Funding is a crucial part of life in early-stage, high-growth businesses, so it’s imperative that founders and their teams know how startup funding works.
More capital is available than ever before, but this means founders can expect the process to be more complex than ever before. Understanding the ins and outs of startup funding rounds and how they build on one another can make all the difference in executing on vision and building a successful business.
In this article, you’ll learn all about how startup funding works and get answers to these questions:
- What is startup funding?
- How does startup funding work?
- What are startup funding rounds?
- How do I start fundraising?
What is Startup Funding?
Startup funding is a process through which early-stage companies receive money to help grow their business in exchange for equity — giving up a percentage of ownership in the company to the people or firms that have invested.
In their earliest days, many startups may receive funding from individual investors, such as friends, family or angel investors. When a startup formally raises a specific amount of money for a specific purpose, it is called a funding round. Funding rounds are typically led by one firm but often include investments from multiple firms and/or angel investors.
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How Does Startup Funding Work?
The startup funding process commonly begins with the following steps:
Market and competitive intelligence is key to building a promising company that investors will want to fund.
Investors evaluate a company’s strategic value in terms of how it fits into a specific market. Founders are often very product-focused, but if they don’t look outside their four walls and consider how they fit into the broader competitive landscape, they will miss out on what customers want and what other companies are doing about it.
They will also have trouble finding product market fit, which can make it more difficult to attract investors, particularly in later stages.
The startup funding process is much easier for founders who find and work with investors that are a good fit for their company, whether they be angel investors, family offices or venture capital and private equity firms.
Every investment firm has its own thesis on what to look for in a startup. At York IE, for example, we prioritize these criteria:
- Market opportunity
- Company vision
- Founder experience and coachability
Also, some firms focus on a particular industry or technology, while others only invest at a certain stages. We typically invest in B2B SaaS companies up to Series A.
It’s important to know all of this information before making your investor pitch.
Startup Funding Pitch
Create a winning pitch deck and refine your presentation. Tailor them to each investor you pitch, but always make sure to include:
- Company and leadership overview
- Market opportunity
- Product and intellectual property details
- Go-to-market strategy and traction
The key to pitch success is mastering the art of storytelling. Investors are of course looking for a return on their investment, so you’ll need to explain how their capital will drive your growth and generate a profit. But a compelling narrative about your intended use of proceeds will go a long way toward building trust and helping them visualize their ROI.
Startup Funding Rounds Explained
The next stage of understanding how startup funding works is to learn about the different rounds. Each round usually targets a different type of investor, for different amounts of capital. Investors will have differing expectations of entrepreneurs and their startups at each stage. While there are always exceptions, these startup funding rounds often come 12 to 18 months apart.
Pre-Seed Funding Round
There hasn’t historically been much in the way of institutional capital available for pre-seed funding, but that is changing as larger venture capital firms have begun to invest at earlier stages.
In 2011, the most common deal size for angel and seed investments was under $500,000. But in 2021, that range increased to between $1 million and $5 million, according to Pitchbook.
Traditional pre-seed funding has come from friends, family, angel investors and the occasional contests and grants. Push your circle out enough and you will find people who have the ability and interest in investing. Just always be mindful of who you give equity to and how much you give up at this particular point.
Seed Funding Round
The seed round is the point where your startup’s funding begins to become more formal.
Seed investors tend to be angel investors and larger seed venture capital firms that normally have under management up to $50 million in capital. Larger amounts of equity can change hands at this point.
Entrepreneurs may still be largely pitching on an idea at this stage, but some may be further along. Seed funds are often used for further research, testing product-market fit, making key hires, and accelerating product development.
By the time you hold a seed funding round, your concept should be ready to go.
Series A Funding
Series A is where the fundraising really starts to get going.
You’ve made good use of the money you’ve already raised. You have some proof that your offering is working and there is good demand and feedback. You have data that potential investors can look at, track and evaluate.
The money raised in this round will help you optimize, polish and systemize. A wide variety of investors can participate in this stage. They may include angel groups and private equity and corporate venture firms.
Series B Funding
Your startup is on solid ground, with product-market fit and a proven product or service, if you are ready to raise a Series B round.
Only about half of all startups make it long enough to raise a Series B. Those that do have real data that investors can make a decision on, with at least tens of millions of dollars in this round. Money raised at this stage will be used to scale and expand on everything you are doing right. You may be moving into new geographic regions, making new hires to handle higher volumes of business, and improving processes for the next stage of growth.
Your investors at this stage will already see some type of path to an exit. Notable venture capital funds are going to be among the main participants in this round.
Series C Funding and Beyond
By this stage of the startup funding process, your business works, and the reality of a big win is on the horizon. Investors at this stage are going to be among the largest venture capital funds, private equity firms, and corporations. They are going to be among the most demanding you’ve met yet.
The new money will be used to make giant moves to dominate the market, expand to new areas and even eat up other companies through strategic mergers and acquisitions.
Series D and Series E startup funding rounds — and beyond — sometimes take place, but they are less common. By this stage, if your business is successful, it should be well established, and raising finance in this way is usually not necessary.
Where to Start Your Startup Funding Process
If all you have is a good idea, pre-seed funding is the way to cover those initial setup costs, proof of concept, and hiring a team to bring your concept to fruition.
Jumping straight to Series A is a big commitment. The money involved at Series A and later startup funding rounds is larger, and investors will expect more return in the short term.
Wherever you start, focus on capital efficiency. If your startup’s revenue doesn’t justify its valuation, you might not be in a position to effectively use the funding you receive. In essence, you’ve sold more of your company than you had to in order to accomplish your business goals.
Let your true business valuation guide you, and make the most of any expertise from experienced investors who can help to build your business so that everybody’s equity rises in value.
Now that you know how startup funding works, remember: Every investor will have a different definition of “investment.” At York IE, we believe to successfully help, we need to invest more than money. We need to invest time, resources and knowledge at all stages.
Our startup funding process is not about investing for fast exits. We’re investing to build sustainable companies and generational wealth. And wealth is about more than money. It’s about legacy.