Startup funding: what it is and how you get it
So, you’ve found your pain point, assembled the dream team and now you want to start building, testing and growing – but where do you get the funds? Raising capital, or startup funding is always a stressful yet exciting time for companies as you plan ahead and see how far this company will grow. Understanding the different avenues startups can choose from to acquire the necessary funding, and different stages in a funding round is essential. This article will give a very high-level overview of what startup funding is, how to get it, and what funding rounds are. Starting here is the best jumping point for you to then dive into details. Looking at the headlines, the state of startup funding might seem daunting – as public markets slump and venture funding pulls back – yet taking a broader lens reveals a hidden opportunity for founders, one that happened during the 2008 financial crisis. As venture capital firms have raised record funds in the last two years, announcing a staggering $144 billion in 2022, yet the global economy is slumped, competition decreases, the labor market opens up and VCs are ready to pounce on early-stage startups. Some predict this amassing of dry powered, combined with reduced valuations due to economic conditions will create a surge in capital raised by startups. Either way, there is never a better time to get your head around the basics than now.
If you are a student founder, or simply interested in startup funding, be sure to check out or upcoming eventsas we regularly host world-class accelerators and various investor profiles on campus, great for you to learn more.
What is startup funding?
Startup funding is the process of raising funds to support a company initiative. There exist different means of doing this, and the types of funding vary depending on the maturity of the organization. Funding rounds will also look different for each company, as there is no one protocol, and terms are applied arbitrarily. Nonetheless, the vast majority of businesses participate in some form of fundraising to increase their capacity for expansion.
Different kind of funding start-ups can receive
Startups obtain funding several different ways. The most popular type is venture-capital led funding rounds which involves raising money from outside investment in return for a percentage ownership, or equity, of the company. This is done through funding rounds. But of course, exchanging equity for investment is not the only way to acquire funds. Companies can look at and combine different avenues, from loans to accelerators, to fund their company growth and maintain full ownership. Understanding what stage you are in and why you need funding is key to deciding where to look for it.
If a startup does not want to give up any ownership, they can look into small business loans. These are usually taken from traditional finance institutions such as the bank or government and tend to be unsecured. You are taking the loan out in your own name and are personally responsible for paying it back. Loans allow you to maintain ownership, yet you are creating a liability as you acquire debt and must start repaying immediately. This is why knowing how to spend your loan and making sure it isn’t a band-aid for cash flow issues, is key. To qualify for a small business loan, you must have been operating for at least two years and show proof of a robust business plan, so lenders know you are able to pay them back. You can read more about the different types of loans here.
Pro: Good for startups with secured cash flow who want to retain ownership. Loans specific to start-ups tend to be unsecured as well, meaning you don’t have to risk any personal assets as security
Cons: You are liable to pay back immediately, and you are personally responsible
Bootstrapping (Or Self-Funding)
In the early stages pre-business plan, most startups choose to self-fund by using their own money or money raised from friends and family. Self-funding is useful when trying to get the company up and running – fund the legal framework and necessary tools, such as server space, whilst avoiding giving out equity or taking on interests from a loan. However, it is a risky method as if the startup fails, the owner loses as much as they put in (which can be everything). Bootstrapping is often used either at the beginning or in times of hardship when you need to crunch, some of the most successful startups have had to bootstrap at some point or other – take a look at the journey of this Sequoia-backed company we recently hosted to gain a better idea.
Pros: retain complete control of the company and not owe anyone money
Con: high risk by putting it all on the line, and lack of funding could hinder your growth
Incubators and accelerators
There exist around the world program who help entrepreneurs in their start-up journey by providing resources, such as office space, funding and access to networks and mentors. These are known as incubators or accelerators. A popular example of successful accelerators includes Y Combinator which incubated the likes of Airbnb and DoorDash, supporting them with funding and network access. Student societies are a great way to gain exposure and meet talent scouts from various incubators, and here at KES we often host members of Entrepreneur First, Antler and other well-known incubators as well as having built connections with the network of student entrepreneurs. If you don’t know where to start, this is it.
