10 Ways Startups Get Funding: Boots, Angels, and Beyond
Businesses change the world.
As the saying goes, “it takes money to make money.” Every business conjured into existence—from the traditional small businesses that populate residential neighborhoods to the tech startups of silicon valley and beyond—may have begun as a fascination of the founder's mind, but how does a startup company obtain the money it needs to get going?
When you are an investor or equity shareholder in a startup it can help to pull the curtain back to gain a behind the scenes look at startup funding. These insights will lend a better understanding and valuation of your private equity shares.
What is Startup Funding?
Startup funding is money raised by business owners to grow into a sustainable organization. There are several ways of receiving such an injection of cash, and all will come with pros and cons. Let’s dive in!
How Startups Get Funding
The first option is bootstrapping, which is avoiding outside funding altogether during the early phases of the startup.
The concept is to self-fund a business using personal savings and resources. This can be very convenient in the initial phase of a business when it is lean and has little overhead. However, as time goes on and the company establishes itself, it may seek outside investment in the form of venture capital or loans.
A founder may use personal savings, credit cards, lines of credit and personal assets, as well as the revenue generated from the business once it is cash flow positive. Bootstrapping is where small business across the world begins.
How much can be achieved by one's self? We need only look to MailChimp to see a successful bootstrap in action. Pending a $12B acquisition from Intuit, co-founders Ben Chestnut and Dan Kurzius bootstrapped one of the most notably successful self-funded companies.
Very few startups can go from bootstrap to exit, but it is possible.
2. Friends and Family
Friends and family are among the most common contributors to new businesses. Asking for money certainly comes with potential struggles. However, the people closest to a business's founders can often embrace their vision more than a lender who must adhere to underwriting guidelines.
3. Angel Investors
Another avenue for companies attempting to establish themselves in the broader marketplace is through an angel investor. These are individual investors (or groups) that fund early-stage startups. Angel investors tend to be wealthier business people with interest in entrepreneurship. Before they invest, they are often given insights into the business, such as a business plan and access to traditional financial information like outstanding debt, credit, and more.
4. Small Business Grants
Another way to raise capital for startups is through small business grants, which are available in most developed countries.
A grant is money that does not need to be repaid and can generally be directed towards any expense of the company. Grants can range from a few hundred dollars to hundreds of thousands and more.
Government grants are issued to support an initiative of the government, which will usually aim to have a direct benefit to the public. Grants are available for everything from humanitarian efforts to supporting entrepreneurship or to providing relief from economic disasters. For this reason, they are specialized and may be more difficult to get than a loan or venture capital.
5. Small Business Loans
A small business loan is any kind of bank-issued loan or line of credit that helps fund the operations of a startup. Eligibility for financing will depend on the business credit as well as the founders personal credit and financial situation.
There are several different types of small business loans, including term loans, equipment financing, and lines of credit. Depending on the credit a company has established, it may or may not need to include the personal credit of the business owners into the mix as well.
6. Small Business Association Guaranteed Loans
SBA-guaranteed loans are available to startups through the Small Business Administration (SBA). These loans are issued to entrepreneurs who might otherwise be unable to qualify for a line of credit. In addition, an SBA guaranteed loan provides the lender with a hedge against the risk as they will guarantee up to 85% of the outstanding loan amount in the event of default.
The Small Business Administration does not issue loans. It does, however, back them. As an initiative to help entrepreneurs grow their organizations, the SBA funds SBIC's so that they can issue credit and financing to small businesses that generally could not obtain the financial boost they need without the help of the program.
7. Venture Capital Firms
Venture capital firms are groups of experienced investors (a.k.a venture capitalists) who can provide insightful management advice for a business in addition to a cash injection or line of credit.
Venture capital is considered the most viable source of fundraising for a larger, growing business that requires more significant amounts of money than can be secured through the typical seed round.
Just how much venture capital is flying around?
Raising venture capital is significantly more complex than fundraising through a typical seed round and steps into sizable sums. Venture capitalists are usually very competitive and selective with their investments. Investing in startups is their job. Their primary goal is maximizing returns, so they will look for businesses that show signs of exponential growth.
In exchange for the investment, a company will usually need to offer a stake in the business, repayment terms, or some form of control over the operation such as a position on the board. It is very common that they may require a combination of so, or even all, of these incentives to earn their buy-in.
Alternative Avenues to Funding
We've covered the most common approaches to fund a startup, but we live in a world that lauds innovation. The traditional approach is most assuredly not the only approach. There are several other ways a business can raise funds, even without relying on high-interest debt or asking friends to spend their savings.
Crowdfunding is a newer way to fund a startup. It is the practice of raising capital for a project or venture from many people, typically via the internet. Crowdfunding is most often used to support artistic projects, but its use has also spread to political campaigns and commercial endeavors.
There are two most popular types of crowdfunding, donation-based and investment-based.
