The Funding Lowdown: Fundraising Strategies to Grow

Fast-growing companies often need funding to scale and develop. This is particularly true for those companies building new technologies designed to disrupt established markets and larger incumbent competitors.

A couple of years ago, it felt as though a different scaling company was celebrating a big new funding round almost every day. Now, the macroeconomic environment has become more hostile to early-stage companies seeking outside funding, and fundraising has become more challenging for many companies. In light of these changed circumstances, how can founders and leaders execute their funding strategy, keeping careful control of their cap tables as they continue to scale?

Let's start by summing up what funding rounds are, and why they're necessary for certain businesses.

Learn more about our cap table management software.

What is a funding round?

A funding round happens when a company raises money from investors, usually to support the future growth of the business. Depending on the stage your idea and business are at, you’ll aim to raise money from either individuals or institutions. Individuals might be friends and family for very early-stage businesses, or angel investors if you’re a little further down the line.

Later on, companies normally seek investment from institutional investors like venture capital (VC) or private equity (PE) firms. Funding rounds often get larger over time as the business grows. As an example, Stripe raised $20 million in its Series B round back in 2012, while the Series H growth round it raised in 2021 totalled $600 million. As well as having much higher operating costs and capital expenditure, larger businesses need more money to kickstart needle-moving initiatives compared to an early-stage startup.

As high-growth technology and software businesses scale, it’s normal for their spending to ramp up while they find routes to revenue growth. As these companies use up capital, they arrive at a point where a new funding round is necessary.

While there are some similarities when it comes to the fundraising process, the data and signals investors are looking for changes with each stage. Let’s find out more about the key funding rounds for startups.

When is fundraising necessary?

There are two scenarios that trigger scaling companies to think about new funding. The first is when your company is planning a period of increased investment in order to take advantage of a growth opportunity. The second is when your company is on track to run out of cash, and an injection of new funding is needed to remain solvent.

Strategic fundraising can help companies execute their growth plans in a number of ways. Some examples of capital-intensive growth initiatives include a period of ramping up hiring; investment in product development; or perhaps acquiring adjacent companies or competitors in order to win market share. If companies desire funding to stimulate future growth in the business, rather than to avoid running out of cash, they will hold more cards with investors heading into the fundraising process.

By contrast, for companies that have minimal runway – the term for how long you can survive with the cash you have on hand – the success or failure of a new funding process can be existential. In these circumstances, kicking off your fundraising process at the right time can make all the difference.

Calculating when you might need to start raising funding can be expressed as a simple equation. How much time do we have left before we run out of cash? Simple:

months of runway = cash on hand / net burn rate

Dividing the cash you have in the bank by the amount you spend every month gives you your runway. (We've used net burn rate here, which is your total spending minus any revenues you make. Gross burn rate is simply your monthly expenditure, and might be more useful for companies that are not yet revenue-generating.)

If you're spending more than you make in a given month, you are 'cash flow negative'. If you are burning less than you're making in revenue, you are 'cash flow positive' as a business. There are many benefits of being cash flow positive (also known as reaching break-even): positive cash flow means that if you keep revenues and spending at the same level, you will remain solvent as a business in perpetuity. It also means that if you decide to raise more funding, to execute on a strategic growth plan, investors will potentially look more favourably at your prospects given your cash levels are self-sustaining.

Typically, companies that are cash flow negative commence new fundraising processes with between six and 12 months of runway left. If you start fundraising with fewer than six months of runway remaining, the pressure can ramp up quickly with

Bootstrapping

Many companies aim to scale without needing external funding at all. The strategy of only spending what you earn as you grow is known as bootstrapping. Bootstrapped companies often grow more slowly than companies taking on VC funding, as they have less room for 'moonshot' product development ideas that might not pay off, and leaner budgets might mean less room for expensive marketing and advertising campaigns.

However, bootstrapping only works for some business models. Startups whose products demand a lot of upfront research and development, and where hiring quickly and early is a critical engine of growth, need to raise capital to scale quickly and disrupt their markets.

