Types of Funding For Startups
There’s never been a workforce more entrepreneurial than the millennial generation. New businesses are flourishing – so much so that the gig economy continues to carve out an entirely new industry category.
While bootstrapping is becoming increasingly popular, most businesses need startup capital. For most founders, the hardest part of early growth is finding enough startup funding to launch & scale the business. Raising venture funding is crucial for improving underlying technology, launching marketing campaigns to drive acquisition, and hiring staff.
Without startup capital, most companies reach the end of their runway never having found product/market fit.
What is Startup Capital?
Startup capital is the money needed by a founder to launch a new product or company into traction.
Depending on the business, startup capital goes into paying for office space, inventory, permits, and licenses, marketing, and other business-related expenses. Often referred to as seed money, startup capital typically isn’t for idea-only solo founders and need some demonstration of market viability. Startup capital is typically lent by venture firms or angel investors, or institutional investors like banks.
There are four primary challenges for a startup when it comes to accessing funding.
1. The business model and growth potential
Investors want to fund businesses with venture scale – that is, a tangible opportunity to reach a billion-dollar valuation. If a business doesn’t show the potential to scale up or ongoing scalability, it’s tough to raise money pennies on the dollar.
Potential can be hard to demonstrate for pre-traction companies and often end up relying on how appealing the founder is (which can be very subjective).
2. Asking for too much funding compared to the business’s needs
Erroneous advice given to startups is that they should ask for more than they need as a contingency. Asking for more isn’t always a good idea – it is, ultimately, a slice of your company. Oddly enough, most startups nowadays should do what they’ve always been told not to – prepare a business plan.
To clarify, this isn’t a meaty, often nonsensical corporate business plan throwing random numbers up in the air. Instead, modern companies need real financial projections tied to actual acquisition channels to justify their validation – it’s no longer as simple as “Ivy League kid with cool social network idea”.
One way the startup tool, MATA, has helped prevent this issue is by allowing investors to see where exactly all the money they are funding is going towards in real-time. There is full transparency and helps ease communication between the investor and the founder.
3. Presenting the wrong business to the wrong investor
Sometimes startups ask for funding from the wrong investor. Researching the investor and their record of investments is the best way to overcome this hurdle.
Yes – fundraising is a grind and requires, to an extent, a shotgun approach. That doesn’t mean you should approach a FinTech investor for businesses providing financial services and the bank if you’re running a towing company business.
4. Potential for mismanagement of funds
This happens in cases where the business owner has had several failed startups that have received funding previously. It may be harder for them to access additional funding for a new business enterprise. If they’re lucky enough to find an investor, they have to prove that with the past ventures, they spent the funds wisely or it was exterior reasons that resulted in failure.
They must also show that they kept the investors apprised of the situation, and did what anyone would reasonably expect to salvage the situation.
Related: How Does Equity Work in a Startup?
Type of Funding for Startups
Most startups benefit from the same channels of funding, which is why there’s massive competition when it comes to accessing financing. These are the usual types of funding options available to startups:
An angel investor is a wealthy patron willing to put seed money into a business venture. The amount invested usually ranges from thousands to millions of dollars, depending on the investor.
This type of funding is quite popular in the early stages of a startup, and the investor usually allows the entrepreneur to retain full creative and executive control over the venture. An angel investor is conversant with the space the business is starting up in, so the entrepreneur doesn’t have to educate them on every aspect of the business. And, because they are conversant with the industry, they also have crucial connections that can benefit the startup.
The angel investor expects a return on investment, just like any other funder. Angels often form network groups, and when an investor pitches their business idea to the network, everyone in it has a chance to review the submission. Angels rarely last beyond Series A round but can be crucial in accessing higher levels of funding.
SBA and short term loans
The SBA loan is backed by the Small Business Administration (SBA). This is a federal government program that facilitates lending small business loans to small business owners. In addition to the loans, they provide mentorship to startups and offer business workshops. To access this funding, the startup has to find a vendor providing SBA loans in their area.
Short term loans are small loans from the bank that must be paid back within a period of 3 to 18 months. These are not sufficient to be seed money, but they can help a business during an emergency or offer the necessary runway to get to market.
Of course, when talking of loans, an entrepreneur can also use credit cards to access money, but they have to contend with high-interest rates. Usually a no-no for all but the most liquid of startups.
Crowdfunding has become a popular way of raising money for startups, especially for people who have already proved themselves in the niche. For example, a consumer tech startup can successfully crowdfund seed money on the backs of a founder with a pop culture reputation – for better or for worse.
New alternatives like Funderbeam are showing promise to allow crowdfunding as a viable method for non-consumer-tech companies as well – a crucial development in graduating crowdfunding as an often “gimmicky” fundraising channel.
Venture financing typically involves a startup engaging in a series of rounds of fundraising over time. The series runs from A to E.
Series A is high-risk funding, largely on the backs of venture capitalists and occasional high net-worth angels. Donors in the Series A are willing to take risks on moonshot ventures because their portfolios generally apply a scattershot approach – a single unicorn pays for the rest.
The definition of Series A has morphed over the years, and today’s Series A is much more competitive than yesteryears and usually requires proven traction and profitability, as well as obvious market scale potential.
This stage of funding is available for startups that have made it through the Series A gatekeeper, which is where most funded startups failed. They have made it and established some product-market fit and tangible signs of 9-figure potential. Series B funding is for expansion of the company (both internally, and into new markets) – hence often referred to as “growth” investing.
Series B funding comes from the same venture capitalists from Series A as they look to protect their share in the startup, as well as new growth-stage investors. Angels are rarely if ever involved at this stage.
For most startups, this is usually the final phase of funding because the business is doing well with expansion planned for other markets or new products developed. The next step is usually an acquisition or an IPO. This is the stage where institutional investors like banks like to invest in such companies because of the low risk, but venture capitalists and private equity firms also remain the primary financiers.
Series D and E
This is special fundraising for companies that want to stay private for longer or want to expand more before going public. If a company has trouble meeting the expectations it set for itself in series C funding stakeholders may also fund it some more in series D – often called a down round, which is purgatory for founders.
There are several fundraising options for founders – and more unique ones pop up every day – but the tried and tested transition of angel > venture series continues to be the most compelling. Hopefully, this guide offered a reasonable primer on the different fundraising channels, as well as some insight into the different enterprise stages they typically cater to.
Are you looking to fund your startup? Or are you an investor looking to fund a startup? Mata is here to get you started!