Wed. Nov 30th, 2022

Startup Funding: What It Is, How It Works, & 5 Tips for Landing It

Raising startup funding is one of the most exciting, challenging times for a company. The CEO searches for investors, loans, grants, and other forms of funding to help their business grow. If successful, the startup has the capital to continue building its products or providing new features to customers. If not, the company may have to close its doors forever.

Fortunately for entrepreneurs, startup funding is at an all-time high. Global venture funding hit $437 billion in Q3 of 2021, up from $284 billion in 2020. Startups around the world benefit from this influx of capital, with the average global deal size at $25 million.

So, how do you get a piece of the funding pie? This post explains the essentials of startup funding so you know what types are available, how funding rounds work, and how to get money to start and grow your business.

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What is startup funding?

Startup funding is the act of raising capital to support a business venture. Funding comes in many forms and differs by company maturity, but a large majority of companies engage in some sort of fundraising to boost their growth potential.

Companies obtain capital in a number of ways. The funding you hear about most in the news involves raising money through outside investment, known as funding rounds. In those cases, investors exchange capital for equity — or partial ownership — of the company.

High-potential startups attract the most investors, but the capital comes with a caveat — investors often get partial ownership and take an active role in the company’s decision-making process.

If founders don’t want to involve outside investors, they can get capital through small business loans. While loans let you retain full ownership of your company, you’ll have to start paying them back immediately — so this isn’t the best option for a startup without cash flow. If your company is making money, you can look for loans through traditional financial institutions or even online lending companies.

Founders that don’t seek startup funding usually choose to bootstrap, or self-fund, their businesses. They use personal savings or money from family and friends to get their companies up and running.

Bootstrapping is a hotly-debated topic, but it does help founders keep control of their businesses — instead of giving equity to investors — and avoid interest payments from taking out loans. The downside? If the startup fails, the founder loses their savings or that of their family and friends.

Ultimately, every founder needs to figure out which type of funding is right for their startup. But how does it even work? Let’s walk through a typical funding process.

How Startup Funding Works

Now that you understand the basics of funding, let’s walk through how the typical startup funding process works for the founder, the investors, and the company.

Let’s say you’re the startup founder. Your business is becoming increasingly mature, and you’re looking to hire more employees to turn your product prototype into the real deal. But you need funding to make it happen. You want to consider outside investment, so you begin searching for investors.

Investors want to support startups they believe in, but they also want to make a return on their investments. That’s why almost all deals with angel investors, venture capitalists, or private equity firms include equity in the company. The idea is that when the company begins to earn a profit, the investors will get their initial money back — plus the extra slice of equity for taking a chance.

Companies looking for outside funding usually begin with a seed round before continuing on to Series A, B, and C rounds. But before any rounds begin, a company valuation must take place. A valuation considers the startup’s maturity, management, market size, track record, profit, and risk, which can impact what type of investors are interested in the company and how much new capital it can bring in.

Once the valuation is complete, startups can begin a funding round. The timeline and process vary by company — some founders search for investors for months, while others close a round in a matter of weeks.

And while certain startups move slowly through each funding round, others build capital much faster. It’s not uncommon for an innovative startup to raise a few million in one to two rounds, while another company raises $25 million in the same number of rounds.

This video by The Rest of Us gives a detailed explanation of the funding process.

Startup Funding Rounds

Seeking new capital can be confusing. Let’s look at each funding round and what it means for founders, companies, and investors.

Pre-Seed Funding

While not a traditional round, pre-seed funding takes place as founders are getting their companies off the ground. It’s the earliest stage of funding a company, and it usually involves an investment from the founder’s personal savings, family, friends, supporters, or network of other founders. This round can go on for years as a company establishes its legs. Or, if a company can prove itself, it can happen rather quickly.

Seed Funding

Seed funding is the first official funding a company raises, and it’s often tied to equity. This capital helps a startup finance its first steps, like conducting product research, launching a product, marketing to a target audience, and building an audience. Think of this stage as the “seed” by which the rest of the company is able to grow and flourish. Without it, a founder wouldn’t be able to hire a team or test their idea in the market.

Seed funding can come from family, friends, angel investors, incubators, or private equity firms. But the amount varies widely — some companies raise $10,000, while others raise $2 million. On average, companies raising a seed round are valued between $3 million and $6 million.

Series A Funding

When a business uses its seed funding to develop a product and build a customer base, it may be time for a Series A funding round. This capital is often used to expand a company’s product offerings, bring in more customers, and develop a long-term plan for growth.

That’s why startups going through this funding round attract investors from traditional private equity firms, such as Sequoia Capital, Greylock, Accel Partners, and more.

Capital raised during Series A rounds can range from $2 million to $15 million, but with increasingly high valuations in the tech industry, high-growth companies have raised significantly more in this round.

Series B Funding

Series B rounds are all about business development and how to reach the next level of growth. The capital raised in this round goes towards supporting an established customer base by hiring new talent and boosting sales, marketing, tech development, and customer support. 

Companies undergoing Series B rounds tend to be valued between $30-60 million and raise an average of $33 million. A higher valuation and a proven business plan tend to attract the same high-level investors as the Series A round, in addition to later-stage investment firms.

Series C Funding

Series C funding rounds are for successful startups that need extra funding to help create new products, acquire other companies, expand into new markets, or hire an exceptional leadership team. The capital is meant to help scale the company’s efforts so it can grow as quickly as possible — and since investment is less risky by this round, new investors come into play. 

