Startup Funding Definition
Startup funding is defined as the capital needed to start a new business. Startups typically obtain funds from investors, such as venture capital firms, angel investors, or banks. Startup lawyers generally advise companies on navigating the legal complexities of startup funding and compliance requirements.
How Do Startups Get Funding?
Securing startup funding can be tricky, even more so if you want to work with a traditional lender. Banks are selective in whom they lend to and typically require a high sales volume, cash reserves, at least one year of verifiable business history, and strong credit. However, there are numerous alternatives to banks and more traditional lenders for startup business financing.
Here are three ways that startups get funding:
Method 1. Self-Funding
If you have sufficient personal savings, you may choose to self-fund your startup or “bootstrapping” it. By self-funding your startup, you retain complete business control and avoid paying interest to external lenders.
Method 2. Investors
Angel investors and venture capital firms are interested in investing in startups with high growth potential. This type of startup financing does not require monthly payments. However, you will likely have to give up some ownership of your business.
Method 3. Loans
Small-business loans give you complete control over your startup, but most lenders have certain requirements and may impose restrictions on how the funds are used. However, you must immediately begin repaying the loan plus interest. Most traditional finance lenders, such as banks, will only lend to well-established businesses with sound financials, meaning you may need to seek financing from alternative sources, such as online lenders.
This Small Business Administration web page also discusses startup funding.
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Types of Startup Funding
There are plenty of financial and legal options when it comes to startup funding. Below, we’ve explained seven different types and how they work.
Type 1. Angel Investors
Angel investors invest in startups for a high rate of return. Typically, they are individuals who have an excess of money to invest in high-risk ventures. Angel investors usually provide funding during the early stages, when things are more challenging.
Type 2. Bootstrapping
Many entrepreneurs finance their startups with their personal savings. Essentially, you invest your own money or capital into your startup rather than seeking funding from outside sources. This method of financing is also referred to as bootstrapping.
Type 3. Crowdfunding
Crowdfunding platforms have altered the landscape of startup financing. Through crowdfunding, you can present your startup concept and additional information to a global audience and receive funding from various sources. Generally, crowdfunding does not require repayment.
Type 4. Family and Friends
Consider a “friends and family” loan if you have friends and family interested in financially supporting your business venture. It is tough to ask them for money, so make a case for your business and offer a specific repayment proposal.
Type 5. Grants
Grants are essentially free money and capital to help you launch, operate, and maintain your business. You do not have to repay the money you receive and obtain startup grants by searching for available opportunities and submitting an application.
Type 6. Loans
Unlike grants, loans are repaid over time. Lenders, such as banks, can provide startup loans. Each loan and lender will have unique requirements and application processes, but you should anticipate beginning with a well-written business plan.
Type 7. Venture Capitalists
Venture capitalists (VCs) invest in startups to profit as the business grows. They typically take an active role in the company, serve on the board of directors, or apply to become co-founders. Since VC investments are made in exchange for equity, you must demonstrate your startup’s growth potential over the long term.
Different Rounds of Startup Funding
You must progress through a series of funding rounds and demonstrate that your idea is deserving of funding while meeting a variety of different goals and challenges along the way. Each round is designed to raise sufficient capital to continue growing and last up to one year. However, many entrepreneurs compress the timeframe to six or even three months.
Startup funding rounds are classified into the following stages based on their purpose:
Round 1. Pre-Seed and Seed Funding
Pre-seed funding occurs when founders attempt to jumpstart their business by investing their money to cover initial startup costs. Following that is the seed stage, where founders seek out angel investors to contribute additional research, market testing, hiring a team, and initiating production. Startups can seek investments of up to $2 million at the seed stage, depending on their needs and presentation through convertible notes or SAFE notes.
Round 2. A-Series
The A-series is primarily targeted at startups with a proven business model, a sizable customer base, and are already profitable. Typical investors in this space are venture capital firms, which need startups to demonstrate actual data and progress from prior investments. Investments at this stage can begin as low as $2.5 million and as high as $10 million, and require a customized strategy to achieve a higher return on investment (ROI).
Round 3. B-Series
Round B assists startups in becoming enterprises and is entirely focused on growing the team and expanding into new markets. They’ve already matured, amassed a sizable user base, and seek venture capital funding. At this stage, investments typically range up to $100 million.
Round 4. C-Series
Expanding to round C entails an even greater degree of expansion. The companies are already profitable, valued at more than $100 million, and seek equal funding. As one of the final funding stages, Round C includes not only extending the capabilities of existing projects but also developing new products.
Round 5. Initial Public Offering
Initial public offering (IPO) is the final stage of a startup’s existence. It is the process by which a private company’s shares are made available to the general public, resulting in a significant funding increase. However, IPOs add another layer of complexity, as you must now deal with shareholders.
Fundraising for a startup requires a significant amount of time and a well-thought-out strategy to succeed. A lawyer for startup companies can help you understand how each round applies to your specific situation and business structure.
Startup Funding Examples
- Mary Hannaford inherited a non-operational vineyard in Napa, California
- She decides to bring the land back to life, produce wine, and sell bottles
- Her inheritance also included $250,000, which is enough money to clean up the land and upgrade farm equipment
- Hannaford estimates that the entire project will cost a few million dollars to initiate
- She decides to start with seed funding rounds and, after proving her business model, move to Series A rounds
- Hannaford convinces venture capitalists to give her $1 million in exchange for 20 percent equity
- She will use this money to curate grape seeds, till the land, plant grapes, and harvest them on a small section of the land
- She will hire three staff members to assist with the process
- Over three years, Ms. Hannaford’s vineyard proves to be a profitable venture, and she convinces the same venture capitalists to help her through the next funding round
As you can see, startup funding not only offers how you grow a business but it also provides a framework for making the ask. Work with startup lawyers to help you draft the necessary legal documents for startup funding, including pro forma templates, website terms and conditions, and privacy policies.
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