If movies – and certainly reality TV – were to be believed, securing funding for your startup would be fairly quick, involve a significant influx of cash all at once, and only require minimal embarrassment. Although the potential for embarrassment is never really off the table (especially early on in the life of your business), the truth about startup funding is that it isn’t nearly so scripted.
As much fun as stories of overnight success are, funding almost always takes time, and it rarely happens all at once. In fact, it’s because the entire funding process has so many misconceptions – along with its own confusing vernacular – that clarification, explanation, and some behind-the-scenes industry insights are necessary. In this guide, we’ll tackle the terminology, walk you through the key steps, and make sure you have a roadmap for navigating funding success by the time you finish reading. How does startup funding work? It’s time to find out.
A Quick Fundraising Overview
Before we go any further, remember that fundraising is a process, and like any good one, there’s more than one step involved, and a clear plan is required. In order to successfully raise capital, the process begins before you even talk with your first investor. Prior to diving directly into action, here are seven steps you’ll need to execute to get your idea funded:
Forecast your financials – how much do you need, and what do you plan to do with it?
Put together a pitch – start by reading this valuable piece on why pitch decks fail
Develop a list of potential investors – who do you know?
Schedule meetings, show up, and pitch your idea – this is the work
Have a system for receiving proposals and responding – organization is key
Navigate the (occasionally lengthy) due diligence process – keep your eyes on the prize
Prepare and execute required documentation and accept funds – it’s go time!
How Funding Works
Those seven steps almost make the entire funding process look easy, and maybe yours will be. We sure hope so. It’s worth preparing for it not to be, though. To be clear – and beyond those steps – startup funding only works if you have a good idea. You may be incredibly likable, have a well-polished pitch, and bring lots of energy to the table. Each of these is to your advantage. However, if you have a bad idea, no one is going to invest their money in your startup. Of course, there may be family and friends who want to see you succeed and are happy to push some dollars your way, but the money you need to actually get your business off the ground won’t materialize.
Let’s start with the assumption that your idea is solid, though, because, of course, it is! You’re about to turn the market upside down and you’re going to have fun doing it – if you can get the funding you need, that is. Depending on how much money your startup requires, who (and how many people) you’ll need to work with will differ. In order to keep track of everyone, it’s helpful to categorize your potential investors into groups. The importance of maintaining some order here can’t be underemphasized. Knowing who you’ve talked to, where they are in the decision-making process, and what the next steps are will keep you from feeling like you’re flailing. The flailing founder is a bad look. That’s a promise.
Organize Investors into Groups
Between your family, a couple of colleagues from the place you used to work, the friend-of-a-friend who mentioned investing that one time at a barbecue, and at least a dozen of the people you’re connected to on LinkedIn, it may be difficult to imagine any real groups at all. As your network expands, it’s worth thinking about organizing your potential investors like this:
Friends and Family
These are people you know personally or at least socially. Typically, they are some of your earliest investors, cheerleaders, and advocates. Eventually, they may not have invested the largest sums of money, but they championed your idea long before anyone else was clamoring for a chance to get on board. These are good people, and you’re lucky if you have a few of these. This group isn’t a guarantee. Remember that and don’t forget to thank them.
As the name suggests, this is a special group with the ability to change the game for you and your startup. Angel investors are frequently accredited, which simply means they are someone whose:
- Net worth either exceeds $1M (excluding the value of their home), or
- Individual income exceeds $200,000 (consecutively for the last two years), or
- Joint income (with a spouse) exceeds $300,000 (consecutively for the last two years)
Angel investors put their own money into startups in exchange for a percentage of ownership in the business or as convertible debt – that is debt that can be converted into common shares at a future date.
Here’s a tip: Look for Angel investors who are local to your area and who also invest in your market or industry. Your odds of converting this prospect into an investor are much greater when both of those boxes are checked.
Venture Capital Firms
Unlike angel investors who are investing their own money, venture capitalists (or VCs) raise capital through private equity funds. With their own trusted network of investors, VCs build interest, excitement, and – hopefully – some capital on behalf of your startup. Like angel investors, venture capitalists exchange the funds they’ve raised for a piece of your company.
While the first three groups probably made plenty of sense, including your earliest employees might leave you scratching your head. Here’s the deal, though: often, those initial hires are clocking in and out because they really like you or they believe in the idea. Maybe it’s both. It’s great when it’s both. Your startup has a lot going for it but the salary isn’t topping anyone’s list. In exchange for working for next to nothing, early hires will often accept shares of stock. In practical terms, these employees have more skin in the game than most. They’ve accepted a reduced wage and they’re working to help you build your business. That’s a solid investment.
