How the Startup Funding Process Really Works
If you’re an entrepreneur who wants to start and grow a business, you need to understand the startup funding process. Startup funding is a way for entrepreneurs to get access to capital that can help them start their business, get a business concept up to scale and potentially lead to an Initial Public Offering (IPO).
Before you decide to raise startup capital for your new business, make sure you understand the fundamentals and know what to expect.
What Is Startup Funding?
Startup funding involves working with investors to raise funds that help a great business idea become a valuable business. In exchange for their startup funding money, investors get a share of ownership in the company, also known as an “equity stake.”
There are many types of startup funding, and not every company needs or wants the same things for its funding. Many businesses are “bootstrapped,” meaning that the business owner raises capital for their business independently, “by their own bootstraps.” Some small business owners raise capital by cashing out their home equity, running up debt on their credit cards or borrowing money from family and friends. Other new businesses get money from crowdfunding platforms by offering donors a free sample of the new product being developed.
The type of funding that is most sought-after is “venture capital.” This is funding that the entrepreneur gets from venture capital (VC) investors in exchange for a share of the business ownership.
With this kind of startup funding, the entrepreneur gets something they need (immediate cash to help the business grow) and the VC investors get something they need (a percentage of ownership of the hopefully fast-growing company). VC investors are trying to invest in young companies that have the potential to become the next Facebook or Google. If your company grows to a significant level, both you and your investors can make more money together in a win-win scenario.
Should I Get External Funding for My Startup?
Some entrepreneurs are uncertain about whether it’s a smart move to take funding. Other company founders are overconfident about their business idea, and they try to have conversations with investors before they’re ready.
The decision to get startup funding from investors is a complicated one, and you need to think through a few questions before you approach investors:
- Are you still at the “idea” stage, or do you have a clear path to revenues and profitability? Most VC investors do not invest in “ideas,” they invest in viable businesses. They will typically want to see your balance sheet, business plan and financial projections — an overall sense of how your business is making money and how much it can grow into the future.
- Can you raise money on your own first, without investors? Try bootstrapping, crowdfunding and raising money from your own immediate family and friends. If the people who know you best are willing to invest or loan you money, that can signify your business has real potential. If you create a successful crowdfunding campaign for your business, and have a track record of raising money from everyday investors, future investors will likely see this as a good sign.
- Who is on your executive team? Most VC investors don’t just choose a business to invest in based on the financial data; they choose based on the business’s executive leadership team. Think about how you can balance your own skill set and personal strengths. If you’re really good at product development, make sure you hire a Chief Marketing Officer who’s great at selling the company.
- Do you understand the risks and costs of taking startup funding? Some entrepreneurs are reluctant to take funding from investors because they don’t want to lose too much of their equity in the company. Make sure you understand the implications of what happens to your ownership of your company if you take investors on board. Do you believe that these investors can help your company grow? Do they have a good track record of helping companies like yours? Do they know your industry? Are you at risk of losing control of the company if the business does not succeed or if there are disagreements with the investors and other stakeholders?
Talk with your own legal counsel before signing any deals. It can be flattering and exciting to receive attention from investors, but make sure the deal’s terms are right for you.
Startup Funding Rounds Explained
There are a few different stages or “rounds” of startup funding that you can take, depending on your company’s goals and growth stage.
- Seed Funding: This is the earliest funding round when the company is still at the initial “seed” stage of growth. Seed funding is typically used for market research, product development, hiring staff and other essential business operations to get the company’s product ready to launch. Seed funding might come from angel investors (individual wealthy investors who like to invest in and provide mentoring for small, fast-growing companies), crowdfunding campaigns or the business owner’s personal/professional networks. A round of seed funding might range from $10,000 to $2 million.
- Series A: Many companies don’t need or want any additional startup funding beyond the seed round; they might already have enough capital to reach their goals and get their company up to scale. Series A is the first round of venture capital (VC) funding. With the Series A round, the amounts of money invested start getting bigger, as do the goals of the company; this is for fast-growing startups with big ambitions. As of 2020, the average Series A funding round was $12.5 million. Series A funding is typically used for further product development and refining the business model for scalable growth and profitability. Venture capital firms participate in Series A, along with some “Super Angel” investors (angel investors that provide larger amounts of funding than typical angels) and accelerators (organizations that mentor and invest in tech startups).
- Series B: This round of funding is about helping a successful company get bigger by expanding its reach — new product development, new markets, new talent acquisition, expanding to reach growing demand, etc. The average Series B round is $32 million of capital.
- Series C: This is the biggest stage of venture capital funding for the most successful companies. The goals of Series C funding are often to help prepare the company for an IPO, expand into new markets or acquire other companies.
How to Find Investors for Your Startup
Getting investors for your company can be similar to finding customers for your company. While customers want to know what your product can do for them, investors want to know how much money your company can make for them. Here are a few ways to find investors for your startup:
- Start with your inner circle. Start by asking your friends, family and professional contacts if they would like to invest in your business. If you are at the early “idea” stage of growth, you may not need much money from each investor — maybe a few thousand dollars at most. But getting investors on board early can be a good test of your idea. If people who know you are willing to risk some of their own money on your business idea, it can be a good sign that your business has bigger potential. NOTE: Be aware that sometimes it’s risky to mix personal and business relationships. Don’t ask your friends, family and professional colleagues to risk more money than you’d be comfortable losing.
- Try crowdfunding. There are a variety of crowdfunding platforms available, such as Kickstarter, that let entrepreneurs raise money for a new product or new business idea. If your idea is clear, catchy and compelling, it might go viral on social media. Be sure to give your investors something in exchange for their money, such as a free sample of the product or a free membership to your service or platform. NOTE: Crowdfunding is often a more informal, casual relationship than a typical angel investor or venture capital firm. People who contribute to your Kickstarter don’t expect to receive an equity stake in your company. But even though it’s casual and online-driven, crowdfunding can still be a good way to test the waters for your business idea.
- Find an angel (investor). Angel investors don’t usually advertise or have a website; they don’t want to be bombarded with pitches from aspiring entrepreneurs. Consider joining some business networking organizations in your city, taking advantage of a local Small Business Development Center or attending conferences for your industry to get acquainted with potential angels that like to invest in companies like yours.
- Join an incubator or accelerator. Many cities have local startup incubators or accelerators that provide resources, networking and direct investment opportunities for startups. Incubators are often focused around a particular location or industry vertical. Look for an incubator near you and get involved; there might be other opportunities for your business, along with possible investor contacts.
- Sign up for a contest. Most people are familiar with the TV show Shark Tank, where founders compete to get investments from top investors. But beyond Shark Tank, many local cities have startup contests where entrepreneurs can get a bigger spotlight for their business. Look for startup contests at industry conferences and regional/national business events, too. This can be a great way to get attention for your startup and get noticed by potential investors.
- Get publicity. Attract potential investors by getting publicity for your business in a local business journal, newspaper, industry publication or blog. This positive first impression can have investors seeking you out, rather than the other way around.
The ultimate goal of the startup funding process is to help entrepreneurs and investors make money. If you believe in your business idea and you have a good strategy in place, raising startup funds from investors can be a great way to grow your business faster than you ever could have done by bootstrapping alone.