One of the most exciting and challenging times for a company is when it raises startup funding. To help their business grow, startup founders look for potential investors, loans, grants, and other sources to raise funding. If the startup is successful, it will have enough money to keep developing its products or offering additional services to potential customers.
This post explains the key factors of startup funding so that you know the types of funding available, funding rounds, and methods for raising money to launch and expand your business.
What is Startup Funding?
Startup funding, often known as startup capital, is the money required to establish a new business. Funding can be obtained from various sources to get a startup from an idea to an actual business.
Startups need more than just an idea to achieve success. They require a lot of work, commitment, dedication, and funding. According to a study, 60% of all startups rely on investors to raise funding.
11 Types of Startup Funding
Grants
Government Support
Governments are working to increase bank lending to small and medium-sized businesses in different countries. A frequent approach is to guarantee a part of the loan, which minimizes the bank's risk.
Government-backed loans often offer better repayment terms over a longer period, which makes them particularly appealing to new businesses. These loans come with strict eligibility requirements, so read up on them before applying for a loan.
409A Valuations
409A valuations are used at different funding stages. A startup company valuation determines the value of the business, which is crucial for founders and startups. The valuation process determines how much equity a founder should give in exchange for financing from an investor.
There are other determining factors, including the ability of the investor to pay a premium to enter the contract. Sometimes founders are desperate in their search for funding that they end up undervaluing their business.
Investors want a greater ROI with a low valuation, whereas founders want a high valuation.
SBA loans
A loan that's backed by the Small Business Administration (SBA) is known as a small business loan.
The SBA is a federal government organization that was founded in 1953. They offer assistance to small business owners through mentoring, seminars, coaching, and small business loans.
The SBA backs the loans, but the loans themselves are not issued by the SBA. To obtain the funding, you need to locate a nearby lender who offers SBA loans. Some of the best SBA lenders are Live Oak Banking Company, The Huntington National Bank, and Newtek Small Business Finance.
Accelerators
Y Combinator and Techstars are the two most well-known accelerators.
Typically, the accelerator program begins with an application phase, after which successful businesses are invited to participate in a particular region. What lies ahead is an extensive mentor program that founders take from a few weeks to a few months.
The accelerator offers a large network of mentors and investors that can be a great asset for developing your startup and helping you raise money in the future. Most accelerators also include a demo day inviting investors to visit your business.
On the other hand, accelerators aren't free. Some accelerators provide startup funding for a percentage of equity in return, and others might charge an admission fee or include you in their corporate network.
Incubators
Most incubators offer to mentor, share a co-working space, and provide a month-to-month lease plan. All businesses can benefit from one another's experiences as they develop their ideas and products, prove product market fit, and design pitch decks.
Although incubators don't provide direct startup funding, they can be a critical element in bootstrapping your business because the space they provide will cut your costs. They also offer a wealth of knowledge.
Most incubators are run by reputable investors, public institutions, and large corporations. Incubators may be focused on particular technologies, industries, or even markets, depending on the sponsor.
Equity-Based Funding
Angel Investors
High net-worth individuals who invest in startups with relatively small sums of money—often between a few thousand and a million dollars—are known as angel investors. Angel investors are a crucial part of early-stage startups as they're one of the most accessible forms of early-stage funding.
The main advantage of partnering with them is that business angels can frequently make financial decisions on their own. Angel investors can make bets they feel comfortable with personally because they don't have to manage a partnership or corporate hierarchy of decision-making. Angel investors are what startup founders need in the earlier stages of growth.
Venture Capital
Venture capital is funding invested in startups and small companies that have the potential for rapid growth but are typically high risk. When venture capitalists invest in a startup, their aim is a high ROI - usually in the form of an IPO or an acquisition.
Funding by venture capitalists is a great option for startups aiming to scale up rapidly. As venture capitalists offer large investments, your startup must be prepared to grow.
Credit Based Funding
Credit Card
Several credit card companies cater to small businesses, offering additional perks such as cashback rewards, airline mileage points, and other benefits.
Some issuers require credit cards to be linked to the owner's credit score and history, as well as a guarantee from the owner. Any defaults or late payments on the business credit card would impact your credit rating.
Credit card interest rates can range from 5% to 19.9% on unpaid balances. Some issuers don't charge an introductory interest for the first few months, while others request low charges.
A small business credit card can be obtained through your bank or online. Capital One, Wells Fargo, Chase, Bank of America, and American Express are the most prominent lenders to small businesses.
In addition, there has been a new wave of credit card issuers that focus on the small business market and don't require personal guarantees, which means that using the card will not affect your credit score. A good example of this type of issuer is Ramp, Expensify, and Stripe Corporate Card.
Bank Loan
For small business owners, banks can offer a wide range of bank loans, including short- or long-term financing for almost every venture. The only requirement is that you have the sufficient cash flow to cover the principal and interest payments. This will determine whether or not you're granted a loan.
You can frequently use your own home and other possessions and assets as loan collateral. Due to corporate banks' general decline in lending to early-stage companies, community, and local banks currently offer more loans to small businesses.
