Startup Funding: What it is, How It Works, & 5 Tips for Landing it

From basics to intricacies, this guide is a complete walkthrough on how you can raise startup funding. To ensure that the aspiring entrepreneurs are financially backed, we have also prepared a list of some actionable tips.

Did you know? Around 16% of startups in the world fail due to financial problems. If you are facing a fund crunch or are unable to take your business idea to the market due to a lack of funds, there are numerous ways of finding investors for startups. One of the relevant ways of funding in such cases is startup funding.

With this article, we will help you understand what startup funding is all about and what the effective ways of raising it are.  

An Overview of Startup Funding

Startup funding is a way to provide the financial support necessary to initiate business operations. It helps in launching your business idea into the market by securing funds from diverse sources.

In the early stages, startups encounter substantial initial costs before generating revenue. Now, you can either ponder upon how you can start a business with no money or think about raising funds. Startup fundraising enables startups to procure essential resources and sustain operations until achieving self-sufficiency.

Securing investment for a startup is pivotal across all growth phases, facilitating product development, team expansion, and other critical initiatives.

Startup Funding: A Walkthrough

In startup funding, investors provide funds to a startup in exchange for a percentage of ownership or equity shares in the company. This entitles them to a share of the startup's profits. Therefore, when the company generates profits, investors receive returns proportional to their ownership stake. However, there is also a risk of loss if the startup fails to meet profit expectations.

Types of Startup Funding

We have found that there are various ways of funding a startup business. Each has its specific requirements, advantages, and considerations. As per our research, here are some popular types of funding that can help businesses grow:

1. Equity Financing

In equity financing, funding of startups is done by raising capital by selling ownership shares to investors. It involves no obligation to repay the invested funds. Instead, investors become shareholders and participate in the company's profits and losses.

This approach carries the risk that if the company does not perform well, the value of investors' shares could decline. Equity funding from an investor significantly influences business decisions, as their ownership can impact major strategic choices.

2. Debt Financing

With debt financing, you can secure funding by borrowing money that must be repaid within a defined timeframe. It usually involves interest. This funding, however, obligates you to adhere to repayment schedules and may involve regular interest payments. 

It also involves the risk associated with repayment obligations, potentially leading to financial strain or even collateral loss. Lenders typically do not engage in the company's operational decisions beyond the terms outlined in the loan agreement. This maintains a more passive role compared to equity investors.

3. Grants

Grants are monetary awards provided to startups by entities such as government agencies or private organizations to assist in achieving specific objectives. This type of funding does not necessitate repayment. It is typically awarded based on meeting predetermined criteria or milestones.

However, there is a risk that the startup may fail to fulfill the conditions required to access the grant funds. Moreover, grant providers generally refrain from participating in the startup's operational decisions, focusing instead on monitoring the progress.

Stages of Startup Funding

Startups require the necessary funding at the various growth stages. Thus, startup funding is done in the following stages. We have described each stage in detail:

Stage 1: Pre-Seed Stage

The pre-seed stage is a phase for initial funding. You can focus on developing your initial business idea during the pre-seed stage. Funding requirements are typically modest during this phase, and access to formal funding channels is limited. Some of the sources of funding for businesses in this stage are:

• Bootstrapping/Self-financing: Bootstrapping involves self funding. It allows you to generate revenue without relying on external investment. Most likely, this will be the initial choice for you because it keeps you from the pressure of repaying the funds or relinquishing control of your startup.
• Friends & Family: As an early-stage entrepreneur, you may seek funding from friends and family. This source benefits from existing trust between the two parties.
• Business Plan/Pitching Events: These events offer prize money, grants, or other financial rewards through competitions organized by institutes or organizations. While the funding amounts may be modest, they are generally sufficient for you in the idea stage. Success hinges on presenting a compelling business plan.

Stage 2: Seed Stage

The seed stage is for you to prepare for conducting field trials, testing products with potential customers, and building a formal team. Therefore, the following startup funding options can be explored:

• Incubators: Incubators are organizations dedicated to supporting you in launching and growing your startup. They provide valuable services such as office space, utilities, and administrative and legal assistance. Moreover, sometimes, they offer grants, debt, or equity investments.
• Government Loan Schemes: Several government-initiated loan schemes provide collateral-free debt to help aspiring entrepreneurs access affordable capital.
• Angel Investors: Angel Investors for startups invest their funds in promising startups in return for equity. We recommend that you can connect with angel networks like AngelList, Funded, Envestors, etc.
• Crowdfunding: Crowdfunding involves raising funds from multiple individuals who contribute small amounts online. This method is facilitated through crowdfunding platforms.

Stage 3: Series A Stage

At the Series A stage, you will find yourself seeking funds to expand your user base, enhance product offerings, and enter new markets. Some common funding options for startups in this stage include:

• Venture Capital Funds: VC funds are professionally managed pools of investment that specialize in funding high-growth startups. Each VC fund operates based on its investment thesis, focusing on specific sectors, startup stages, and funding amounts. In exchange for startup capital funding, VCs acquire startup equity and often provide valuable mentorship and strategic guidance.
• Banks/Non-Banking Financial Companies (NBFCs): Startups at the Series A stage may opt for formal debt financing from banks and NBFCs. This option becomes viable as the startup demonstrates market traction and revenue, validating its capacity to meet interest payment obligations. This type of funding is particularly useful for securing working capital without diluting equity ownership.
• Venture Debt Funds: Venture debt funds are private investment funds that primarily provide capital to startups in the form of debt. Typically, these funds co-invest alongside angel investors or VCs, offering startups additional financial resources to support growth initiatives.

