The Ultimate Guide to Startup Fundraising
Dec 18, 2022
Startups are exciting. They fill you with that entrepreneurial spirit that energizes every thought, action, and fiber of your being—driven by the thrill of creation and possibility.
However, emerging businesses aren’t fueled entirely by that electric spark. They need capital.
Startup fundraising is a necessary step in many entrepreneurs’ journeys. To guide you along the path from big idea to big deposit, we’ve put together the ultimate guide to startup fundraising:
What Is Startup Fundraising?
Startup fundraising is the process most entrepreneurs undergo to raise capital for their fledgling or scaling business. This comes from outside investment, typically exchanged for equity in your company.
Why Do Startups Fundraise?
When startups have the next game-changing idea, they want to bring it to market as quickly as possible. But to go from inception to fruition and experience rapid growth, startups need a healthy reserve of cash. That’s where fundraising comes in.
However, startup fundraising is about more than a cash injection—it’s a means of networking and forging strategic partnerships. Most startups benefit by working with specialized firms and private individuals that understand the path you’re on.
While you’re juggling long-term strategy and day-to-day operations, fundraising partners will provide additional insight and support.
Different Types Of Startup Funding
At each stage of the fundraising journey, you’ll be best served by implementing varied strategies and engaging with different types of investors. These often correlate to the various stages of startup fundraising, beginning with pre-seed.
During a pre-seed funding round, most founders will “pull themselves up by their bootstraps” to launch the earliest version of their company. This often involves using personal finances to pay for initial startup costs before seeking outside investments.
Friends And Family
Many founders will also turn to their closest contacts and earliest supporters—their friends and family—for smaller investments during pre-seed funding. However, these groups may also participate in seed funding rounds.
Crowdfunding can occur at any stage but is most commonly associated with pre-seed and seed rounds. Generally, crowdfunding is made available to the public, but instead of equity, those who pledge money will receive early access or discounted products in return.
Startup incubators are collaborative workspaces where founders can build alongside each other and advisors during their pre-seed days. Once you’ve acquired seed funding, you’ll be fully grown and ready to fly the coop.
An accelerator is an incubator for more mature startups, usually those seeking Series A or B funding. In addition, they provide mentorship aimed at the challenges involved with scaling at this stage.
Angel investors generally provide seed or Series A funding, investing in an emerging company in exchange for equity. These individuals usually take on higher risk but hope for a larger payout by funding a startup with high growth potential.
VC firms don’t typically enter the scene until you’re seeking Series A or B funding. They’re generally more risk-averse than angel investors but still desire to acquire equity in promising early-stage startups.
How To Prepare For Startup Fundraising
Before you brainstorm how much funding your startup will need at each stage, you must prepare your pitch for investors. To chart your business’ roadmap, consider these six elements.
Most startups will generically categorize themselves as “early stage,” and you’ll need to provide more detail for a capital infusion. To that end:
- Have you started generating revenue yet?
- Are you profitable?
- Have you experienced positive monthly cash flow consistently?
Knowing your startup stage will help you determine the type and amount of capital infusion you need.
2. Cash Revenue Model
How does your company make money? This includes income-generating structures such as:
- Transaction-based: Selling an item or a service directly to a customer, either B2B or B2C.
- Advertisement-based: Creating ads for a website, service, product, or app and placing them on specific high-traffic channels.
- Commission-based: Charging users a fee for each transaction. This is the most popular online business model.
- Affiliate: Selling based on commissions through coded affiliate links.
3. Product Or Service
Understanding your product’s market differentiators, use cases, and user personas is essential.
The key is to provide objective information that will convince investors that your product is worth funding and to inform potential changes or adjustments.
4. Production Cost Or Operating Expenses
Reaching profitability often depends on your production costs or operating expenses. So as you prepare for a capital infusion, investors and lenders want to see how you’ll use the money.
If you plan to reduce high production costs, you can explain that through objective data and a detailed business plan.
5. Customers And Market Size
Do you know who your customers are down to their demographic and geographic information? By gathering data about your clients, you can identify your ideal customer base and your current (and future) market share.
6. Sales Pipeline
How diverse is your sales pipeline? An effective pipeline will have a long list of potential customers at various stages of the sales lifecycle.
This should include a combination of customers who:
- Are close to purchasing (opportunities)
- Have been contacted (leads)
- Who need to be contacted (prospects)
In addition, you should have the proper tools in place to manage and track the sales cycle.
What Are The Stages Of Startup Funding?
Each stage represents a different benchmark and growth opportunity, starting with the seed investment round and moving through the alphabet toward an eventual IPO.
Each subsequent round ultimately mirrors the seed round—in that capital injections are necessary to reach the next growth stage—but your company’s maturity and needs will change between fundraising stints.
Pre-seed funding is the upfront capital you raise to initially develop your business.
To eventually acquire seed funding, you’ll need a minimum viable product (MVP), a cohesive business plan, and proof of viability. The pre-seed stage is the initial touchpoint.
At this stage, angel investors, friends, family, and even small business loans are common, but their investments aren’t typically exchanged for a substantial company stake.