But you might be wondering, what exactly is the difference between an incubator and an accelerator? Well, to be specific an incubator focuses on the earliest stages of startup building, such as pre-idea, pre-business model. Indeed, some incubators such as EF and Antler are there to help you meet your co-founder, even if you don’t have an idea yet. Accelerators, on the other hand, focus on speeding up development of a startup which usually already has a team and preliminary business model, which tends to include a product market fit. You apply to these programmes on the basis of having a strong enough profile, either as a specialist, engineer or commercialist, that these organizations will train and develop you trusting your idea will be successful and return capital, as they often also take an equity percentage. Incubators and accelerators can come from venture capital firms, universities, commercial organizations or not-for-profit companies.
Some incubators focused on helping from pre-idea are open to all stages of life, from graduate to serial entrepreneur – this breadth gives them the ability to find key matches between co-founders and strengthen combined expertise. However, you must ensure you fit the criteria of each program which are often very selective.
Pros: Access to help not usually available, such as mentors, industry specialists and other helpful resources. Some incubators (and accelerators) also help lead funding rounds.
Cons: Give up a percentage of ownership, good programs are very selective so not guaranteed
Start-ups which aren’t able to take on debt that want to raise the biggest amount of capital will often turn to private equity finance, such as venture capital (VC) which focuses specifically on early-stage companies with strong growth potential. This type of financing is carried out by venture capital firms with funds raised from investment banks, insurance companies, pension funds and other financial institutions. After the 2008 crisis, the entry of sovereign funds (state-owned funds) and private equity firms have also shifted the investment ecosystem – exceeding $10 trillion in assets in 2021. Usually, VCs establish the large percentage of ownership which they split between investors, through limited partnerships. When startups and VC firms enter in an agreement, this entails an amount of funding, depending on the start-up’s valuation, in exchange for equity, a percentage ownership. Interestingly, venture capital does not necessarily take a monetary form it can also be provided in form of technical management or expertise. The process for startups involves submitting a business plan, the VC will then perform due diligence and if all looks good a term sheet will be created, binding or not. We will go into more detail about how VC funding
Pros: offers to fund to new companies that cannot go public and do not have access to enough cash flow to accumulate debt. Also opens start-ups to networks and status
Cons: Investors will often take a significant equity percentage, in order to get a return on their investment, but this also means founders lose creative control and management over their startup
Another type of venture capital investment can come from angel investors. But who are they? Well, angel investors have a similar investment profile to VCs, where they invest a certain amount in exchange for equity, however this is not provided by a firm but rather high net-worth individuals. These individuals are a diverse group, but they tend to be entrepreneurs themselves, which means they are keen on supporting innovation and have an instinct for successful businesses. However, they do tend to look for key characteristics in these companies. Notably, they want to invest in well-managed companies with developed and solid business plans, showing lots of growth potential. Often, angel investors can be industry-specific, through past experience or academic training, and look for other companies in this sector. The difference between VCs, the terms they offer a business are less aggressive and usually ask for no more than 30% equity. Larger deals are now becoming more common through angel investment syndicates. Angel investors tend to be very involved in the business they are helping, which is why it’s important to research the person you are chasing and not just run after funding.
Pros: access to valuable business advice and mentorship, alongside cash injections
Cons: As above, reducing total ownership of your company
Now that you’ve understood the basics of raising capital from investments, let’s take a look at what the venture capital funding process entails. So, let’s say your company is set up, growing and you are ready to take on external investment. Startups raise money through several rounds, but before this can happen, they must complete a company valuation, a ‘pre-money’ valuation as the startup has yet to receive any investment. Essentially, startup valuation is calculating how much it would cost to build a similar company, from scratch.
