The Lifecycle of a Startup: From Seed Funding to Initial Public Offering (IPO)

Pre-seed and seed: proving the idea

In the earliest stage, founders often fund the company themselves or raise small amounts from friends, family and angel investors. The goal is to build a prototype, test demand and assemble a core team. Accelerator programs can provide funding, mentoring and connections in exchange for equity.

Seed rounds typically fund the search for product-market fit, the point at which a product clearly satisfies a market need. Many seed investments use simple agreements for future equity, known as SAFEs, introduced by the accelerator Y Combinator in 2013, or convertible notes. Both defer setting a precise valuation until a later priced round.

Series A, B and beyond

Once a startup shows traction, it raises priced equity rounds, usually labeled Series A, B, C and so on. Each round typically involves venture capital firms buying preferred shares with negotiated rights, such as liquidation preferences and board seats.

Series A investors look for evidence of a repeatable business model. Later rounds fund scaling: expanding into new markets, hiring rapidly and building infrastructure. Growth-stage rounds may include investors such as private equity firms, hedge funds and corporate investors.

• Pre-seed and seed: validate the problem and build an early product.
• Series A: show a repeatable way to acquire and keep customers.
• Series B and C: scale the business and expand the team.
• Growth and late stage: prepare for profitability and an eventual exit.

Valuation and dilution

In a priced round, investors agree on a pre-money valuation, the company's value before new money arrives. The post-money valuation equals the pre-money valuation plus the new investment. An investor's ownership equals the investment divided by the post-money valuation.

For example, if a company with a pre-money valuation of 16 million dollars raises 4 million, the post-money valuation is 20 million and the new investor owns 20 percent. Existing shareholders are diluted proportionally: founders who owned 60 percent before the round own 48 percent afterward. Dilution is normal and acceptable when the capital increases the value of the whole company faster than ownership shrinks.

Most companies also set aside an option pool to grant equity to employees, which further dilutes existing holders and is often negotiated as part of each round.

Terms that matter beyond valuation

Headline valuations get the attention, but the terms attached to preferred shares often matter as much. Two offers at the same valuation can produce very different outcomes for founders and employees in a modest exit.

• Liquidation preference: investors get their money back, often one times the investment, before common shareholders receive anything in a sale.
• Anti-dilution protection: adjusts investors' conversion price if a later round is priced lower, most often on a weighted-average basis.
• Pro rata rights: let existing investors maintain their percentage by participating in future rounds.
• Board composition: determines who controls major decisions as the company grows.
• Founder and employee vesting: commonly four years with a one-year cliff, so equity is earned over time.

Down rounds and failure

Not every round raises the valuation. When a company raises money at a lower valuation than the previous round, it is called a down round. Down rounds can trigger anti-dilution protections for earlier investors and hurt employee morale, although they may be the only way to keep a company alive.

Many startups fail before reaching an exit. Venture capital returns depend on a small number of very successful investments compensating for many that return little or nothing, which explains why investors push for rapid growth and large markets.

Paths to an exit

Investors eventually seek liquidity through an exit. The most common exit is an acquisition by a larger company, which can happen at any stage. Public listings are less frequent but tend to involve larger, more mature companies.

Companies can go public in several ways. A traditional initial public offering raises new capital with the help of investment banks. A direct listing, used by Spotify in 2018, lets existing shareholders sell shares on an exchange without issuing new ones in the usual way. A special purpose acquisition company, or SPAC, merges with a private company to take it public, an approach that surged in popularity around 2020 and 2021.

How a traditional IPO works

The company hires underwriters, investment banks that help prepare the offering, set the price and distribute shares. It files a registration statement, the Form S-1 in the United States, with the Securities and Exchange Commission, disclosing its business, finances and risks.

Management then conducts a roadshow, presenting to institutional investors. The underwriters gather orders in a process called bookbuilding, and the final price is set the evening before trading begins. Insiders are usually subject to a lock-up period, commonly 180 days, during which they cannot sell shares.

Life as a public company

Going public brings access to capital and liquidity for shareholders, along with new obligations. Public companies must file quarterly and annual reports, hold earnings calls, comply with governance rules and face scrutiny from analysts and investors. Stock prices can be volatile, particularly in the first year after listing and when lock-ups expire.

For investors, IPOs offer a chance to buy into growing companies, but early trading can be unpredictable, and many newly listed companies have underperformed the broader market in the years after listing. This guide is educational rather than investment advice.