A guide to startup funding rounds and how they work

The basics of all the stages in which startups raise funding, and who brings in the money.

The evolution of Pakistan’s startup ecosystem has meant that in the past few years, there has been continuous news about different startups raising money in different rounds of funding. It seems everyday there is some new round of funding and some new massive amount of money that has been raised. But for those uninitiated in the world of venture capital, the many rounds and kinds of funding that are a part of the startup system can be confusing. 

If the back to back startup funding announcements make you want to start something of your own, or simply make you want to understand what in the world is going on, you need to be aware of how startup funding works, how it starts, and what are the important stages that define it. Funding and where it comes from can often determine the direction that a startup takes, which is why it is essential to understand exactly what is happening in a country like Pakistan, where the startup culture seems to be thriving.

There are different types of startup funding rounds which are raised at different stages of a startup’s life. These rounds come as pre-seed, seed, Series-A, Series-B, Series-C and beyond. The rounds which are venture capital funded but are not categorised as any series are called venture rounds. The funding in each subsequent round is higher than the previous one and is raised during various stages of startups growth journey. 

Funding in these rounds starts coming from founders and their friends and family, eventually leading to participation of big venture capital firms if the startup is able to make it big on growth. Essentially, you start very small like with any business. Your dad gives you a loan, you ask your friends for small contributions, someone says they’ll make an investment and you get started. 

Then, maybe when you start seeing signs of the idea or the company growing, professional investors seem interested in the idea and make offers to give you funding in exchange for equity in the company. These investors are who we call venture capitalists – they look out for good ideas and invest in them at an early stage for a minority stake. Normally, they don’t get involved in the workings of a startup which means they simply evaluate the founders and the team and determine whether a startup can put its money where its mouth is and turn profitable. If they do manage to become profitable, then the venture capitalist gets their initial investment back and also a steady stream of profit.   

Some basics 

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Before we get into the details, it is necessary to understand who exactly is investing in these startups. Yes, as has been mentioned, initially the absolute initial stage is friends and families. However, the maini investors that any startup wishes to attract are venture capitalists. There are two kinds of venture capitalists, either individual ‘angel investors’ or venture capitalists firms. 

In the case of angel investors, they are private venture capitalists operating on their own – lone wolves. Venture capitalist investment firms are different. These are usually collaborations where a number of investors pool their money to invest in different startups, except the firm hires someone to manage this money. This person can be hired separately or can be one of the investors, or the decisions can be made in collaboration as well. It all depends on how that firm wants to structure itself. 

Firms don’t generally invest in high risk companies, and it is usually angel investors that take the plunge with more high risk ventures. However, investing in any startup is risky by nature as you are investing not just in an idea, but also in the people leading that idea and the team they are hiring. This risk is taken because the venture capitalists know that while these companies could fail, if they do make it, the returns would be massive. While these startups are very high risk, they are also very high return. 

Pre-seed 

Consider this as the ideation stage of the startup. You have an idea and you want to carry out research, formulate a plan and start building the product around it. The startup is just taking off the ground and funding can come as founders’ own capital and funds from friends and family. Many angel investors are the source of funding at this stage. On the other hand,  VC firms have also started funds to invest in startups at pre-seed stage. 

Since it is just the beginning, startups usually do not have solid data to present and investors are betting on the the founders, the team, product and the market to make the investment decision. The investment size is also small since the idea is to invest in developing the product and carry out the research. Pre-seed funders take anywhere between 10-25% equity at this stage.

Since this is the concept stage, the size of funding is very small compared to the later stage rounds, usually running in tens of thousands or in some cases hundreds of thousands of dollars. Lately in Pakistan, however, startups have been coming big with their announcements of large amounts raised at pre-seed stages. For instance, B2B platform Bazaar raised $1.3 million in pre-seed funding in 2020, and more recently, edtech startup Maqsad came with the announcement of $2.1 million in pre-seed funding. 

