As a first-time startup founder, you’ll be learning so much! One of the most important things you’ll learn is the mechanics of fundraising and types of funding for startups.
You’ll learn the differences between stages of fundraising, how that correlates to different stages of product development, alternative sources of funding, and a little bit about where to seek funding. Let’s jump in.
There are a wide variety of different types of funding; today, we’re going to be focusing on a few of the most common:
Venture capital, or VC, is one of the most highly publicized forms of startup financing. Most of the name-brand startups you know were VC-backed. In the most basic terms, this arrangement typically looks like a venture capital firm offering a certain amount of cash in exchange for equity ownership in your business. Venture capital firms are looking for fast growing, tech-enabled unicorns. They need the company to reach $100 million ARR in 5-7 years in order to justify $1Bn+ valuations and exits. VC is only right for very quickly growing companies addressing huge markets.
While VC funding is essential for the startup ecosystem, it’s really difficult to secure. There are pros and cons of different startup funding options; as a founder, part of your job is determining the funding path that’s right for you.
The reality is that most new businesses aren’t a fit for venture capital - but that doesn’t mean they’re not worth building or that they won’t be successful.
This is one of the most traditional types of capital: a bank offers you capital and you agree to pay it back with interest. The trouble is, this type of funding is typically only available after you’ve been in business for 1-3 years, and often requires some kind of hard asset as collateral. For most early-stage startups, this isn’t really accessible. For some businesses with existing cash flow or hard asset collateral (i.e. inventory/machinery/etc.), an SBA loan is a low cost source of growth capital.
Another common way that startup founders fund their businesses is through personal debt. This might look like taking on a personal loan, or using a high-interest credit card. While it’s helpful in a pinch, this can be expensive capital.
A wide variety of new financial options are emerging, which can help founders access capital in ways that are more flexible and more aligned to their current growth stage.
Chisos’s Convertible Income Share Agreement is one of these options; it’s a dynamic blend of an Income Share Agreement and a SAFE. You can learn more about how it works here.
But that’s just one option. There are a variety of non-dilutive capital options, too, and unique types of “AltVC” or “FlexVC.”
Some blogs refer to the Pre-Seed stage (more on that below) as the bootstrap stage. At Chisos, we look at bootstrapping a little differently.
Our perspective, based on conversations with founders, is that bootstrapping is a longer-term decision about how to fund a startup. In our experience, founders who choose to bootstrap intend to primarily self-fund, and focus on using the business’s revenue to fuel future growth.
Depending on your offering, crowdfunding can be an option. This is where you solicit investment from the general public, including non-accredited investors. In addition to providing capital in the short-term, crowdfunding can be powerful evidence of traction for later-stage raises. Be warned though: it’s really difficult to crowdfund. Anyone looking at this route as “easy cash” should probably reconsider.
Two of the most popular crowdfunding platforms for startups are Republic and WeFunder.
Now that you have a quick understanding of a few different types of startup funding, here’s guidance on the different stages of fundraising for startups.
First things first, these stages are typically used to refer to VC fundraising. That is, accepting capital from venture capital firms in exchange for a percentage of ownership in your business.
The truth is, less than 2% of startups will receive VC funding. It’s a difficult path that’s definitely not for everyone. (That’s part of why we believe the startup world needs new funding options!) That said, the terminology is essential to understand because it’s used by the entire ecosystem to understand your startup’s growth stage.
Generally speaking, these are the different stages of startup fundraising:
In recent years, the size of the round has increased significantly. In the past, a pre-seed round was typically up to about $100K; these days, a pre-seed round can be millions.
That said, these rounds are almost always raised consecutively, regardless of the round size. That means that even if you manage to secure a $2M pre-seed round, your next round will be a seed round, even if you raise $10M.
Typically, founders expect to raise additional rounds every 12-18 months; in today’s fundraising environment, we’re expecting those durations to stretch out. After years of free-flowing capital, we think it will be important for founders to stay lean, maximize runway, and focus on growth.
With those basic things in mind, let’s learn a little more about what they mean.
