How to get funding for a startup

So here you are: you have a brilliant business idea or maybe even an MVP. All you need now is to turn that idea into a reality. But to do so, you need money. And probably a lot of it, if you want to join ranks with other high-growth companies.

Obtaining startup funding is a huge challenge for small businesses. 

You could turn to friends and family for support, however, to do so would naturally mean putting their money at risk and thus your relationships, too. It is a risk you may prefer not to run.

So what other options do you have?

From this article, you will learn what are the more popular startup funding models these days and what you'll need to know when looking to raise capital for your own venture. 

Startup business funding: where to start?

If you’re a business owner, you should be aware of the main reasons for startup failure. According to CB Insights "run out of cash/ failed to raise new capital" is No 1 on the list. For this reason alone, a whole 38% of businesses fail.

So, before you raise money, it is crucial that you determine how much funding you'll need – and when. These numbers must coincide with a time schedule to kickstart your startup and secure smooth business operations.

Any disruptions in access to finance can be catastrophic. Once you've established your startup capital requirements, be sure to have all the necessary resources to support your case when convincing others to entrust your business plan with their money.

A solid pitch deck is a must. It should explain your new business venture in a concise and convincing way. It should include a value proposition, target audience, market landscape, and information on financial resources required (how much funding, when, and for what).

To support raising a startup funding process, you will also need a business plan (particularly when seeking bank loans), a business model (to illustrate main revenue streams), and further ideas for business development.

Where there is already an established business with traction, lenders will usually query its business history and request financial statements, including those for profit and loss.

These requirements may change depending on the source of funding, the level of financial resources required, and funding rounds. Whatever the case, no time devoted to the preparation of the pitch deck, business model, and financial projections will ever be wasted.

Funding rounds: how do they work?

Terms you may have heard such as pre-seed and seed funding round, series A, B, or C, refer to the processes of growing a startup business through external financing. Typically, a startup founder starts with pre-seed funding round and continues with the next financial rounds as the company grows, explores its customer base, and hires new employees.

Before any funding round takes place, the representatives of outside investment groups need to investigate the startup company and undertake valuation, including pre-money valuation.

They must verify the startup's value proposition, its competitive landscape and growth opportunities. Once the potential for a successful startup is confirmed, a strategy is implemented for raising money through investment funding rounds.

Types of funding rounds in a nutshell

Pre-seed funding is:

• funding for startup companies in the early stages

• dedicated to validating the hypotheses, attracting first customers, and setting up operations

• usually financed by a business owner, friends, and family, and not in exchange for equity

• not done with ordinary investors' venture capital funds since those investors tend to support businesses with well-defined value propositions and business models

Seed funding is:

• the first official funding round in exchange for equity

• dedicated to the product development process, market research and formation of a key team

• usually financed by angel investors

• the most frequent funding stage - many startups fail to raise next rounds while the transition from seed to series A is crucial to ensure stable grounds for success

Series A:

• happens when the product development process is completed and a customer base is established

• is dedicated to scaling the business up (new markets, wider target audience) and financing the operational costs before revenues can cover them

• is the second official funding stage in exchange for equity (usually from 10 to 30% of the company shares)

• is usually financed by venture capital firms and startup accelerators

• can involve more than one investor in the funding round

• once closed, usually takes from 6 to 18 months to gain working capital

Series B:

• happens when the product-market fit is confirmed and the customer base is expanding

• is dedicated to expanding the business, including new team members and distribution channels

• is usually financed by venture capital firms offering not only money but strategic advice and expertise also

• is perceived as less risky for investors - startups tend to overestimate market opportunities, however, should they deliver KPIs at the series A level, then they will be perceived as stable growth companies by investors at the series B level

Series C:

• happens when the business model proves profitable

• may be dedicated to expanding the offer to acquire new business

• is usually financed by venture capitalists or investment banks given the minimal risk posed at this stage

• startups looking for series C are more selective about potential investors as it is the industry expertise and international connections that matter the most at this stage 

• is often the last funding round although some startups will go on to series D, E, and F

Understanding the differences between particular funding rounds is crucial to the long-term planning of the capital-raising process. Once you start asking for money, you should consider not just the first funding stage but indeed the bigger picture. Your ability to illustrate this picture will affect your credibility with investors. It will show that you have a broader vision; that you perceive your business as a long-distance journey and not a mere sprint.

If you're interested in how many startup companies go through funding funnels, here’s an analysis made by CB Insights "Venture Capital Funnel Shows Odds Of Becoming A Unicorn Are About 1%".

Startup financing models: choosing your best option

Now it's time to introduce what options are open to you when raising capital for your new business concept.

Personal savings

Self-funding, also known as 'bootstrapping', lets you finance your business without borrowing money. Personal savings is free money. You don't need to pay it back with interests or in equity. Using your own capital puts you in full control of your venture whilst taking on all risks to it. With no interest incurred, it’s equity-free.

Bootstrapping is used during the first phases of developing the business concept. It verifies whether there is logic in your concept and whether it has the potential for success.

Personal investment can also increase your credibility in front of other lenders because it indicates that you're serious about your startup and that you're willing to make long-term commitments to it.

Before tapping into your own financial resources, however, it is important that you be clear on your financial capabilities and that you establish how much of these resources you're willing to risk.