Donation-based crowdfunding is a way for individuals to support other people's projects while getting rewards from those people or the crowdfunding platform. There is no expectation of a return on the investment or an equity stake. These contributors may receive some free items or another form of good karma, but this is more or less a way for communities to support ideas.
Investment-based crowdfunding acts more like a business transaction, as each investor receives equity in return for their financing. The risks and rewards are distributed among the people who provide the funds.
The sums raised through crowdfunding will vary wildly, as the barrier to listing an idea is low. While crowdfunding is a viable concept, companies don’t expect to raise a million dollars in cash this way. The average investment is said to be $5,922 worldwide and $8,258 in the US.
An accelerator is a temporary program that takes a small business and puts it into an intensive 10 to 12-week accelerated growth process. They are usually meant for startup companies that have already developed an initial product prototype, market presence, and a customer base. In most cases, they provide seed money, advice, connections, mentoring, and training in exchange for equity in the business.
Startups that went through accelerators raised more investment funding than their counterparts in the years following the experience.
The concept has proven the services effective enough that in 2014 the SBA launched a program in support of accelerators.
An incubator supports early-stage companies through connections, mentoring, and funding. While an accelerator focuses on rapidly building new businesses, incubators focus on helping startups launch and grow their business.
The main emphasis is to provide a fledgling business with the necessary resources to develop into successful enterprises by allowing them to "incubate" in a business environment where they are surrounded by the people and resources needed to grow.
Incubators exist all around the world. There are many stand-alone programs in local communities. Many business incubators are located at universities that provide seed money, mentoring, networking, and other support services for startups spun out of the university's research labs.
Eliminating the need to search for local individuals and research services that could support a startup is an incredible help to any young business.
Seed funding is typically the first money a startup company receives.
It's intended to bring all of the pieces together and get a product or service off the ground. Primary uses for seed funding include proof of concept, market research, prototype development, and customer acquisition.
Startups that are seeking to establish themselves for long-term growth will often do so through periodic investment rounds known as Series Rounds.
Series A Funding
The first round of funding intends to help establish a new company. It aims to get the team in order and prepare the product for launch.
The average amount of money raised in Series A as of October 2021 has been around $21.5M. Companies have entered Series A with an average valuation of around $24M. This is before they raise additional capital during the round.
Series B Funding
A company that proves its concept after Series A may seek another cash injection through another round of investments. At this point, it has momentum and is looking for funds to carry it onward.
The average amount raised in Series B in 2020 was $33M, with companies holding a valuation of approximately $40M at the beginning of their Series B round.
Series C Funding
A company that makes its way through Series A and B may have its eye on an exit. These companies may enter late-stage investments intended to position them for successful entry to the public markets. The average Series C investment in 2020 was $59M, and companies were valued at an average of approximately $68M when they began seeking their Series C investments.
At this point, most companies will be positioned to scale globally and will no longer need to seek outside funding. However, companies can, and do, continue past Series C. According to research conducted by Crunchbase, the average number of rounds seems to vary by industry, with subscription and e-commerce companies being more likely to exit after Series C; tech startups and as-based businesses averaging 4 rounds and; social media and marketplaces going through an average of 4 and 5, respectively. The primary difference between each round is the size of the investments and how established the company has become.
Why Funding Methods Matter for Investors and Shareholders
The approaches that a company takes to secure funding might seem like behind-the-scenes business operations with little relevance to investors and shareholders, but it has a drastic impact on valuation, liquidation, and more.
If a company raises venture capital by providing funding in exchange for an equity stake, it is likely that the VC will be issued preferred stock. An occasional benefit of preferred stock is known as liquidation preferences which prioritize the preferred stock during a liquidation event.
Potential investors and shareholders alike will want to understand if venture capital is raised that results in preferred stock with liquidation preferences being issued, as its presence can devalue common stock.
Involvement in a startup is a bit of a rollercoaster ride. Shareholders with an equity stake in a startup can yield amazing returns, which makes private equity an alluring incentive for early employees. Seeing your company raise a big round of capital is incredibly exciting, as the value of their shares can increase exponentially. However, they should also expect the reduction of their ownership percentage (a.k.a. dilution), each time capital is raised from new investors.
There are many factors that go into the valuation of a startup. Historic revenue, profits, overhead, market share, patents, to name just a few.
Another method of valuation is achieved by calculating the price paid by VC’s and the equity they are awarded for the investment. This can be looked at both from a single round or a trend over time if there have been multiple series rounds. Because of this, a new series round with a lower valuation can instantly drive the value of existing shares up or down based on the outcome of the funding.
Roster of Investors
While we may know that perception is not always reality, it certainly matters. The individuals that choose to invest in a startup can directly affect the value of the company by their mere involvement. Lead VC’s generally perform reliable due diligence prior to their investment. When VC’s with a history of success come aboard, it can increase confidence in a company, and value right along with it. A potential investor may be more willing to pursue a company based on the players involved.
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