Pre-Seed is typically the first stage of building your business. It’s sometimes referred to as the “acorn stage” or “pre-revenue funding.” “Angel” refers to a specific type of investors, and these so-called “angel investors” are typically active at the pre-seed stage.
During the pre-seed stage, your company is pre-traction and you’re likely raising capital on the merit of your idea, the potential market, and often, your personal brand and relationships. You have a firm idea, and you’ve probably tested it somewhat, but you don’t have an MVP of your product or paying customers.
Few VCs or banks will provide capital this early. (In fact, DocSend refers to the pre-seed round as the “gateway round” for future VC funding.) Instead, you’re likely looking at angel investors, cash from friends and family, or self-funding with savings and credit cards.
It bears mentioning that a handful of startup capital providers will provide capital at this early stage - including Chisos! More on that later.
Startups at this stage are typically trying to raise up to a few hundred thousand dollars in capital.
This is your first “official” fundraising round. At the seed stage, most startups are raising capital while building their MVP, finalizing business plans, zeroing in on product-market fit, and everything else it takes to get ready for launch. At this stage, a startup may already have beta users or some evidence of traction, but that’s not necessarily required.
What is required is that there is clear evidence of growth potential, team productivity, and customer interest.
The money you raise during the seed round will likely be spent building your team, and developing real traction. Series A investors are going to be looking to see that you hit your growth milestones. (Later investors typically see your ability to successfully define and hit growth targets as evidence that it’s worth putting more proverbial fuel in the tank.)
There are VC investors and other investment firms that specialize in the seed round.
At the seed stage, most startups are raising in the low millions. However, as we said at the top, the size of rounds are increasing and that number can be much higher.
By your Series A round, you’ve proven product-market fit, you’re hitting your projections, and you’re ready to begin to really scale. (At this point, you need cash to grow, not to figure out if you can grow.)
Your goal during this raise is to show investors that your startup has serious scalability and long-term profitability potential.
In recent years, the Series A round can be in the $20M range; Crunchbase reports that the global average Series A is $18M, and the median global average is $10M.
After your Series A round, your goal is to deploy capital and achieve that elusive “hockey stick” growth path. Series B investors will look for that kind of growth to justify the investment in this “growth stage.” At the Series B stage, you’re looking to continue developing your product offering, capture more market share, and establish yourself as a leader in the space.
Your Series B raise can range anywhere from $10M - $100M (and even this is a loose range).
Frankly, very few companies make it this far! If you do, kudos. Because you’ve proven yourself, different and more established investors are likely to be interested.
At the Series C stage, you’re still looking to continue improving offerings, enhance your team, and scaling up. Depending on your business, that might look like reaching new markets globally, building new products, or even acquisitions.
This round is bigger, typically above $40M. In recent years, the Series C round can be hundreds of millions of dollars.
Not every company will raise a Series D round; in many cases, the Series C will be enough to reach global scale or even IPO.
Raising a Series D or E round can be a sign that the startup has struggled to achieve its goals. On the other hand, some startups see an opportunity that would help them have a more successful IPO, and may raise a later round to activate it.
Every round past Series D is decreasingly common, and also tends to be perceived poorly. But like all other guidelines, there are exceptions.
The IPO, or Initial Public Offering, is a major milestone. This is where a company transitions from being a privately held company to a publicly traded one. It can be used to generate funds, and it’s also a stage where founders may exit.
At the IPO stage, you need to keep your focus on growth, while also showing that you’re a successful, stable company. No surprise then that going through an IPO requires a significant legal and corporate governance effort.
These stages of startup funding typically correlate more closely with product development and sales growth, rather than the amount raised.
While there are a lot of different ways to articulate this, here at Chisos, we really appreciate Village Capital’s VIRAL growth pathway.
Here’s how you can loosely connect your fundraising stage to the product stage:
Just last month, we published a long blog about how to find investors for your startup. We outlined 7 simple steps, and we also shared a list of high-quality investor databases.
Here are three of our favorite startup investor databases:
Drop your email here to get access to the complete list of startup investors.
Here’s our open source term sheet and what we look for when we invest in startups.
When you’re ready, you can apply here.