Explorer, an incubator set up by Banco Santander that offers young entrepreneurs training in entrepreneurship, mentoring, and funding, and even offers a trip to Silicon Valley, the cradle of start-up ventures, to develop their projects.
By the second stage, known as seed capital, entrepreneurs will have already developed their project and will now be looking to launch it to market. Business angels once again play a key role at this point. But there are new players too:
Seed capital or venture capital: This is about finding sufficient funding to establish a business, which could come either from investment funds or private investors. The fundamental difference between seed capital and venture capital is the size of the investment.
Whereas seed capital is all about ‘planting the seed’ and establishing a business, venture capital is usually given to larger businesses which are expected to grow and provide a return on investment. Another difference is that whilst venture capital is about pure financial investment, seed capital may involve buying into a share of a start-up – if it stirs up an investor’s interest.
According to Investopedia an example of seed capital is the investment Google made in a centre for developing renewable energies in 2016. The aim of the Cupertino giants was to incorporate the technology in their own buildings, so really the investment went beyond the purely financial. Equity crowdfunding platforms: These relate to
“investors who contribute a financial sum in exchange for shares in start-ups. This is done using an aggregate model, through platforms which take on the task of selecting the most promising projects and offering the opportunity to contribute small sums”,
states The Crowd Angel. One example is GoFundMe, a platform allowing entrepreneurs to attract funding from small investors.
The third stage of a start-up is the early stage. This is when “company founders attempt to scale-up their business model”. And to do so, they need new sources of funding. This is when funding rounds come into play.
“In this phase of the cycle, businesses raise funding rounds – either series A (of between one and five million euros) or series B (between six and ten million euros) based on their level of progress” according to The Crowd Angel. These activities are often led by venture capital funds, but other players can be involved such as equity crowdfunding platforms.
The fourth stage is the growth stage, when start-ups access series C funding rounds (for higher amounts than those mentioned before). And finally, the last stage: exit. This is when businesses end up going public or being acquired by larger companies.
Regardless of a project’s level of growth, the types of players involved in funding are truly diverse. At least knowing what these concepts mean might help when you dive into the world of start-up business ventures.