Startup Funding Explained: Everything You Need To Know

If you're new to the world of startups and venture capital, the different names and stages of funding rounds and what they mean can be a bit intimidating at first — they're not intuitive concepts if you're not familiar with them, and there isn't a single definitive guide to them. In this article, however, we'll break it down and explain the main differences between each funding round, when is the right time to consider a company as belonging to a funding stage, and the different types of startup funding and how it works.

Types of Startup Funding

Accelerators and Incubators

Startup accelerators and incubators are programs designed to support early-stage startups through structured programs mentorship, resources, and funding. While often used interchangeably, they serve different purposes and cater to different stages of startup development.

Accelerators typically focus on fast-tracking the growth of startups over a defined period, usually around three to six months. During this period, selected startups enter an intensive program that provides access to mentors, workshops, and networking opportunities with industry leaders and potential investors.

Startups in an accelerator program usually receive a small amount of seed funding in exchange for equity. The primary goal of an accelerator is to prepare startups for the next phase of funding, often culminating in a demo day where they present their business plans to a room full of investors.

Incubators, on the other hand, provide more long-term support aimed at nurturing a startup's growth from the ground up. They tend to focus on startups at earlier stages, often before they reach product-market fit. Incubators offer resources such as office space, business development assistance, and access to industry research. It's less common for incubators to offer direct capital injections to their participating startups.

Crowdfunding

Crowdfunding has emerged as a popular alternative for companies seeking funding without relying on traditional venture capital or angel investment. This method involves raising small amounts of money from a large number of people, typically through online platforms like Kickstarter or Gofundme. There's a series of caveats to this model though, such as the lack of options for continued growth and the expectation of some sort of perk or reward for backers.

Grants and Loans

In addition to crowdfunding, startups also have the option of seeking grants and loans as funding sources. These two avenues can provide financial support without diluting ownership or giving up equity, which is an appealing prospect for many entrepreneurs.

Grants

Grants are funds provided by governments, nonprofits, or other organizations that do not need to be repaid. They are often designed to encourage innovation and development in specific sectors such as technology, healthcare, or education. The application process for grants can be competitive and often requires detailed proposals outlining how the funds will be used.

One of the significant advantages of grants is that they can provide substantial financial backing without any equity stake or repayment obligations. However, the process may require a lot of time and effort, as well as adherence to particular guidelines and reporting requirements after the funds are allocated.

Loans

Loans can also be a feasible funding option for startups, particularly when quick cash flow is a necessity, and the startup has a concrete plan for repayment.

Loans can provide a much-needed financial boost without requiring business owners to transfer ownership or dilute their equity. Different types of loans are available to startups, including traditional bank loans, Small Business Administration (SBA) loans, and personal loans.

The downside, similar to crowdfunding, is the lack of an option for continuous funding further down the line, other than taking out a second loan. Keep in mind that personal loans  and credit cards are prone to snowballing and are ill-advised for this purpose.

Venture Capital Funds

Venture capital (VC) funding is the gold standard for startups looking to scale quickly. VC firms are a source of funding for high-growth potential companies in exchange for equity stakes. This type of funding is particularly beneficial for businesses operating in fast-paced industries like software or biotechnology, where rapid scaling is essential for market success.

How Venture Capital Works

Venture capitalists typically invest in rounds, known as Series A, Series B, and so on, with each round providing progressively more capital as the business scales. In exchange for their investment, VC firms often seek significant influence over the company's direction, which can include board seats and a say in major decisions.

The allure of VC funding lies in the substantial amount of capital that can be raised, which can facilitate rapid expansion, product development, and market penetration. This funding model allows startups to innovate and take risks, often leading to groundbreaking advancements in their respective fields.

Angel Investors

Angel investors are a set of VC investors. Usually they're affluent individuals who provide capital for startups in the seed or pre-seed stage in exchange for convertible debt or ownership equity. They are usually one of the first sources of funding for a new venture. Angel investors not only provide financial support but can also offer valuable mentoring and advice based on their own experiences.

When approaching potential angel investors, startups should have a clear business plan, a prototype, or an initial product in place. This helps in demonstrating commitment and validates the idea's potential. Funding amounts vary widely, ranging from a few thousand to hundreds of thousands of dollars. In essence, angel investors are crucial in the early stages of a startup's lifecycle, providing not only funds but also credibility.

