What is Startup Funding?
Definition: Startup funding – or financing startups – is an investment in companies founded by entrepreneurs who are interested in developing a product or a service, and validate a viable, scalable business model.
Understanding Startup Funding
Every startup starts as an idea. Often, to make this idea a reality, you need to have the capital to both help you develop, build, and execute the plan, and to establish a working, living, breathing, and hopefully, super-successful business. The startup funding you receive is a crucial stage in the life of every startup company. It has a significant effect on how the company’s holding structure, valuation, financial framework as well as its business model and the time it will be allowed to operate until the next fundraising.
Many entrepreneurs who are just starting out on their innovative journey might find this a complicated phase, and not all startups will succeed in their fundraising efforts. However, to most startup entrepreneurs, particularly those associated with new, deep technologies, funding is a necessity.
What Types of Startup Funding Are There?
The money needed to launch a new business can come from a variety of sources:
- Personal savings and credit. Self-funding of startups by the founders themselves (Bootstrapping). Many entrepreneurs believe in their disruptive, innovative idea so much so that they are willing to put their money where their mouth is and use their own capital to help the company establish itself. This type of funding does not require a dependency on any other entity, however, the amount of personal funds entrepreneurs are willing to risk is often limited.
- Friends and family. The closest people to us are often people we can trust, the ones that truly know who we are and what our aspirations are. It is only natural that while looking for startup funding, they will be easily convinced to write a check. Along with the ease of raising the funds, keep in mind that the relationship must be properly and clearly defined (legal documentation and setting return of the investment is highly advisable). Some founders avoid fundraising from their friends and family, as it might have potential personal complications.
- Venture capital. Venture Capital (VC) funding is an essential source of raising capital for startups. It is a form of private equity financing provided by investors in venture capital funds or firms to startup companies and businesses with high growth potential, in exchange for equity or an ownership stake. Getting the support of a venture capital fund is not only about the money, though. It provides technical and managerial expertise, business, and networking opportunities to help create value for companies, so they continue to grow and expand.
- Angel investors. An angel investor is a private investor. A high net worth individual who provides capital for a business startup and entrepreneurs, usually in exchange for convertible debt or ownership equity. Angel investors usually make decisions on investments on their own.
- Banks. Small business loans are also a way to help startups get off the ground. Traditional banking institutions are usually careful with their investments and often retain full ownership of the startups they choose to invest in.
- Grants. Government grants are financial awards given by a governmental authority, many times tied to a governmental agency which has clear requirements for startups who want to be qualified for receiving the funds, as well as how to use them.
- Accelerators. Startup accelerators are programs built to offer a combination of funding, guidance, and mentorship to help startups take shape.
- Crowdfunding. Raising money from the public, mostly through online platforms and social media. In some cases, a startup crowdfunding is done in exchange for a proportionate slice of equity in the new company.
Startup Series Funding
To get a startup going and to keep it expanding, founders many times raise money through a series funding. Founders often start with Seed Funding, and as time goes by and the company grows, they move to Series A, B, C, D, and sometimes E and further. Simply put, a series funding is the process of growing a business through outside investments.
Understanding the distinction between these rounds of raising capital is very important, as well as understanding that each startup’s path is a little different than the other.
In usual funding rounds, each Series can include a combination of investors. Investors put money in the startup, and in return for their investment, they receive a stake in the business, and may request or sometimes demand the startup to operate according to specific instructions. If the company grows and earns a profit, the investor will be appropriately rewarded.
Ahead of any startup funding round, the company’s valuation is reviewed by analysts with the expertise to do so, according to factors such as the team, the market size, etc. The valuation of the business, alongside its growth prospects and stage of development, are key markers that separate between funding rounds. These factors predicate the investors willing to join the round and the impetus to seek new capital.
Investors Expectations For Each Stage of Startup Series Funding
|startup funding strategy||Financing Round||Startups Expected to Show|
|Get the startup up and running||Pre-Seed||A strong team, a plan for developing a business model based on an innovative idea, a product/market fit, a prototype or an early version of the product.|
|Prove worthiness||B||A product that works, an expansion plan, knowledge of how to increase revenues.|
|Grow the business||C||Readiness for new markets, acquisitions of new businesses, the development of new products.|
|Expand operations||D and up||How additional funding will allow them to expand in a new way, why they want to stay private and the areas in which an additional funding may help the company.|
|Exit / IPO / Viable business|
Fundraising for startups happens in stages or rounds that depend on the status of the company and product. At each funding stage, a startup is expected to show certain levels of progress and milestones. These milestones are typically evaluated by investors to assess the startup’s potential for success and to determine whether and how much to invest in the company. Funding for startups can take anywhere from weeks to months to find investors. The size of the rounds differs depending on the stage and other factors such as the product, market, valuation, and the growth strategy.
At this initial stage, the fundraising startup is focused on getting up and running and developing and testing its idea or product. Investors are typically looking for a strong founding team with complimenting expertise in the relevant markets, a unique and innovative idea, and early signs of market validation, such as customer interest or early adopters.
The startup looking to raise its seed investment round should be focused on building a strong team and refining its business model/prototype. Investors at this stage are looking for evidence of product-market fit, customer feedback, and at some cases an early user base.
This stage represents the startup’s readiness to scale its business and expand into new markets. Investors at this stage are looking for evidence of sustainable revenue growth, an expanding user base, and a clear path to profitability. The startup should also be focused on expanding its strong team and refining its business processes.
To raise its Series B round, the startup should have established a product that works, a strong market position and be ready to scale rapidly. Its goal is to prove its worthiness to get returning investors to continue adding capital and to get additional investors to join the round. Investors are looking for evidence of continued revenue growth, expansion into new markets, and the potential for large-scale disruption. The startup should also be focused on building a strong brand and further refining its business processes.
This round represents evaluating a startup’s readiness for new markets, possible acquisitions of new businesses, and the development of new products. The fundraising startup should be a well-established market leader with a proven business model and a clear path to profitability. Investors at this stage are looking for evidence of sustained revenue growth, a large and expanding user base, and a strong competitive advantage. The startup should also be focused on further scaling its business, expanding globally, and possibly preparing for an IPO or acquisition.
Series D and up
At this point, the company has achieved significant market traction and growth and may be looking to expand its operations and establish a dominant position in its market segment. The funding is often used to finance the company’s growth plans and expand into new markets, products, or services. Although many choose to IPO, some startups choose to stay private to maintain control over their operations and strategy and avoid regulatory requirements.
Understanding startup funding including the types of funding, different series rounds, and investor expectations at each stage is critical to the growth and success of any startup. Founders go through many challenges throughout their entrepreneurial journey and should be aware of all their options and financial models that best support their business.