From the inception of a start-up company until the point where it becomes a consistently profitable business, all companies have something in common – the need to finance operation and growth. There are various methods for financing a start-up company through debt or equity securities, each of which may be advantageous and/or appropriate at different stages of a company’s development.
Typical types of financing include the following:
Generally bootstrapping occurs when a company is funded solely by the founders without assistance from external sources of capital. Doing so provides founders with the greatest amount of flexibility in terms of running the business but also requires the founders to take on additional financial risk.
A Seed Financing typically involves a relatively modest amount of capital invested to fund the investigation of a market opportunity or the development of the initial version of a product or service. Seed Financings are often provided by the founders themselves, “friends and family” or angel investors. Typical Seed Financing structures include:
A Note Financing is a loan which is either repayable upon demand by the investor or upon a stated maturity date. A note financing is often the simplest investment structure and is often used by founders or “friends and family” investors to allow a company to maintain its operations for a short period of time before an anticipated influx of capital, such as a Series Seed or Venture Capital Financing or receipt of customer revenue.
Convertible Note Financing:
A Convertible Note Financing is a loan where the principal and interest are convertible into current or future equity of the company either at the option of the lender or automatically upon achievement of specified milestones (such as a Venture Capital Financing).
Common Stock Financing:
In Common Stock Financings, investors receive an ownership stake in the company (i.e. they own a certain percentage of the company) in the form of common stock in exchange for their investment in the company.
Series Seed Financing:
In a Series Seed Financing, investors receive preferred stock in exchange for their investment in the company. Among other things, investors who hold preferred stock often receive the right to get their investment back (plus an additional return in some circumstances), called a “preferred return”, before holders of common stock are paid upon the sale or liquidation of the company.
Venture Capital Financing:
A venture capital financing typically results in a larger investment in the company from venture capital firms, in exchange for preferred stock of the company. In addition to receiving a preferred return like in Series Seed Financings, venture capital investors also typically receive important corporate governance rights (like seats on the Board of Directors and approval rights on certain transactions). Companies that receive venture capital financings typically can demonstrate the potential for exceptional growth rates in large markets, and a need for capital to exploit the business opportunity.