Access to Venture Capital: Startup vs. Small Business

Private equity firms rarely invest in traditional small businesses. What constitutes a startup and what doesn't is an interesting discussion that we've addressed elsewhere, but in this scenario, it essentially boils down to which kinds of company can grow their revenue exponentially by a magnitude of several times in just a few years, and which kinds of company cannot accomplish this.  

In the earliest stages, it might make sense to set out to build a viable product and a business model that ensures that the company remains profitable. This approach is based on common sense, but it's not that common in most tech startups, which may operate at a loss for years before achieving the full growth potential of their business idea, going through additional funding rounds to extend their runway time.

In short: if your company has the potential of achieving ten times its current revenue without having to scale the cost of its operation by the same amount, then it could be considered a startup, and thus eligible for venture capitalists to invest in. Due to the nature of these industries, it's far more common for software and tech companies to seek startup funding options.

However, it's important to recognize that not all startups will successfully attract venture capital investment. The competition is fierce, and investors are looking for specific criteria before committing their resources.

Stages of Startup Funding

The path of startup funding involves several stages, each with its own characteristics, requirements, and types of investors involved. While there isn't a defined guideline for what constitutes one stage or the next —a seed round can be $50K or $5M— it's worth grouping a set of characteristics that will help you pinpoint the stage your startup is currently at.

1. Pre-Seed Funding

The journey of fundraising begins at the pre-seed stage. This is the earliest phase of funding, where entrepreneurs rely on their personal savings, family, and friends to kickstart their ideas. At this stage, formal funding may be limited, but it’s a critical time for developing a minimum viable product (MVP) and conducting initial market research. The goal here is to validate the business concept and prepare for more significant investment rounds.

2. Seed Funding

Once the MVP is developed, entrepreneurs may seek seed funding to further enhance their product, conduct market tests, and expand the team. Seed funding can come from angel investors, seed venture capital firms, or crowdfunding platforms. This stage often involves presenting a business plan showcasing the startup's potential for growth and market traction. Seed funding amounts can vary significantly, generally ranging from $10,000 to $2 million, though there are exceptions.

3. Series A Funding

Once a startup has demonstrated its potential through seed funding, the next critical step is Series A funding. At this stage, the company is typically looking to optimize its business model and scale its operations. This funding round is geared toward startups that have a validated business concept and are ready to take significant steps toward growth.

Series A funding generally involves larger amounts than seed funding, often ranging from $2 million to $15 million, depending on the industry and the startup’s valuation at that point. The primary goal of this round is to secure sufficient capital for advanced product development, user acquisition strategies, and establishing a robust market presence.

Investors in this stage include venture capital firms that specialize in early-stage funding. Unlike earlier rounds, where personal networks may have played a larger role, Series A often requires a more formal relationship with institutional investors. Startups will need to prepare detailed financial projections, demonstrate traction, and showcase user engagement metrics to convince investors of their growth potential.

Be careful, many startups get stuck between the Seed Stage and Series A. It's a very delicate time in your company's lifetime, and what will test whether or not it's built to succeed.

4. Series B and Beyond

At this point a startup already has a track record of its ability to scale and adapt to the market, of developing and improving a robust product, and of its capability to compete (or even dominate) in its market. Because of this, the funds raised during Series B and subsequent future funding rounds are often allocated to hiring new talent, increasing marketing efforts, improving infrastructure, or even making strategic acquisitions to bolster the business. The amounts raised during this stage vary considerably, and can in some cases be lower than previous rounds, though unicorns like OpenAI have broken records with $10B investments.

How Much Do I Need To Raise?

The short answer to this question is whatever you need to get you to the next round. Your roadmap should have a set of fundable milestones such as releasing a complete product, meeting a set minimum in one of your KPIs, or becoming profitable. As a rule, startups operate at a loss for years before achieving exponential growth, and your main focus as a founder should be to avoid running out of money.

A solid Financial Model will allow you to stay on top of your runway and calculate when and how much your next funding round should be. We've created a simple template for you to do so.

Download our free template

‍