Know the Stages of Startup Fundraising Process
A lack of funds is one of the primary reasons that limit the growth of any startup or hinder the shaping of a startup idea in the first place. The first few years of any startup are very crucial as they decide whether the startup will grow or fade away and funds play a very crucial role during this time.
In the past few years, fundraising has been glorified to such an extent that making money has become a secondary goal for many of the founders. Their focus is shifted to ‘raising funds’ from ‘making profits’. Since success now is all about raising money, it seems that it’s difficult and complicated though it’s certainly not. All it needs is a correct approach to find financial support for your venture.
An understanding of the available funding avenues, suitability of such avenues with your motive for raising funds, and a well prepared and impressive pitch are the precursors for your success in fundraising.
Why Raise Funds?
There are several reasons why any startup needs funds during starting up. Following are the top reasons for fundraising.
Without funds in place, sometimes it becomes difficult for startup founders to even develop product prototypes or test market assumptions, especially for entirely new products or markets or develop disruptive solutions.
The businesses need funds for their day to day activities. Costs are incurred in daily transactions, usage of resources, etc. These are operating costs and funds are required for payment of such costs.
Companies also need equipment, machinery, office space, etc., for their business. The procurement of such company assets also requires funds.
During the initial phase of starting up, companies need a small number of funds for marketing their product. Usually, expenditure on marketing is more pronounced during the later stages when the company has a ‘ready to launch’ product and an established business model. But startups too need funds for attracting early adopters and showcasing their presence.
Licenses & Certifications
Startups need funds for obtaining licenses and certifications. It depends on the type of offering and operations.
Sometimes the new entrepreneurs or founders during the very initial stage of starting up do not feel the need of raising funds and quite often use their own funds at least during the ideation or prototype development phase.
Later in their journey, they realize how important it becomes for them to raise money. Here the founders need to know the meaning of a startup in the first place. Startups are growth machines with scalable business models. So, to fully utilize the power of scalability, they need funds which they do not have most of the time.
Funds during the initial stages are required to generate enough investor interest needed for fundraising during later stages.
Types of Funding
The following table broadly categories various types of funding along with their characteristics:
Ways to raise funds
Bootstrapping means funding the business with one’s own money. While bootstrapping, entrepreneurs either use their savings or reach out to their family and friends to gather money during the initial stages. The entrepreneur and his team bear the entire risk in the business.
- You as an entrepreneur have total control over your company.
- Your main focus is on the development of your offering (which may be a product or service) and financing our business through sales rather than external funding.
- Since you do not borrow money, your costs in the form of interest or equity are significantly reduced. This helps you to achieve a positive cash flow.
- This stage involves less documentation.
- Bootstrapping is a perfect option for you when your startup needs a small investment during very early stages.
- Insufficient funds force you to be profitable but simultaneously affect growth.
Debt/ Bank loan
It means you borrow money, usually from a bank, to finance your business and repay the money with interest within a defined period. Loans can help you finance your day to day business needs like payroll, working capital, and other miscellaneous expenses.
One big disadvantage of a bank loan or debt is that they increase your expenses due to the interest that you have to pay. This has a direct impact o your cash flow.
The most important prerequisite for a bank loan is to have a detailed business plan. This will allow you to know the amount of funds that you would need & areas to allocate them, the current financial position of your business, and your returns.
Through equity sharing, you minimize your risk by sharing some portion of your ownership in your company in return for capital. Venture capital is the most common type of capital that is usually invested by investors in startups through the equity sharing route. Venture capitalists take risks by investing in a startup seeing a massive potential for exponential returns. They are usually aware of the risks involved in it.
Here, if you or an investor likes to sell their part in the business during later stages, you can do so by first determining the ‘valuation’ of a company.
During very early stages, say at the idea stage, with no operations or sales, your valuation will usually be based on future cash flows, which ultimately depends on how best you execute your idea.
Now depending on which stage you are at in your business, there are various ways of raising funds from investors:
a) Seed/Angel Funding
Seed funding is the first round of funding, and it often happens at the idea or prototype stage. Seed funds are generally used to develop the product and build a team (hire key members).
At this stage, it is always good if you are ready with your minimum viable product. Investors look for signs of product-market fit (i.e. market should need your proposed offering), and few early paying customers of your product or service. You should focus on validation and the potential to scale at this stage of funding. This round is usually led by angel investors.
b) Accelerators and incubators
Accelerators (like Y Combinator) and incubators are organizations run by experts who try to help startups achieve their goals. Mentorship and resources are a few other things that they provide to startups apart from funding.
c) Series A, B, C Funding
Once the startup has achieved the objectives with the funds at the seed stage, it might need further funding to grow and scale. The next phase of funding is called series A funding followed by B, C, D, and so on. With each funding round, your ownership in the company is diluted and more VCs are added on the board.
d) IPO – Initial Public Offering
This is the time when you offer the shares in your private limited company to the public. Now the public can buy and sell your shares at a price determined by the demand and supply of your shares in the share market.
This is the time when investors look to “exit” from your business. They sell the equity they have in your company and take the money. By exiting, they get exponential returns on the investments they have made in your company.
There is also an alternative for exiting the company and that is to sell your entire company to another bigger company.
Even though funds are not the deciding factor for the success of any startup, they are still essential. Capital gives you a massive advantage over other players simply because it puts you in a position to capture a large market for yourself in a very short period.
Fundraising takes careful research and planning. Your presentation to investors must demonstrate the unique value proposition, traction achieved, and how your startup is poised to generate a positive return on investment.
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