Friends and family funding businesses

Some business founders may count on support from friends and family, but that support very much depends on the relations and material situations among those friends and family. They may, of course, simply lend or donate funding, yet might also become investing co-founders should they share sufficient faith in a venture.

Some new businesses do indeed turn into successful family-owned companies, but then there are some businesses whose families look good only in the photo. Ultimately, it is you alone who judges whether or not to form a business with your closest ties.

Angel investors

Typically, an angel investor will be a retired executive with a successful track record who now wants to invest in a new business that has been established by others. Angel investment is popular in the early stages of startup development.

In exchange for money, an angel investor will usually want a seat in a management/advisory board with full transparency. He or she may also require a stake in your startup.

Here, an added advantage is the gained access to a broad network of experienced professionals from which sound business advice may be drawn. In a venture's early stages, this in fact may be more valuable than the investment itself.

Venture capitalists

Before approaching venture capital firms, be aware that they do not and will not invest in just any business. What they look for are tech-oriented, high-growth companies with potential for market success.

Their focus will usually be on specific industries (e.g. biotechnology, ICT, sustainable development). Finding a fund from your brunch is a good thing. In that case, you can count on strategic advice. What’s more is that when you connect with those in your own industry in this context, you jump from one strength to another: not only is financial resource invested, but knowhow and experience shared.

What do they seek in return? Equity, return on investment, and at times, even a place on the management board. It is important to bear this in mind and that you be prepared to consider sharing your company's ownership with others.

Also, be aware that signing an investment agreement with venture capitalists is not always a straightforward procedure. Their analysts will thoroughly investigate your business plan and its market landscape before making any decisions, at which point you should be cautious about what KPIs are set in any agreement.

The investment horizon of venture capital funds is limited, and they will push you to achieve goals -- especially those concerning sales.

Traditional business loan

A bank loan used to be a typical source of financing, especially in the case of small and medium-sized companies. Currently, this is more common for companies in the tech sector that cannot count on support from venture capitalists.

Small business loans usually offer some preferences, but in each case you should be prepared to pay interest and make a personal guarantee.

Before applying, you also must decide on the kind of bank loan you need, whether that be a personal loan, equipment loan or revolving loan etc. With standard business loans, you can also get access to a business credit card.

In each case, it will be required that you submit a detailed business plan with financial projections. You must also follow the repayment schedule so that there is no delay in the payment of loan instalments.

If you have difficulties with a bank loan, you may approach small business administrators or online lenders. Their rules are usually less strict.

Accelerators and business incubators

Over the last several years, these organizations have been gaining in popularity. They offer a wide range of dedicated services to help startups incubate business ideas. Such services often come in the form of space, access to infrastructure, support from mentors, opportunities to pitch ideas in front of investors, and training. Some accelerators also provide funding.

Although you shouldn't expect a big-ticket contribution from most, the funding they do provide may be sufficient for purchasing advisory services in the fields of market research, user testing, and refining value proposition.

But there are exceptions. YCombinator has created a new model for funding startups in the early stages of development. They invest USD $500k per company, which, as a substantial amount of money already, may indeed be one to boost your business. So, you should thoroughly research available accelerators to discover which varying funding models on offer may be most beneficial to your business idea.

This is especially true when considering how significant the accelerators' role is in the startup ecosystem. Through their extensive network of connections with mentors, angel investors, venture capital funds and small business administration, you can enjoy the considerable benefits of their support, and across many fields.

Crowdfunding

This funding model is about collecting smaller amounts of money from many people. There are numerous platforms available for facilitating online crowdfunding campaigns, one example being Kickstarter.

Crowdfunding is becoming more and more popular. One of its benefits is that it doesn’t oblige any involvement in strict investment agreements with funds or banks. You don't need to pay the money back either. However, once people put trust in your campaign, it is essential that you show the determination required to achieve your set goals.

It's also imperative that you be transparent about the allocation of funds.

To run a successful crowdfunding campaign, you must choose the right platform, investigate your target audience and produce compelling marketing materials. It's also good to offer benefits to donors (e.g. free products).

Small business grants

Numerous government agencies offer subsidies. However, depending on the source of financing, small business grants may be difficult to get. This is mostly owing to the high competition for them that is generated by recipients not having to pay grants back.

Rules of granting subsidies vary in countries, with grants for research and development being the most popular. If you want to use such a grant, be aware that you will not get the entire funding. The government or other agencies usually support some level of investment (a percentage of eligible costs), so you'll need to finance the rest on your own or through a business loan.

The decision on granting a subsidy is based on the grant application. A template is shared by the granting agency in which you will likely be asked to describe your business idea, time schedule, budget, benefits of the project, and team members.

Once you decide on applying for a small business grant, you will need to prepare for inspections. The representatives of granting agencies may visit you or ask for documentation to verify that you have implemented the provisions from a grant agreement.

Startup funding: step by step

Once you recognize the main reasons for business failures, understanding the differentiation between funding rounds and startup funding models can help you mitigate risk and grow your business.

Here is a summary of useful tips in the funding process:

1. Determine how much funding you'll need and when you'll need it

2. Refine your value proposition and prepare a comprehensive business plan

3. Collect necessary documents like a pitch deck, financial statements and revenue projections

4. Investigate which of the available startup funding models is the best option for you and your business

5. Ensure you deliver commitments made to funding institutions

6. Persevere

 And good luck!