Now, what about the “rounds” founders and investors are always talking about?
StartUp Funding Stages Happen in Rounds
Again, funding isn’t an overnight process. As your investor groups organize and grow, so too will your opportunities to raise capital. Of course, the needs of your growing startup will also change, as will the company’s appeal to potential investors. Here’s what you need to know about how startup funding works.
Pre-seed Funding Stage
If you’re nervous about beginning the funding process, here’s some good news: you may have already experienced your first round without even fully realizing it! Pre-seed funding typically happens when a founder (or a group of co-founders) injects their own money in an effort to get the company off the ground. Family and friends who simply want to see you succeed – that is, who aren’t investing in a strict sense – may also be included in pre-seed funding.
If the pre-seed funding stage felt less than official, the seed funding series is where that changes. In this round, the focus is on growth, because that’s what seeds do. Potential investors are able to look at your business like a seed and ask themselves a few pertinent questions. For example:
- How much potential does this business have to grow? (TAM = Total Available Market)
- Are the conditions right for success? Is there Product:Market fit? Is there revenue traction?
- Is money the only thing preventing growth or expansion? How strong is the team?
Thinking back to the groups of investors you’re working with, several of them will be drawn to this round. While friends and family may certainly take this opportunity to invest officially, venture capital firms and incubators will too. Seed funding is also a chance for an angel investor to enter the picture since they often appreciate the risk/reward ratio of a brand new venture.
Know What You Need (and Who is in Your Network)
While it’s impossible to project what a seed funding round might look like for cash in the bank for your startup, much of your success in this round will come down to need and network. Normally a good seed funding round can produce anything from five to seven figures. If your funding needs are relatively small and you have a broad network of potential investors to work with, it’s possible that your startup will receive all of the funding it needs to launch and be sustained. On the other hand, if you know you need several hundred thousand dollars or more, it’s possible that other rounds of funding will be necessary. This isn’t unusual. Here’s what you need to know.
Series A Funding
Ideally, between pre-seed and seed funding, you were at least able to get your startup off the ground. All of your funding issues aren’t solved yet, but the wheels are turning. Yes, of course, it may have been nice to raise all the startup funds and capital you needed early on, but that’s not what happened – which could be to your advantage. You have a tremendous opportunity to focus on key performance indicators – from developing a customer or client base to maintaining consistent revenue numbers.
Creating this kind of track record sets your startup apart. It’s an opportunity to demonstrate that your business is more than just a good idea. At this point, you have something tangible – some proof. As with each funding round, a key (or “anchor”) investor can often generate interest among other investors once they sign on. If venture capital firms were slow to invest during the seed funding round, know that they will be paying attention this time. Angel investors may still look for an opportunity, however, with the kind of capital that is often raised in a Series A round, private equity crowdfunding has the opportunity to create a significant impact.
Series B Funding
For startups that are past the development phase, Series B funding has the potential to elevate your business or brand to the next level. Much of the basis for Series B funding comes from unmet demand. In short, your startup may grow quickly – faster than even you can imagine. Sustained growth presents an opportunity for later-stage investing, because production or warehouse space, talent acquisition, expanded technology to boost supply takes an infusion of cash.
Companies that fall into the Series B category are well-established. Their valuations range from $30 to $60 million. As with Series A, a key investor – someone with their own track record of investing wisely – can be helpful to get the ball rolling, and you can expect even larger VC groups to get involved before the chance is gone.
Series C Funding
Businesses that navigate their way from seed funding rounds to Series C funding all have one thing in common: they are really successful. At this point, additional funding isn’t about making payroll or staying afloat, but rather things like new product development, market expansion (nationally or internationally), and/or competitor acquisitions or mergers. These are all questions of scale, and for businesses ready for Series C funding, scaling as quickly as possible is the goal.
While additional funding rounds (including Series D and E) do exist, the businesses that qualify are no longer startups in any realistic sense of the word. While a company may utilize Series D or E to pursue unmet goals in earlier rounds, that isn’t the only purpose. The kind of funding that is raised in rounds like these – typically in the hundreds of millions of dollars – is put in place for global expansion, market takeovers, or a final valuation boost before an initial public offering (IPO).
Okay…Understood, but What About…?
Organizing your potential investors into groups and understanding when and why they may be interested in making a move is important – but those aren’t your only questions, are they? We didn’t think so. At The Main Stage, we work day in and day out with founders just like you. Not surprisingly, many of you share the same questions and concerns. As you might imagine, quite a few of these questions have to do with funding. We’re going to tackle a few of the most common here. Let’s go!
“How do startup companies receive funding?”
