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The Venture Capital Funding Process

The VC funding process can be illustrated as a funnel as deals flow from the top where they are sourced to the bottom where they are negotiated. This funnel winnows down hundreds of potential opportunities to a few concrete deals. The VC funding process creates this funnel in four stages. Here is a look at those stages: 

1. Deal Origination 

The first step of the funding process has to be getting deals to come into your company who need funding. This can be done in several different ways: 

  • Build strong referral network 
  • Inbound (deals come to VC) and Outbound Sourcing (VC searches for deals) 
  • Use deal origination software like SourceScrub to proactively look for companies that fit your investment thesis. 

2. Introductory Meeting 

The introductory meeting is the step where the investors and potential company sit down for the first time to determine if the company is right for them. Usually this meeting includes a presentation of their business model and a general pitch of why the VC should invest in them. 

3. Due Diligence/Internal Analysis 

Due diligence is the process by which the investors do a deep dive analysis into the potential company to see if it’s really a good fit and a sound investment. Due diligence is a laborious investigation and assessment into every aspect of the investment opportunity. It covers everything from market potential to legal implications, and general business model and plan. This intensive evaluation sheds light on every facet of the company and helps to determine whether or not this company is a good fit for investment. 

4. Negotiation and Investment  

The final step in the VC funding process is to negotiate a term sheet which draws up the potential investment agreement. This step is where final negotiations are made to secure what has been determined (by the three preceding steps) as a good investment. 

In addition to these general funding stages, it’s also important to look at the VC financing cycle from seed to Series C funding. These are the different types of funding that VC firms give out. 

Seed Stage 

The seed stage is the first official round of funding. This is the initial source of capital into the business. Like the name suggests, the funding from this stage is like a seed planted in order to eventually see a flourishing garden. At this stage the business will need that cash to start market research and product development. At this early stage the company may not be operational and may only have an idea of their product and they need the funding to grow that idea into a thriving business. Seed funding investments can range anywhere between $10,000 to $2 million. 

Series A 

Series A funding is used to ensure the continued growth of a business. It can be used to aid in product development and in procuring more talent to help grow the company. Before Series A funding is obtained the VC firm looking to invest will do due diligence and a valuation of the company. “The goals of valuation in series A fundraising include the identification and assessment of progress made by a company using its seed capital, as well as the efficiency of its management team. Additionally, the valuation process demonstrates how well a company and its management use the available resources to earn profits in the future.” As of 2020 the average Series A funding is $15.6 million.  

Series B 

Series B funding comes in once the business has been launched and established, has started its operation, and proven its business model. In addition, securing Series B funding only comes in when the company has been generating stable revenues and has earned some profit. Series B funding is used to take the company to the next level by infusing the capital it has raised and putting it towards sales, marketing, talent acquisition, and developing new technologies. The average capital raised in a Series B round is estimated to be about $33 million. 

Series C 

“Series C funding is meant for companies that have already proven themselves as a business model but need more capital for expansion.” These companies are already quite successful, established, and growing. “At this point, the startup is no longer really a “startup,” but rather an established business with a proven business model, which needs to either expand its product offerings, expand into new markets, or expand its marketing output.” The Series C funding will be used to make strategic investments which can include product development, market expansion, or acquiring other companies. Series C funding is usually between $30 million and $100 million, with an average of $50 million. 

The funding process and financial cycle of Venture Capital firms provide a comprehensive picture of how VC firms spend their money. Through these processes we see the why, how, and who of VC funding.  

Sources: 

Series A Financing, https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/series-a-financing/ 

The Understandable Guide to Startup Funding Stages, https://visible.vc/blog/startup-funding-stages/