Funding rounds by stage

In a company's early stages, they can progress reasonably quickly through different funding rounds if they are growing fast. Pre-seed and seed funding rounds represent the very earliest investments in brand new companies. A Series A round is usually the first time a startup will raise money from a professional investment firm. And for companies that continue to grow successfully, Series B funding rounds subsidise further expansion, talent acquisition, product innovation, business development, marketing activity and other essential growth efforts.

Depending on the nature of the problems you’re solving, companies might need further funding rounds to continue scaling. This is especially true if your market is highly capital-intensive. Taking on the global ride-hailing market, for instance, meant Uber needed funding rounds up to (and beyond) Series G before it was ready to go public.

The exit

Companies seek exits to give investors returns on their investments, and to reward employees for all the work they’ve done to build the company. Generally, an exit might mean an acquisition (by another company or occasionally by a PE firm), or an initial public offering (IPO), where the company lists on a public stock exchange.

The work you do during fundraising processes has a huge impact on exits and liquidity events. When you exit, the order in which your shareholders see their returns becomes important. Your investors may have ‘preferred’ shares, for instance, which mean their returns are delivered before the ‘common’ shares of founders and employees. Conventionally, investor preferences operate on a ‘last in, first out’ principle, where later-stage investors (who may not expect the same percentage return as the very earliest investors) are paid out first.

Want to understand more about how funding negotiations impact exits? Our blog on term sheet negotiations includes a helpful guide to preferences at exit or liquidation. With Ledgy, you can model scenarios to give you insight into the distribution of capital to different stakeholder groups depending on the valuation, liquidation preferences and other covenants.

Alternatives to institutional fundraising

We've spoken a lot about equity finance. However, raising cash through equity fundraising might not be right for every business. What are some alternative financing models that can help businesses grow?

Venture debt

Venture debt is a type of lending arrangement designed for companies that have secured venture capital backing. VC funding is used to gauge risk and to price the loan facility for each customer.

Venture debt can be short-term or long-term, but the key difference is that the debt – unlike equity – is repayable.

Convertible loans

A convertible loan is a form of debt that converts (hence the name) into equity depending on whether certain conditions in the original contract are met. This might mean the company hitting a certain rate of growth, for instance, or a revenue target being achieved within a certain timeframe. (More Ledgy insights on convertible debt here.)

Bank lending

Of course, obtaining a business loan from a bank is also a reliable source of capital for scaling companies. Generally, it's fair to say that banks are more risk-averse than a VC firm or a venture debt specialist; this may be reflected in the pricing of loans or in any associated performance covenants.

There are different types of bank loan available to businesses, including term loans and revolving credit facilities (which are more overdraft-like).

Crowdfunding

Well-engineered crowdfunding campaigns can generate valuable cash and attention, even for later-stage companies like Brewdog. They can also help your company attract the attention of institutional investors, as nowadays there is less stigma from VC investors about backing crowdfunded businesses. Some companies have raised mixed Series A funding rounds featuring crowdfunded capital and VC investment, for instance.

A reminder, though: successful crowdfunding campaigns demand a lot of preparation. You’ll need great content, a strategy for social and press distribution, and a tempting pre-launch strategy to turn visitors into backers.

Keep track of your cap table with Ledgy

Carefully managing your cap table and equity data is an essential part of engaging investors and progressing through the fundraising process. Sharing up-to-date, transparent equity documentation reinforces your credentials as a viable candidate for investment.

Ledgy’s powerful, intuitive equity management software helps you extract greater insights from your equity data. You can share information and documentation easily, model financing rounds at the touch of a button, and improve communication on equity and fundraising with the rest of the organisation.

FAQs

What is the objective of each startup funding round?

Different funding rounds have different objectives. Pre-seed, seed and Series A funding rounds are designed to let businesses test ideas and find product-market fit. With later funding rounds, companies should have proven their business model but they might need capital to scale internationally, hire more experienced people or to fund acquisitions of competitors. In Ledgy's 2023 State of Equity report, we found that less than half of founders had not raised capital in the last 12 months; read the report here.