Seed stage

The business idea has moved on from the concept stage to product development and testing the viability of the business model. Investments at this stage are usually small coming from angel investors and seed stage VCs. Many incubators and accelerators also invest at this stage, putting in small amounts in the startup. Average investment size is usually small, running in a few million dollars. But after the pandemic, we are seeing the seed funding rounds fetching investments running in tens of millions of dollars. 

Recently, Pakistan’s BridgeLinx raised $10 million in its seed round, while fintech startup TAG raised $12 million in its seed round. 

At the seed stage, since the product is still in the testing stage, there is no solid trajectory of growth for investors to make an investment decision. Investors are again taking the risk with their bets on the founders and the idea. The funding is usually spent towards developing the product, recruiting the talent and on getting the initial traction.

Series-A 

Series-A is the financing round raised when the startup has managed to get the product off the ground, has a dedicated user base and revenue coming in. Series-A rounds are raised to further consolidate the strategy for long-term growth and earn profits. 

In the Pakistani context, very few startups have made it to Series A rounds. Globally as well, startups which generate investor interest following the seed round are small in number. That is because not all the startups are able to become a hit in the market after their launch. 

World’s top VC firms such as Kleiner Perkins, Sequoia Capital and Andreessen Horowitz have usually invested in startups during the Series-A rounds. Angel investor participation in Series-A rounds is also not uncommon and early investors also follow on to maintain their shareholding in the startup. 

Series-B  

Series-B financing rounds are mostly about bringing stability in the business. The startup has built a dedicated user base, the product is optimized for the market and the idea now is to expand the scale to a bigger level. 

Series-B funding rounds run in tens of millions of dollars, and in some cases, hundreds of millions, depending on the market. The startup at this stage is focused on spending to capture the market through sales and advertisement. Of course product iterations are ongoing always, but the basic product is already optimised for the market. 

Same sort of investors, late stage institutional VCs and angels, are also participating in the Series-B rounds with large cheques coming in this time. The round is usually led by a single institutional investor, or co-led by two or three big investors. Earlier investors may also follow on and some may think about exiting. 

In recent times, Bykea is the only startup in Pakistan which reached Series-B funding in September 2020 and raised $12 million, in a round led by Prosus Ventures. Earlier, Careem, and Zameen.com’s parent company Emerging Markets Property Group (EMPG) raised Series-B rounds and beyond. 

Series-C and beyond

These are the serious rounds raised when the startups has reached a high level or growth and the idea still is to consolidate further. Big funding comes in during this round which can be utilised to introduce new products or services, scale into new geographies and carry out strategic acquisitions. 

By the time Series-C is reached, founders and early investors’ shares have increased considerably in value and sets stage for an exit.Since the value of the company at these stages is high, exits will reap lucrative returns. Series-C funding can be followed on by Series-D and Series-E, or even Series-F in some cases, all focused on raising funds to consolidate as market leader by eliminating competition, scaling into new geographies, setting ground for an IPO or to achieve some other key performance indicator (KPI) set by the startup for itself.

Investors which participate in these rounds are the prominent VCs which inspect the business in and out. Startups affiliated with Pakistan which have made it to the Series-C or beyond are Zia Chishti’s Afiniti, Mudassir Sheikha’s Careem, Shoaib Makani’s KeepTruckin and EMPG helmed by brothers Zesshan, Imran and Haider Ali Khan. All three of these startups are also the only four unicorns which have a Pakistani connection.

Bridge rounds

Sometimes startups need interim funds to make it to the next planned round. In these instances, a bridge round is raised to fund the requirements to make it to the next round. Startups can sometimes miscalculate their funding requirements and raise less in a round. Contrarily, they might spend more than planned, in which case they will need some interim investment to fund their requirement, but only to make it to the next funding round. These rounds, known as bridge rounds, then simply act as a bridge between two funding rounds.

 

 

Taimoor Hassan
The author is a staff member and can be reached at [email protected]

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