Types of Startup Funding: Pre-Seed, VC Financing, and More Types of Startup Funding: Pre-Seed, VC Financing, and More
Wondering how financing your startup works? There are a variety of funding sources available to startups, from generous friends and family to major venture capital firms, and most successful startups typically use a combination of funding sources to fuel growth and achieve their business goals.
Quicklinks:
- Self-Funding, Pre-Seed Funding, or Bootstrapping
- Family and Friends
- Small Business Loans
- Crowdfunding
- Angel Investors
- Venture Capital Funding
- Seed Funding
- Series A Funding
- Series B Funding
- Series C Funding (And Beyond)
- Bridge Stage
Key Takeaways:
- There are a variety of funding methods available to startup founders.
- Most startups use a combination of the types of funding listed below to achieve their growth goals.
- Some founders use their own funds or money lent by family or friends to help get their business off the ground.
- Angel investors are another source of funding for early-stage startups.
- VC firms are a common source of funding for startups that are more established.
- Startups can join accelerators that offer funding upon completion of cohorts, they can also apply for grant funding depending on industry/eligibility.
Funds raised by startups are used for a range of purposes including hiring employees, purchasing office space, product development, operating expenses and more. Many types of funding sources can help startups achieve different goals, so it's important for founders to consider their business goals when deciding what type of funding to pursue at different points in their growth journey. Choosing the right type of funding for your startup at the right time is crucial, and we'll dive into some of the different types of funding available to startups below.
Self-Funding, Pre-Seed Funding, or Bootstrapping
The first type of funding many startup founders take advantage of is their own personal savings, also known as bootstrapping or the pre-seed stage. When a startup is just getting off the ground, doesn't have a proof of concept yet, and has not generated any profits, it can be difficult to secure funding from outside investors, so many founders dip into their own savings accounts for some of the early expenses associated with launching a business. While self-funding can certainly be risky for founders, ideally any money spent through self-funding will be recouped later once the business starts generating a profit. Usually, self-funding is a temporary option for founders that is used until their business is established enough to attract outside investment (more on that below). Self-funding a business also shows others that you are willing to invest in yourself, to take a risk you are asking others to take. The first thing any additional investor will want to see is that the founder has their own “skin in the game.”
Family and Friends
Another early-stage startup funding option is family members or friends. While this type of funding may or may not be given with an expectation of earning interest, it's important for founders to consider whether accepting a loan from friends or family is the right choice as it could impact personal relationships for obvious reasons. If you do pursue funding from family members or friends to help get your startup off the ground, be sure to consider establishing the terms of the loan and repayment in writing so that expectations are set and clear for all parties involved. Sometimes [HL1] the easiest audience for a founder to convince that they are going to be the person to make this dream a reality is their own family and friends. For the price of a small piece of equity, the founder may be able to raise[HL2] some much needed initial capital from those who theoretically believe in them most.
Small Business Loans
Small business loans are a funding option many startups choose to take advantage of because with good credit, a business may secure a loan that will provide them enough capital to achieve early-stage growth goals. Financial institutions like Leader Bank help founders apply for small business loans, which give startups access to a set amount of funding which is required to be paid back with interest. The U.S. Small Business Administration has several startup loan programs including the SBA microloan which can provide founders up to $50,000 in funding to achieve a range of growth goals. Small business loans are ideal for cash flow positive companies in industries that banks are comfortable lending to, and this can vary bank to bank. One thing that does not vary is that banks like to see as much history as possible when lending which is why this funding option does not cater well to startups.
Crowdfunding
Crowdfunding has become an increasingly popular source of funding for startups in recent years. Usually staged through an online platform, crowdfunding involves raising money from a large number of individual investors often in exchange for the business's product or service before it's available to the public. Crowdfunding is an attractive option for startups as a supplemental source of funding to some of the other options mentioned in this article, but it can be difficult for founders to raise a significant amount of money this way.
Angel Investors
Among the myriad funding options for new businesses, angel investors are one of the more common types of startup funding. Angel investors are individuals who invest their own money in a startup in exchange for equity. There are also angel investor networks comprised of multiple investors who pool their money to make investments, but most angel investors operate alone.
Angel investors usually tend to focus on early-stage companies and will invest smaller amounts of money than venture capital investors. As they are getting financially involved in mostly early-stage businesses, angel investors may require less proof of concept and do less due diligence than a VC investor would. They also generally do not take on a hands-on role in running the business in exchange for their funding.
However, angel investing is more than just an important way for startups to raise money in their early stages. Angel investors are more often than not successful, savvy businesspeople who can serve as mentors for founders. In addition to providing capital investments to help a startup achieve important growth goals, angels can serve as human capital for startups as well by helping founders network with other potential investors, sharing business advice, and more.
