When it comes to startup funding, new entrepreneurs and founders have tons of questions.
Questions like ‘How can I raise funding for my startup?’ ‘Where do I start to raise funding?’ ‘What’s the best way to raise capital for a startup?’ and of course, ‘How does startup funding work?’
These are but a few of the most frequently-asked questions about startup funding and launching a business.
In this article, we’ll be talking about the different types of investors and types of funding for startups. We’ll also look at the funding process.
Why do startups need funding?
If you’ve been part of the corporate world, then getting funding to get your company to grow and expand may seem strange to you.
But the situation is different for startups.
Unlike traditional companies, startups need to grow – FAST!
Here are several reasons why startups need funding:
1. To speed up development
One of the top reasons startup founders seek funding is to speed up product development. The faster they can develop their product, the faster they can start marketing and selling it and accordingly generating revenues.
So how can they speed up development? With money (which they likely don’t have).
With enough financing, startups can improve their prototype, test their product, reach their target audience, and hire more people to support the development and marketing initiatives.
2. To market their product or solution
The next step is getting your product before people and marketing it. And you can’t market anything without having money on hand to launch ads whether across various social media platforms, radio, TV, or elsewhere.
With funding, startups can market their products or services to a wider audience. They can also start getting initial reviews and find out how they can improve their product to fit the market.
3. To increase services and grow
Another benefit to getting funding is that startups can increase their range of services (or products) to customers.
However, this step can be remarkably difficult with bootstrapping or with initial funding coming from the founders themselves.
4. To grow their network and connect with mentors
One of the benefits of connecting with investors is getting mentors who can support the startup not only in its bid to acquire funding but also to get support and expertise for their product and its position in the market.
5. To gain credibility
Once a startup is able to raise funds, it signals that it is trustworthy and capable of scaling. Investors find it an opportunity and believe in it and its ability to grow. It also gives the startup a boost in the market with customers.
6. To hire more people
An essential part of any business is its people. And to increase its service or product range, it needs people. It’s therefore any startup founder’s intention to grow their team by hiring new people.
However, people need to get paid. Therefore, to grow and scale, startups need to raise funding to grow their team members.
7. To manage expenses
A major dilemma for most – if not all – startups is managing finances and expenses.
In fact, 38% of startups fail because they ran out of cash or were unable to raise funding. (CB Insights)
In its early stages, a startup will spend more than it makes, resulting in negative cash flow. In other words, it will burn its available cash to cover its variable and fixed costs, while being unable to generate enough revenue.
To sustain this for a period of time till it can generate revenue and eventually profit, it needs funding.
Further reading: Need Funding? Learn How to Answer These 15+ Questions Investors Ask Startups
Types of startup funding sources
So what are the top types of investors, investment methods, and funding options you need to consider to get funding for your startup?
Let’s look at these 9 investor types:
1. Bootstrapping
Bootstrapping is a common method among startup founders. It’s almost how every startup begins. Some international and now super-popular startups have stayed in business for years using bootstrapping.
A common startup term, bootstrapping is when an entrepreneur or founder launches a company with limited capital coming from their pocket.
“An individual is said to be bootstrapping when they attempt to found and build a company from personal finances or the operating revenues of the new company,” explains Investopedia.
While bootstrapping means there’s a financial crunch, it also offers the founder or founders more control over their company.
2. Accelerators
A startup accelerator or seed accelerator is a public or private entity that offers short-term financing, mentorship, and other supporting services to early-stage startups.
Accelerator programs will only accept startups with a minimum viable product (MVP). That is, they’ll accept startups that have an initial version of their product along with some of its basic features.
However, it’s worth noting that a startup will not get all its funding needs from an accelerator. Moreover, one of the benefits of joining an accelerator isn’t just to get funding but to get mentorship and expertise from people who are well-versed in building and scaling startups.
For example, two popular startup accelerators in Egypt and the MENA region are Flat6Labs and Falak Startups.
Further reading: What Is Financial Mentorship? When & Why Do You Need It?
3. Incubators
Often mixed up with accelerators are incubators. Startup incubators are programs that help new startups grow and succeed.
The incubator program is a collaborative program that provides startup founders and entrepreneurs with training, mentoring, and some funding.
“Often used interchangeably, accelerators and incubators actually serve different purposes, have different outcomes, and accept different kinds of startups. Knowing the difference helps you focus the search for funding in the right areas, and improves your chances of success,” explains MassChallenge.
Like accelerators, incubators can also be managed and funded by public or private entities. And though many are associated with tech or software-as-a-service (SaaS) startups, incubators aren’t limited by or bound to a specific industry.
The length of the program is different between accelerators and incubators. Accelerator programs usually range from three to six months, whereas incubator programs can range from a year to five.