Your seed round begins when your startup is prime for its first significant capital injection. At this point, your business model is ideally structured so that the only input remaining is the funds you’re trying to raise (unless you’ll use those funds to acquire the last necessary input).
If you’re seeking seed funding before an initial product launch, you’ll want to be in the last phases of refining the details, as investors will want to see more than a prototype or basic proof of concept.
Series A Funding
Series A is the first funding round when larger venture capital firms (VCs) and “accelerators” will invest in return for equity via preferred stock and board-level decision-making input.
However, according to the startup funding database Fundz, less than 10% of startups jump from seed investors to Series A.
The Series A round typically occurs after a company has assembled the primary team and earned steady revenue, but before they’ve fully optimized their offering and staked their market competitiveness.
Series B Funding
A successful Series B round indicates that you’ve become a genuine market threat.
As a result, securing Series B funding is more difficult than Series A. Those that have secured Series B funding reported an average pre-money valuation of $40 million in 2021.
To land Series B funding, you’ll have to convince venture capitalists that you’re on a direct path to becoming a dominant market presence – with the only growth inhibitor being more capital.
Series C Funding (And Series D, E, F, And So On)
There’s no final cap on the number of funding rounds a startup can have. If you need more capital to absorb a greater market share, investors will be keen to consider the opportunity.
The major difference between the earlier stages and Series C rounds is that large institutional investors will begin making significant offers.
At this point, your company is likely well beyond its “startup” phase.
After your fundraising rounds conclude, you may choose to sell equity via stocks with an initial public offering (IPO). Some founders may even decide to exit at this point and sell their company altogether.
When To Raise Seed Funding
Seed funding is the first funding stage. It’s usually the first official money that an enterprise raises to grow the business. Numerous indicators will tell you it’s time to raise seed funding, including when you need to:
- Hire employees
- Move into an office space
- Acquire equipment or increase production
- Merge with or acquire another company
Seed rounds occur when your business model is sound and you’re showing indicators of market traction, but you lack the capital to scale.
Outside of your startup’s maturity, your “pre-money” valuation (i.e., the valuation before securing funding) can also indicate when to begin your seed round.
Your valuation is generally determined by either EBITDA (earnings before income, tax, depreciation, and amortization) or the “times-revenue multiplier” for your sector.
Per Angel Resource Insitute, a $3–6 million valuation is common, and the overall average for startups seeking seed funding was $8.6 million between 2018 and 2020 (likely skewed by some surging valuation trends).
How To Raise Funds For A Startup
Raising capital is rarely a straightforward process. There are myriad avenues, structures, and partners to choose from, not to mention the terms that follow a positive response.
As general pillars in the preparation phase, a startup needs to outline its operating costs, review the terms and conditions, and complete its due diligence. You should be just as deliberate about your decision-making process as the investor.
Establish The Cost To Run The Business
Every business should know its break-even number (when the total revenue equals the overhead costs). It’s a metric you can measure weekly, monthly, or annually.
You can use that number to show potential investors or lenders your startup’s opportunities. If you find the break-even number is too high compared to current sales, you can create a plan to reduce your costs.
Knowing your break-even number will also help you determine how much money you want to raise. Exchanging equity for capital means you need to have a target investment that accounts for your growth plans and the portion of the business you’re leveraging.
Inspect The Terms And Conditions
Once an investor or lender has made you an offer, analyze the terms and conditions, as not all willing investors will benefit your business.
At this stage, you need to justify the terms of the arrangement. Do they work in your favor once the company is profitable? Will you be satisfied with the level of ownership you’ve relinquished in the long term? And if the investment incurs debts, when will those payments begin? How much will they eat into your overhead costs and cash flow integrity?
In the simplest words possible: don’t just accept capital because it’s being offered.
Complete Your Due Diligence
Due diligence is the final step after coming to an agreement with an investor or lender for a capital infusion, in which you’ll provide documentation such as:
- Corporate records of charter
- Financial plans
- Business plans
- Intellectual property
- Details of any ongoing or pending litigation
- Bank account information
However, this is a two-way street.
While you need to validate your position, you should also ask your investor to produce the documentation that asserts their track record and trustworthiness (previous investments, overall portfolio, outstanding liabilities, etc.).
Completing your due diligence is the final act in determining whether or not the relationship is a good fit for both parties. Once this stage is completed, the answer should be clear.
Financial Advisory For Venture-Stage Companies
Although most founders learn the fundraising process through trial and error, the financial preparation and documentation scale in complexity alongside your startup’s growth.
Between pre-seed funding and a successful IPO, your financial projections, bookkeeping, and compliance considerations demand veteran industry expertise.
At Propeller Industries, we provide fractional financial services to companies that are at that venture stage. Whether you are preparing for a fundraise and need support or just received a capital infusion and are looking for guidance on how to put it to work, our team is here to help.
As your partner, we offer strategic foresight, careful diligence, and unprecedented access to the wisdom and experience attained from nearly fifteen years of working with the leading companies in this space.
Most importantly, we work to ensure you have the support you need so you can get back to doing what you’re meant to do – piloting your unique idea into reality.
If you have any questions about how to raise money for a startup or are looking for a financial partner in your fundraising journey, you’ve come to the right place.
Reach out to us today to learn more.