No matter how brilliant their business models are, fast-growing companies often need funding to scale and develop. This is particularly true for those companies that are seeking to build new technologies that disrupt established markets and larger incumbent competitors.
From the outside, it seems like most startups raise money effortlessly as they move smoothly between funding stages. But the reality is very different. Fundraising can be a grinding process full of false dawns and difficult moments. And access to ‘insider’ knowledge makes a big difference: if you are a first-time founder or someone without an extensive startup and investor network, the fundraising process can seem opaque. Where do you find the investors who share your mindset? What does a great pitch look like? Should you reply to every investor email?
This article digs into the basics of startup fundraising. We’ll clarify what you should look for from different funding rounds, identify what makes a solid fundraising strategy, and talk about the importance of managing share ownership as you progress through funding rounds. Ready? Let’s go.
You have a brilliant idea. It’s an idea so innovative you’re sure it will disrupt the way things are done in your sector of interest. To make this exciting plan a reality, you need to move faster and scale faster than your peers. So far, so good.
But where does the money to scale come from?
You can aim to bootstrap your way to growth by building lean products for small subsets of your customer base, learning quickly and iterating as you go, with the aim of scaling organically. This is a fantastic way to grow, but it 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.
So to create digital disruption and become an innovator in your field, you’ll have to raise funds. But where do you start? Who do you speak to? Let’s kick things off by uncovering what funding rounds are, and what the different funding milestones – from seed through to IPO – actually mean for you.
Startups raising funds go to market looking to secure investment. 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. Venture capital (VC) investors are conventionally responsible for most investments in high-growth startups. It’s worth remembering, though, that investors which traditionally specialize in more mature businesses, like private equity (PE) firms and family offices, are showing more and more interest in early-stage startup investments.
As early-stage, high-growth businesses scale, it’s normal for their spending to continue to outpace their revenues. As these companies use up capital, they progress through different funding rounds. 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.
Pre-seed and seed funding rounds represent the very earliest investments in brand new companies. Essentially, they provide the initial capital to get you off the ground.
‘Pre-seed’, ‘friends and family’ and ‘angel’ rounds can be used interchangeably – but are they really the same thing? In short, not quite. Let’s look at how these funding definitions vary from each other.
Pre-seed, friends and family, and angel rounds
Pre-seed funding happens very early on in the life of a company. A founder and an idea can be enough to excite investors and secure an initial tranche of capital. Pre-seed investors might include friends and family members. Fundraising from friends and family can help you raise money without approaching banks or institutions. Using your closest network is also a handy way to learn how to pitch your idea to a more open and informal audience.
Angel investors are individuals who choose to invest very early in a company’s lifespan. Some angels specialize in one-off cash injections, while others set aside money to follow on their successful investments into later funding rounds, where they will invest alongside VCs and other institutions.
Returns for angels can be enormous, but angel investments are very high-risk given how young portfolio companies are when angels invest.
A Series A round is usually the first time a startup will raise money from a professional investment firm. Series A rounds may be the first time investors analyze the fundamentals of the business, from revenue projections to customer acquisition costs. VCs might provide additional guidance and advice by taking seats on your board when they invest in a startup.
(To learn more about what it’s like raising a Series A funding round, take a look at our CEO Yoko’s blog on what she learned from her experience raising Ledgy’s Series A!)
For companies that continue to grow successfully, Series B funding rounds subsidize further expansion, talent acquisition, product innovation, business development, marketing activity and other essential growth efforts. Generally, companies at this stage are expected to have developed more predictable revenue streams and have identified a true fit with a significant target market. They may also have expanded their executive team, with the founders being joined by VP or C-level hires who bring experience scaling other startups or larger enterprises.
VCs involved in your Series A funding round may also invest in your B round, but you might also look to bring on new investors with different areas of geographic or sector expertise. Investors follow on their investments because they believe in the potential of their portfolio company, and to prevent their stake becoming diluted when other investors join the party. Check out Ledgy’s blog on dilution and anti-dilution tactics when fundraising for a deeper dive on this subject!)
Series A and Series B funding rounds cement a company’s position as a rising star in their market or industry. Depending on the nature of the problems you’re solving, though, you might need further funding rounds to continue scaling. This is especially true if you’re in a highly capital-intensive space. 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.
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, exits 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.
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.
(Interested in learning more? Ledgy’s blog on term sheet negotiations includes a helpful guide to preferences at exit or liquidation.)
Fundraising can sound simple in theory, but if you haven’t ‘been there’ before, you might not know where to look for funding opportunities or how to formulate fundraising strategies. Here are four quick tips to help you get started.
Networking is a big part of fundraising. If you have knowledge gaps, or if there are a small group of investors you are especially interested in partnering with, attend online and in-person networking events featuring them wherever possible. Learning about their ideas and investment theses will help you identify whether they could be the right partner for your company.
Angel investors and VCs tend to be receptive to warm intros from people they’ve worked with before. Find connections to the investors that excite you, and your ‘hit rate’ could increase.
Startup accelerators give founders invaluable coaching, resources and advice. Many accelerators take an equity stake and invest in the ‘classes’ of startups they incubate each cycle. Accelerators like Y Combinator, Entrepreneur First and Techstars have built close partnerships with the best VC investors, making it easier for accelerator-backed companies to find the next source of funding for their idea.
Well-engineered crowdfunding campaigns can generate a lot of money for early-stage startups. They can also help your company attract the attention of institutional investors: crowdfunded businesses are no longer a barrier to VC interest. Health and wellness company Larq recently raised $10 million in a mixed Series A funding round featuring crowdfunded capital and VC investment.
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.
Last but by no means least, be prepared to be persistent. Even if your conversations with investors go well, the laws of probability mean that most pitches will end with a ‘no’. But a no from a potential investor does not mean your business is going to fail. Just take a look at the ‘anti-portfolio’ of Bessemer Venture Partners, one of the world’s most successful VC investors. Bessemer rejected companies like Airbnb, Google and Zoom in their early days, and who’s heard of those guys since? Over time, keeping in touch with investors who pass initially can be a great way to secure future investment partners.
There are a lot of pressures on CFOs (and other functional leaders) at this moment in time. The modern finance function must be an engine of growth as well as managing critical business processes, particularly in early-stage companies. With so many companies rethinking their approach to remote options in the last 18 months, managing a cap table and employee share options now means understanding processes and regulations in international markets as well as the many pre-existing challenges.
Ledgy’s powerful, intuitive equity management software helps you extract greater insights from your equity data. You can share information and documentation with investors, model financing rounds at the touch of a button, and improve communication on equity and fundraising with the rest of the organization, including your employees.
To learn more about Ledgy, book a call with us today.