Venture Capital Funding
Relying on the generosity of family and friends and your own savings will only go so far to help get your business on a trajectory toward sustainable growth. Startups may also receive venture capital funding from VC firms, which is an investment group comprised of individual investors known as Limited Partners. The fund manager or General Partner uses a combined pool of the Limited Partners funds to invest in startups for a return of equity ownership.
So far this sounds pretty similar to angel investing, right? Where venture capitalists differ is the stage of startup they tend to invest in. While angel investors tend to come on board as investors earlier on in the startup journey, VCs typically look for more established startups to invest in. Venture capital investors want to see a more fleshed out proof of concept, solid business plan, established customer base, and a clear strategy for turning a profit over the long-term. As such, VC investors also tend to do significantly more due diligence and internal analysis into a startup before deciding to invest.
While VCs are generally more risk-averse than angel investors, they tend to invest significantly more than angel investors do. Because they are investing at later stages than angel investors when a company is valued higher, they understandably have to pay more for their equity stake. With this larger investment size, VCs usually want to be more actively involved in the management and direction of a startup. There are several different types of VC series funding available to help your business raise capital, which we'll get into more detail on below.
Seed Funding
Seed funding is generally the first official equity funding stage for startups and is usually when startups begin working with venture capitalists to secure funding. During the seed phase, startups will prepare a pitch deck to show potential VC investors how they plan to achieve profitability with their product or service.
If a startup is able to successfully pitch their business and secure VC funding during the seed stage, they will be able to pay for additional market research, and hire a management team to lead the company through future growth, the development and execution of a business plan, and further product development. Essentially, money raised during the seed stage is primarily used to nurture enough growth to prove to investors that the business is scalable and worth supporting through future rounds of investment. Often, startups will be pitching investors on future funding rounds (more on those below) during the seed round.
Common sources of startup funding during the seed phase are the founder, their family and friends, close contacts, angel investors, and early venture capitalists. It's worth noting that because seed funding takes place very early on, any VC investors will be taking on a considerable amount of risk, and as such startups will likely have to give up equity and potentially board seats during this phase. VCs will typically agree to accept either a SAFE note or a convertible note. Reference our previous article to learn more about the differences.
Series A Funding
The Series A round funding comes after a startup has an established business idea and vision, a pitch deck to show potential investors how the product or service fits into the market, an understanding of their customer base, and reliable revenue flow. Potential Series A venture capital investors are looking for a startup that has a strong business strategy for turning a profit over the long term.
Series A funding comes from more established VC firms, corporate VCs, angel investors, startup accelerators, and family trust offices, and is usually received in exchange for preferred stock in the company. Startups may find that once they've secured investment from one firm as part of their Series A funding round, also known as an anchor investor, others will show interest in turn. While angel investors do sometimes participate in the Series A round of funding, they will generally be less influential in this round than during the seed phase.
Additional funding raised during the Series A phase is used by startups to accomplish a range of business goals including growing their workforce, continuing market research and product development, and executing their business plan in order to attract investors for future rounds of funding.
Series B Funding
If a startup has made it through the seed and Series A phases of fundraising, it has already experienced a level of success that the majority of businesses will never reach. Startups that have reached the Series B phase have made it past the initial development stage, have proven there is a market for their product, have generated revenue, and are ready to scale. These types of performance milestones are what investors look for when considering whether to take part in a startup's Series B round.
This funding round provides capital investment that is primarily used to help startups achieve growth milestones and will support manufacturing, marketing, advertising, and general operations. Series B fundraising can come from different types of investors including venture capital firms, corporate VCs, and family offices. One of the notable differences between Series A and B fundraising is that the latter usually involves venture capital firms that specialize in investing in later-stage startups. The Series B stage also involves the exchange of stock for capital investment.
Series C Funding (And Beyond)
Startups that are lucky enough to reach the Series C or later round of fundraising are officially on an exponential growth trajectory with a proven track record of profitability and an established customer base. Companies that are initiating a Series C round are often looking to develop new products, expand into new markets, or acquire another startup to either expand market share or product offerings.
The Series C phase is most commonly funded by hedge funds, private equity firms, late-stage VC firms, corporate VC firms, and family trust offices. Because most businesses initiating a Series C round are well-established with a proven track record of success, investors take on much less risk during this stage of funding than the previous phases. Generally, Series C funding is the final round of external equity funding for startups.
Bridge Stage
A lot of startups proceed directly from their Series C or later funding round to IPO. As mentioned above, a startup that has reached Series C fundraising is a successful business with a track record of profitability, and as such some of their investors may choose to sell their equity in the company to get a return on their investment.
This makes it possible for new, late-stage investors to provide capital investment for further pre-IPO expansion and growth.
Still have questions about how to find the different types of funding available to startups? Leader Bank's Startup Banking team is here to help with an invaluable knowledge base, personalized relationship banking services, and flexible solutions for both emerging and established funds.