You may not believe just how frequently we hear this question, and typically it’s asked almost apologetically. Cut yourself some slack, founder. If this is your first startup or even the first one you’ve gotten this far into the funding process, the process is brand new. There are no bad questions. Here’s what you need to know:
Rounds of funding through investors, as we’ve described above, are one of the ways startup companies receive capital, but they aren’t the only ways. Here, in no particular order, are a few others you should at least be aware of:
Self-Funding (or, “What’s in Your Wallet?”)
Self-funding is often referred to as bootstrapping because, well, you’re effectively pulling yourself – by way of your startup – up by your own bootstraps. Whether you have savings or the ability to liquidate some assets, self-funding isn’t without at least two key advantages:
- Using your own money allows you to retain full ownership of your business
- You can avoid paying interest
Interest, of course, can become an issue when you borrow money. Frequently, startup founders apply for loans through some combination of traditional banks, the U.S. Small Business Administration (SBA), and online lenders. Unlike the groups of investors we helped you break down earlier, these lenders won’t be interested in ownership stakes, but they will expect the loan – with interest – to be repaid.
NOTE: One particularly helpful program is the SBA microloan. Designed specifically with startups in mind, the microloan has term lengths as high as seven years, relatively low fees, interest rates that tend to range from 6% to 9%, and low amounts up to $50,000. If pre-seed of seed rounds were uninspiring, if you need a smaller amount to launch your startup, or if ownership (especially early on) is important to you, one of these programs might be advantageous.
“How do investors get paid back?”
It’s a common concern and one that’s kept many founders awake at night. Exactly how do investors make their money back? Here’s a hard truth: Sometimes they don’t. We need to address that upfront before we go any further. Despite all the work, each and every hope or dream, and even thousands – or hundreds of thousands – of dollars, sometimes an investment fails. Startups stop. People try again. It happens. Reward almost always includes some degree of risk. The more risk, the higher the reward.
Now that the hard part is out of the way, let’s focus on the reward. Let’s imagine that one or more round of funding was sufficient and you have made the most out of the capital invested. Bravo! Here’s some more good news: Those investors were not lenders. Whether you had an angel investor, a few venture capitalists, or a group or family, friends, and colleagues (or some combination), they didn’t invest their money in exchange for repayment with interest. These were not loans. They were investments into your company in exchange for a share of ownership – typically in the form of stocks or shares. As your startup grows into a full-fledged business, these shares continue to grow in value. These shares can payout significantly when there’s an exit – that is when your company is sold to or acquired by a larger competitor.
“How long does it take to get funding for a startup?”
Once you’ve made a decision to launch your startup and pursue some form of funding, the days, weeks, and months that follow can often feel like a race against the clock. Other times it may seem like that clock is standing still. Like any good founder, you’re eager for there to be money in the bank because that will allow you to make more products, hire more employees, or invest in better technology.
Much of the timeline, for good or bad, will come down to you – the founder. If you’re a relatively unknown quantity – as most startup founders are – funding may take a little longer than it would for someone who’s had some previous successes (e.g. businesses that launched, grew, and were acquired). We’re talking months, not weeks. Possibly longer. Likewise, if you initially have a small network of investors, it might be harder to get the funding ball rolling. Again, this underscores the importance of the organization we mentioned at the beginning. Know who’s in your network, build those relationships so that you can connect to their networks, and watch your business grow.
On average, the fundraising rounds we broke down earlier take place every 12 to 18 months, however, a good seed round can potentially replace the need to raise any more capital. The time spent between rounds is often reserved for the due diligence process.
The Bottom Line
For founders who just want to go to work building their dream or putting their idea into motion, fundraising can feel unnatural, overwhelming, and even confusing. No one understands that better than we do. At the Main Stage, each member of our team has walked the journey you’re now on. We’re investors, start-up founders, and, well, real people who know the ups and the downs of forecasting, pitching, building a network of investors, and finally – thankfully – seeing that hard work pay off.
That’s good news for one reason in particular: It means we can help you. Whether you’re:
- creating the perfect pitch on our Story Vault™ platform;
- organizing and managing those investor relationships in our proprietary CRM system;
- or closing the deal and putting cash in the bank with our industry-compliant Data Vault;
The Main Stage is how and where fundraising happens. Are you ready to get started? So are we. Click here for a chance to learn more and sign up for a free 14-day trial.
Aishlin Harrison is the co-founder of The Main Stage, as well as an artist, musician, and passionate entrepreneur. In addition to these roles, she serves as Creative Advisor for RedCrow™, Inc., a direct investment and marketing platform for healthcare companies. You can connect with her on LinkedIn.