Another benefit of asking for a loan through a community bank is that local banks have a reputation for being creditworthy, even if your new startup hasn't yet demonstrated that.
Hard Money Loan
Hard money business loans are secured by your company's commercial real estate, which includes land and property. Hard money loans heavily rely on collateral. They're intended to accommodate business owners who don't qualify for other types of financing options.
Small businesses or those with poor credit generally prefer hard money loans because they're easier to obtain. Hard money loans are more expensive and thus are difficult to repay.
You can apply for a hard money loan through Flip Funding, Groundfloor, and Kiavi.
Other Funding Methods
Personal Savings
The majority of startups raise capital from personal savings. Founders must be willing to go all-in personally if they hope to find investors for their unique idea.
As you don't need to rely on anyone but yourself to use personal savings, this is also the most accessible type of funding.
Friends and Family
Many founders ask their friends and family for financial assistance. Since they already support your endeavors, you don't need to persuade them in the same way you would a venture capitalist, angel investor, or bank.
Starting your business with friends and family can be a great idea. Still, it's essential to follow due diligence and ensure that the professional aspect of the relationship is made clear. Make sure everything is legally documented, and let your loved ones know they might not get an ROI. Some business owners avoid this sort of funding due to the possibility of personal complications.
Crowdfunding
Crowdfunding is the method of raising money through the combined efforts of friends, family, customers, and potential investors. This method uses the collective efforts of a large number of individuals. Their networks are used to expand reach and visibility. It's mostly done online through social media and crowdfunding platforms such as Fundable, Kickstarter, and Patreon.
How Can a Startup Get Funding?
To fund your startup, follow these five steps:
Determine how much funding your startup needs
A business credit card is the best option if you need to finance a large, one-time purchase. An investor is the better option if you need a large capital sum. Determine your required capital before submitting an application or reaching out to your network.
Prepare a pitch deck
Many lenders and potential investors require a pitch deck. This document should, among other things, outline your business model, management team, funding requirements, financial projections, and how you intend to make a profit.
Compile important documents
These documents often include business and personal tax filings, bank and financial statements, and other legal documents about your company.
Determine the best type of funding for your startup
Conduct research to determine which type of funding is best for your company, and then target your applications accordingly.
Make sure you can repay it
Before you borrow money, make a plan for how you're going to repay it. A credit card payoff calculator or business loan calculator can assist you in estimating your payments and ensuring that they're within your budget for due diligence purposes.
Funding Rounds Explained
Here are the different stages startups go through during their fundraising process:
Pre-Seed Stage
The pre-seed stage is the startup's initial research stage. Answer the following questions during your pre-seed funding round:
- Is your plan practical?
- Has your concept already been used?
- How much will your operating expenses be?
- Which business model will you implement?
- How are you going to start?
- What are your day-to-day operations going to be?
In many cases, you or your family and friends provide most of the business capital during this early pre-seed stage. During the pre-seed round, the overall worth of companies might range from $10,000 to $100,000.
Seed Round Funding
After the pre-seed round, your idea has developed into a functioning business with some customers during the seed funding round. The seed round is the first venture capital round that new startups raise.
To convince investors to fund your company during the seed funding stage, you must give them company equity in exchange. The costs covered by seed investors during seed rounds include:
- Market research
- Minimum viable product
- Product launch
- Product market fit
- Product promotion
- Personnel consisting of the founder, co-founder, and other team members
Startups between $3 million and $6 million are eligible for seed funding.
Series A Funding
Venture capitalists become investors during the Series A funding stage. Just like the seed-funding stage, Series A funding offers company equity in exchange for funding.
You can begin setting up your company for future growth during this stage. This includes the following:
- Improve your product or service
- Offset financial shortfalls or losses
- Optimize your business
- Create a scalable growth plan
Series B Funding
In this stage, companies have a strong customer base and a consistent market share. You've already shown that you can scale your idea. Now, investors can assist you with the following:
- Advanced market reach
- Increased market share
- Create operational teams for areas such as marketing and business development
Series C Funding
Series C funding is given to successful companies that are already grown and want to expand internationally. Finding investors may be simpler at this point if they believe the company will prosper. At this series funding stage, money is invested in the company for the following things:
- Building new products or offering new services
- Reaching new markets
- Purchase of underperforming startups in the same market
Series D Funding and Beyond
There are two main reasons why a company goes past series C:
Potential opportunities
A potential opportunity might arise that requires your company to act before the IPO (Initial Public Offering) and choose to sell equity in return for common stock options. At this point, some founders choose to utilize an exit strategy and sell their business altogether.
Not performing as well as expected
In other cases, the founder may seek to raise more funds if their startup hasn't reached the expected goals in the series C funding stage. There isn't a limit to how many funding rounds a startup can go through. If a startup has higher revenue goals, more investment is required.
Which Type of Funding is Best for Startups?
The best type of funding for your company ultimately comes down to your specific goals and risk tolerances. Your startup can obtain investment from almost anywhere. Now that you're familiar with the different funding sources, you can decide which one best meets your requirements, demands, and objectives. Make sure to follow due diligence, keep your options open, and explore multiple options before making your final decision.
Oran Yehiel: October 17, 2022