Stage 4: Series B, C, D & E

At these advanced stages, you will typically seek substantial funding to accelerate your growth and expand operations. Some ways of startup funding to consider during this stage include:

• Venture Capital Funds: VCs help startup founders with larger investment capacities focus on funding late-stage startups that have demonstrated significant market traction. It is advised that startups approach these funds after achieving substantial growth metrics. Sometimes, a consortium of VCs may collaborate to fund startups collectively.
• Private Equity/Investment Firms: While traditionally focused on established businesses, some investment firms have recently shown interest in funding fast-growing late-stage startups with consistent growth. These firms may offer substantial capital injections to support further expansion and market penetration efforts.

Stage 5: Exit Options

Once your startup is established, investors look for an exit plan to realize their profits. Some of the common exit strategies they follow are:

• Mergers & Acquisitions: Investors may opt to sell their portfolio company to another entity in the market. This involves either acquiring another company or being acquired.
• Initial Public Offering: An IPO is the process where a startup offers its shares to the public for the first time, listing them on the stock market. This is typically undertaken by startups with a strong profitability track record and consistent growth. However, an IPO involves rigorous regulatory processes.
• Selling Shares: Investors have the option to sell their equity or shares to other investors. This allows them to realize their investment and potentially reinvest elsewhere.
• Buybacks: Startup founders may choose to repurchase shares from investors if they have sufficient liquid assets. This allows founders to regain control of their company and adjust ownership stakes within the startup.

Here’s How to Get Funding for Startup

To raise funding, there are some steps you must take. We have listed down the pivotal steps for you:

1. Assess the Need for Funding

You need to determine the appropriate amount to raise and why it is required. Developing a milestone-based plan with clear timelines for the next 2, 4, and 10 years is crucial. This plan should include a financial forecast, which is a carefully constructed projection of company development over a specified period. It should consider projected sales data, market trends, and economic indicators.

2. Assess the Readiness of Investment

While identifying the need for funding is crucial, ensuring your startup is ready to raise funds is equally important. Investors will take you seriously if they are convinced about your revenue projections and their potential returns. Typically, investors look for the following in potential investee startups:

• Revenue growth and strong market position
• A reliable, passionate, and talented team
• The entrepreneurs' vision and future plans
• Clear timeline to break even and profitability
• Uniqueness and competitive advantage of the startup
• Favorable return on investment

3. Pitch Preparation

A pitch is a detailed presentation about your startup. It outlines all the important aspects. Thus, creating an investor pitch is all about telling a good story. Your pitch is not a series of individual slides; however, it must flow like a story connecting each element to the other.

4. Target an Investor

Every investor operates based on an Investment Thesis, which outlines their strategic approach to investing. This thesis specifies the stage of startups they invest in, geographic preferences, sector focus, and what sets them apart from other firms.

To understand a VC firm's Investment Thesis, you must thoroughly review their brochures, company website, and fund descriptions. Researching their past investments and speaking with entrepreneurs who have successfully raised equity funding can also provide valuable insights.

5. Investor Due Diligence

Usually, angel networks and venture capitalists conduct extensive due diligence on startups before finalizing any equity deal. This process involves analyzing the startup's past financial decisions and evaluating the background of the team. The goal is to verify your startup's growth projections and market data to identify any potential issues.

6. Term Sheet

A term sheet represents a preliminary, non-binding agreement proposed by a venture capital firm during the early stages of a deal. It outlines key terms and conditions governing the investment agreement between the investor and the startup. 

Best Tips to Secure Startup Funding

Getting investment for a startup can be a challenging task. However, keeping these tips in mind will improve your chances of securing an investment. They are as follows:

1. Build a Strong Team

The team you assemble is crucial to the success or failure of your venture. A strong founder-market fit is essential. Founders can deeply understand their users and possess unique insights into unresolved problems, which investors highly value.

2. Pursue a Significant Market Opportunity

Investors are typically interested in substantial returns. Hence, it is crucial to target a sizable market opportunity quantified by metrics like Serviceable Addressable Market (SAM) and Total Addressable Market (TAM).

TAM represents the total market size based on potential customers and annual spending capacity. On the other hand, SAM identifies a feasible segment within TAM that your business can effectively serve.  VC firms often provide guidance and support to help you understand these metrics.

3. Strategically Plan Financing

Rather than simply raising capital indiscriminately, adopt a strategic approach to funding. You must aim to secure sufficient funds to achieve the next valuation milestone for your company. 

However, you must also be cautious when diluting the ownership of your company. You must typically not sell more than 20% to 25% of your company per financing round. It will allow you to have the flexibility for compelling financial partners.

4. Effectively Communicate With Investors

When pitching to investors, communicate your ambition, business vision, financial projections, and execution strategy. Building investor confidence requires you to demonstrate your steadfast commitment to achieving long-term goals.

6. Generate Competitive Tension with Multiple Investors

If possible, attract multiple investors to create competitive tension, enhancing your negotiating position. Competitive tension arises when investors vie for the opportunity to invest in your business, potentially leading to improved terms and favorable outcomes. However, this approach should be balanced with strategic decision-making to avoid appearing overly opportunistic or alienating potential partners.

Final Thoughts

Starting your own business calls for a considerable sum of money, and startup funding is the most adequate solution to this problem. It is designed to provide the necessary financial support to new entrepreneurs to drive innovation.

However, securing investor funding is not an easy task. Therefore, we suggest that you must conduct thorough research about your idea and devise the most viable plan to approach your target market. Conveying this effectively to your target investors would immensely help you land a deal and bring your dreams to life.