For early-stage startups which do not yet have revenue, it can be especially tricky. Investors will use startups calculate valuation to determine how much they will pay for a certain percentage ownership of the company. The value of these shares combined represent a startups valuation. Once your company has been valued, you can begin a funding round. The length of time spent looking for funding can vary, but they all follow a common process involving different stages and amounts raised. So, let’s take a look at each funding round
Pre-seed funding is the earliest stage of the funding round which can also include self-funding, raising funds from friends, family or a network. It generally is considered to start with the companies first cash injection and can go on for years as the company finds its footing and develops a business plan. Companies are ready to start raising pre-seed as soon as they feel, but usually includes having a minimum viable product, good market fit or experienced founding team. However, pitching to the right investors or being part of an incubator cohort can bring that investment much earlier
Often, seed funding is the first official funding a company receives when shares (equity) are exchanged – however this can happen in pre-seed. This initial capital is then used to complete market research, product building, hiring and other necessary steps to start growth. Deciding when to start seed funding depends on when you feel ready to persuade investors – but usually you need to have a strong team, figured out your market potential and delivered a product with noticeable traction. Startups need to raise as much as possible to ideally become profitable, or at least so they can meet the next funding round in about 12 to 18 months. It also depends on dilution, or how many shares you are adding (hence diluting ownership of shareholders) – YC combinator suggests you should aim for 10% but never surpass 25%. Great ways to meet investors to begin seed funding is demo days or meet directly with VC firms via a ‘warm introduction’ – i.e., through a connection in their network. If all goes well, the investment deal can usually be closed quickly, which can be made more credible through the handshake protocol. On average, startups raising a seed round are valued between $3 million and $6 million
This funding round begins when a product and customer base is built – your startup can now focus on scaling up. Companies tend to attract investors from traditional private equity firms such as Sequoia Capital or Greylock in this round. Indeed, the average valuation of a startup in this round goes up to between $2 and $15 million. Now, companies need to focus on a plan for long-term profit to attract investors. Typically, now select VC firms will serve as an anchor, whose reputation can then be used to attract other investors.
Once your company is launched and you are ready to move past the development stage, it may be time to acquire Series B funding. This round can only begin once the company is carrying out its operations and has proved its business model. As the round is generally less risky than earlier ones, more investors tend to be involved. Typically, as in series A, the company will re-value itself and then publicize it is selling equity. Investors can be the same from Series A or additional parties in this round, most startups are valued between $30 million and $60 million as they are well-established, proven companies. Indeed, you will also have more negotiating power
Although your company has now proven its business model, you may be looking to expand. This is where Series C funding rounds can start. For most startups this is the last stage before going public. Indeed, at this point your company is no longer even considered a ‘startup’ – you have established your business model and now need to expand. By this point, your valuation is likely over $100 million. In this round, the strategy for approaching funding will differ as previous investors may be priced out, you will start looking for bigger players such as private equity, large VCs and banks.
Series D and Beyond
Most companies never reach this stage, as they are able to go public beforehand. However, for some startups whose business model is based around raising capital, they can continue their funding rounds.
Being an entrepreneur is massively exciting but also requires an enormous amount of dedication, hard work and perseverance. Especially when it comes to securing funding, as you enter the competition pool or put everything on the line. But as we have seen, there is great variety in the type of funding startups can raise – from loans, savings to selling equity – and each are more applicable in different situations. At the end of the day, doing your research is the most important. So, at the bottom we have linked some further reading if you want to dive deeper. We hope this article has been the starting point you needed, now, go out and start raising!
If you are a student founder, knowing where to turn to for funding can be daunting – this is where incubators and student-entrepreneur focused VCs come in. Here at KCL, we have our very own Entrepreneurship Institute and Kings Entrepreneurs Society which regularly hosts talks and events with these incubators or student-focused VCs such as Initiator VC. We also have a great network across London of students who are either founders themselves or work within various startups and VC firms. Check out our Instagram page or website for more information, at KES we are always happy to chat with interested parties and welcome any questions or ideas you might have! Just drop us a DM or email
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