These days, everyone and their grandmother wants to be a startup founder or work at startups. You could blame it on the increased focus on entrepreneurship, the success recorded by successful founders, or the allure of a non-conventional work environment; whatever you choose, entrepreneurship has been elevated.
If you’ve read any tech media recently, you’ve come across funding terms like pre-seed, Series A, or Series B. On Monday, March 14, 2022, Nigerian mobility fintech, Moove, raised a Series A2, leaving many, including startup founders, asking what a Series A2 was. This guide will help you understand startup funding rounds.
To be clear, raising from investors is not the only option available to startups and many startups choose to bootstrap their operations. In 2021, Mailchimp was sold to Intuit for $12 billion, having been bootstrapped for 20 years.
Why do startups need to raise money?
A few years ago, it was rare for African businesses to raise money and venture capital investments were infrequent, if not completely absent. The common practice was to save for years before starting a business and, where impossible, get a loan from a bank or family and friends.
However, that has changed, and in 2021, African startups raised approximately $5 billion from investors. But why do these startups raise money?
A significant reason is to facilitate growth. By their nature, startups are designed to be fast-paced environments, but that’s not all; everyone involved expects a startup’s growth to be quick.
Between marketing, product development, and hiring a team, startups often need more money than the founders can put up. In exchange for an investor’s money, they give up a part of their company. This is called equity financing and means that the investor co-owns the business. However, unlike a loan, the investor could lose all their money if the company fails.
The pre-seed round is considered unofficial by many people, especially outside Africa. However, it is common to see African startups refer to the first round of funds they raise as a pre-seed round.
Your startup is probably still an idea at this stage, usually in its first few months to a year. You may not have evidence to prove that there's a market for your product or even a team.
Investment gotten at this stage is often used for market research and building a minimum viable product (MVP). Unless you've previously succeeded at a startup, the types of investors you'll get will often be limited to friends, family, and angel investors.
Pre-seed rounds are typically below $1 million, but numerous African startups have raised pre-seed rounds that are above $1 million.
At the seed funding stage, your startup is ideally more mature than at the pre-seed stage. By this time, you've moved from just an idea to a product with some traction.
The level of traction will often be determined by the industry where your startup plays and could be anything from revenue to the number of users. Most startups will raise a seed funding round within their first three years of operation.
A report by Briter Bridges and Catalyst Fund puts the average seed round of African startups at $1.7 million compared to $4.6 million and $5.7 million for Indian and Latin American startups, respectively.
Many startups do not go beyond the seed funding stage as the founders may believe that what they raise is enough to get them started. There's no specific stage at which startups raise a Series A, but most will do it within their first five years.
At the Series A stage, you've proven that people like your business and that your business model works. Now, it's time to scale, and you may be looking at expansion into new territories or significantly increasing your customer base.
Consequently, you'll look to raise a large amount of money. According to Africa: The Big Deal, in 2021, Series A deals in Africa ranged from $225,000 to $200 million, while the median deal size was $8.3 million.
From Series A onward, there’s very little difference between the rounds. The funds are raised for growth and usually involve plans for expansion outside their primary market. Startups frequently raise intending to acquire other startups as part of an expansion strategy.
However, we have seen African startups make acquisitions even before raising a Series A round. The size of the rounds is also larger and for African startups ranges between $2.3 million and $110 million. Startups are ready for their Series B rounds at different times, which could be determined by the industry. Often, startups will be ready for a Series B within seven years of opening shop.
Very few companies get to raise beyond a Series B round. Ideally, a startup at the Series A round has proven its business model and hit specific milestones that show progress. A startup is ready to go public or even get acquired from Series C onward.
At the Series C stage, investors make decisions based on data provided by the business. It is also common to see bigger investors, private equity firms, and hedge funds get involved.
In some cases, a startup may still raise beyond a Series C. One reason for this is that they have discovered new opportunities for growth and need some injection of capital to get there.
Another reason could be that they have failed to reach certain milestones, in which case they may raise funds but at a lower valuation than they would have ideally gotten.
What kind of investors do you need?
If startups are vehicles, investors are the filling stations providing them with the fuel needed to drive growth. However, different types of investors exist for different stages of a startup's funding journey.
Some investors choose to invest at the early stage (pre-seed to Series A), where there is greater risk but also greater reward, while others only invest in later stages (Series A and above). Generally, you’ll have friends, family, angel investors, venture capital firms, private equity firms, hedge funds, and development organisations to choose from.
Angel investors usually invest at the early stages when the startup is probably just an idea on paper and are usually individual investors. There are also angel groups that invest together and super angels – angel investors who can put up significant sums, often tens of millions.
It’s also crucial to understand that most investors have a thesis that guides their activities. Some investors are driven by a gender or industry lens, and you’ll boost your chances of success by understanding an investor's thesis.