This can include private equity firms, hedge funds, secondary market groups, or investment banks that want to cement their place in the world of successful investment. Companies in the Series C stage are often valued at or above $118 million and use this round to boost their numbers before an IPO.

Series D and Beyond

Not many companies extend beyond Series C into Series D or E rounds.  The ones that do are often looking for a final influx of capital before an IPO or need more funding to achieve the goals they set out to accomplish in the Series C stage. A company at this stage of funding should have an established customer base, revenue streams, a track record of growth, and a solid plan for how it will utilize new capital.

5 Types of Startup Funding

The number of funding options can be overwhelming for a new startup. We rounded up the common types of startup funding to help you understand what’s out there and how it aligns with your company’s goals. 

1. Loans

Plenty of options exist for financing your startup through loans. The U.S. Small Business Administration offers programs, such as the SBA microloan, to provide companies with up to $50,000 of working capital. The money can be used to build, repair, enhance, or re-open a business. 

If you have a strong credit score and personal finances, you can also take out a personal business loan. This type of loan may have a lower interest rate and a quicker approval time — but make sure your lender doesn’t have restrictions about taking out a loan for business funding. 

Another option is a microloan, which is great for founders who may not qualify for standard business loans. This type of capital can help a founder build their credit score so they can access more funding in the future.

2. Grants

small business grant is an investment given to a business by a government, corporate, or non-profit entity. Grants are mission-driven, so your business goals or values have to align with the organizations’ in order to apply for and be awarded the capital. Since grants are considered gifts, they don’t have to be repaid. 

3. Crowdfunding

Crowdfunding is a way to raise money online in exchange for rewards, equity, debt, or nothing at all. Small businesses can use crowdfunding sites to quickly access cash, but at the cost of building a strong promotional strategy, giving up equity in the business, and being transparent about the company’s health. 

Interested? Get your next business or product off the ground with the help of these crowdfunding sites.

4. Private Equity Firms

High-growth companies and venture capitalists often suit each other well. Unlike other forms of startup funding, there’s significant risk involved. If a company fails, the investors won’t see a return on their contributed capital. But if a company succeeds, the payout can be in the millions. 

Investors hope the companies they invest in go public or get acquired and are able to pay back their investments, plus interest. While private equity firms get involved in a company’s dealing by sitting on the board or acting as advisors, they have a stake in it and will do what they can to help it succeed.

5. Incubators and Accelerators

Incubators and accelerators are programs for startup companies that provide capital, mentorship, and networking. There’s a slight difference between the two, which you need to know if you’re considering this type of startup funding. 

Incubators help entrepreneurs build their business, so they focus on developing a business plan, name, website, and minimum viable product (MVP). If a company already has an MVP, an accelerator expedites growth. Here, founders receive mentorship, funding, and networking connections.

Startup life is fickle, and funding has traditionally been accessible for a small, elite group of founders. That said, the industry has been shifting to support founders who haven’t been given access to private equity, loans, or grants. 

Sustainable funding resources are essential for equitable entrepreneurship, and this guide outlines financial programs for Black founders. But it also includes funding for people with marginalized identities, such as non-black people of color, veterans, women, the 2SLGBTQI+ community, and people with disabilities. 

For more ways to access capital, founders can look to these private and public funding opportunities.

How to Get Funding for Your Startup

Startup fundraising is part art, part science. It depends largely on your business idea, your background, and your access to financing. Given the variety of factors that can influence funding, it’s important to improve your chances by following these steps.

1. Calculate your funding needs.

Before reaching out to investors or applying for a loan, you need to know how much money you need to achieve your business goals. Looking for a small, one-time sum? A business loan or grant might be the right fit. A larger contribution? An angel investor may make more sense. Understanding your funding needs lets you take the best approach. Use this calculator to figure out your costs.

2. Create a business plan.

Investors, lenders, and even family members will want to see a business plan before handing over money. The plan should outline the opportunity, team, target market, industry, implementation, marketing plan, financial summary, and required funding. This business plan template makes it easy to create a detailed plan so you can start pitching your idea.

3. Evaluate your financial health.

You can’t figure out what type of funding you need if you don’t know where you stand today. Gather business and personal tax returns, bank statements, a profit and loss statement, and revenue projections to help you (and investors) understand how much funding you have on hand — and how much you still need.

4. Research funding options.

Reading this post may have opened your eyes to the types of available funding. Before you choose a specific type, do an extensive amount of research to see if it’s right for your business. There are hundreds of resources available online about how to approach investors, apply for business grants, or distribute equity.

5. Make a repayment plan.

Accepting capital is no small gesture, especially if it’s millions of dollars. Most founders only need several thousand dollars to get started, but it’s still wise to create a plan for paying back the money you borrow. You can use a business loan calculator to estimate payments and work them into your budget. If you can’t make the payment, don’t take the funding.

Find your startup funding.

No one type of funding works for every company. Some businesses need a massive amount of capital from outside investors to bring ideas to life. Others need a small loan to push them toward higher revenue and financial freedom.

Whatever the case may be for your business, it’s best to consider your current finances and funding options before choosing a set route. You can look at what similar businesses in your industry have done, calculate a loan repayment plan, or find inspiration for a crowdfunding campaign. We hope this post gave you a starting point to find the funding you need to bring your business to life. Now go out, and get that money.

SOURCE https://blog.hubspot.com/sales/how-startup-funding-works

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