4. Angel investors
Angel investors are “high-net-worth individuals” who invest their own resources and capital to help small businesses, including startups, grow. An angel investor may also be referred to as a seed investor, angel funder, or private investor. (Investopedia)
An angel investor will often take a small percentage of the company (around 10%) in exchange for their investment, which may be a one-time investment or an ongoing one.
“The funds that angel investors provide may be a one-time investment to help the business get off the ground or an ongoing injection to support and carry the company through its difficult early stages,” explains Investopedia.
One of the benefits of having an angel investor is that they make decisions quickly, can make an investment at any stage of the business, and come with industry knowledge and expertise.
5. Venture capital
Venture capital (VC) is one of the most-sought after funding, albeit one of the hardest types of startup funding sources.
Unlike angel investors, VC investors and firms prefer existing companies, especially those that have raised funding in the past or have a record of success. In addition to being picky about the startups they invest in, VCs often ask for additional benefits such as a board seat and closely monitor how you manage your company.
VCs often invest in startups in two ways, either in the form of equity, that’s buying a stake in the company, or in the form of debt.
6. Crowdfunding
Though not very popular in all regions, crowdfunding and kickstarter campaigns are among the methods used by founders to get funding.
Both types of funding sources can be easy and fast ways to raise money.
There are four types of crowdfunding, namely: equity crowdfunding, donation crowdfunding, rewards crowdfunding, and debt crowdfunding.
Equity crowdfunding is the most commonly-used investment type among the four. It involves founders selling a portion of their startup, to an investor or group of investors, in exchange for funding.
Meanwhile, as its name suggests, donation crowdfunding relies on getting donations. This is usually done with non-profit initiatives.
Rewards crowdfunding is similar to kickstarter campaigns where founders offer their products, services, or other gifts to people in exchange for funding. Lastly, debt crowdfunding involves founders borrowing money in exchange for an annual interest rate. However, this is done through people not from a bank.
7. Investment funds
There is a growing number of investment funds that are created, especially by government entities, to invest in early-stage startups.
Governments realize the importance of having an active and healthy ecosystem and accordingly launch startup investment funds to support up-and-coming entrepreneurs.
8. Loans and debt financing
While banks may remain an option for some founders, their loans are harder to come by and may carry larger requirements than investments from angel investors and VCs.
Still, debt financing is a possibility among startup founders.
9. Hackathons
Though founders shouldn’t look to hackathons as a main funding alternative, hackathons can help early-stage startups get initial investments that give them a boost.
A hackathon is a type of competition where startups compete against each other to win a final monetary prize that may range from $10,000 to up to $250,000.
Winning a hackathon usually gives credibility to a startup and its team. However, it cannot be relied on as a source of funding because there is usually one to three winners at most.
How the startup funding process works
Now that you know the different types of funding available for your startup, let’s examine the startup funding process.
As a startup founder, there are a few documents you need to present to potential investors, these are:
- Your elevator pitch
- Your pitch deck
- Your business plan and financial model
- Your startup valuation
Based on the funding stage you’re in, you may be required to present more information to entice investors. After all, the further in the investment round, the higher the figure you want to raise will be.
For example, startups begin with bootstrapping and angel investors. The latter may also come in the pre-seed and seed rounds, where your startup may raise anything from $100,000 to $2 million. However, there have been exceptions.
Getting to Series A, your startup can begin raising $3 million all the way to $20 million or $25 million in funding. Following Series A, are Series B, C, D, and so on.
The next step is knowing that getting an angel investor or VC to invest in your startup isn’t easy.
There are hundreds if not thousands of other startups looking for investors, which means there’s a high competition and demand for investors who are in limited supply.
This prompts investors to be picky about the startups they want to put their money in.
Best way to raise capital for your startup
But which type of investor or investment is best for your startup?
Unfortunately, there is no one-answer-fits-all to this question. Each startup is unique and not all founders are willing to give up large portions of their startups to VCs for example.
Similarly, getting your startup from bootstrapped to pre-seed requires much effort, research, and lots and lots of networking.
That said, you’ll often see a pattern depending on the stage your startup is in. Angel investors, for example, tend to be part of pre-seed and seed rounds and can offer up to $1 million.
On the other hand, VCs seek already-growing startups, so you’ll more likely see them in seed rounds or Series A, B, and C funding rounds.
Conclusion
As a startup founder, there’s lots to do to connect with and attract investors.
Chief among those is making your startup attractive to investors and ensuring that your numbers and financial data is correct and includes well-researched relevant forecasts.
If you need help creating your pitch deck, drawing up a financial forecast, uncovering your startup’s valuation, among other financial services, get in touch with the Stride team.
We’ve helped startups like BioEnergy and Mumerz raise funding.
