Startups need to purchase equipment, rent offices, hire staff and grow rapidly in order to stay on top of the game. Below are the basics of raising capital to get their company off the ground that every startup founder should know.
Raising outside capital. In almost every case, startups need to raise outside capital since the amount of money needed to take a startup to profitability is usually well beyond the financial ability of founders and their friends and family. Usually, high growth companies need to burn a lot of capital to sustain their growth prior to achieving profitability, hire experts, and better service providers or expand. At the same time, funding is a competitive advantage: belief in the concept, partnerships, and marketing. The good news is that there are a lot of investors today looking for startups to fund. The bad news is that fundraising is a long, complex, and hard process.
When to start raising money. Investors happily write checks when they believe in the idea, see the opportunity, and when they are persuaded that the team can turn vision into reality. Today, with the crowded startup ecosystem, unicorn valuation and shifts in the funding power landscape, it is enough to have a story and a reputation. You are ready to talk to investors when you have a product/prototype, that generated some amount of customer adoption, market interest. You need to know your perfect customer, your competition, understand your market opportunity and go-to-market strategy. And you need to know how much money you need to raise and what terms you are ready to accept.
How much capital to raise. The majority of startups raise as much money as they need for the 12-18 months runway and then go for follow-on rounds. Depending on the business model, maybe you will need to raise only once before you get to profitability. When determining the actual dollar amount you need to raise, keep in mind how much progress that amount of money will give you VS credibility with investors and dilution. Best case scenario, you give away 10% of your company in your seed round, but most rounds will require up to 20% dilution (try to avoid 25% and more). The amount you are asking for must be tied to a believable plan – this shows investors that their money will have a chance to grow and builds trust to you as a founder.
Financing options. Funding a company usually happens in “rounds”: a seed round, then a Series A, then a Series B, then a Series C, and so on to acquisition or IPO. None of these rounds are mandatory and all have different standards. Most early stage rounds are structured as either convertible debt or simple agreements for future equity (SAFE). Convertible debt is a loan an investor makes to a company: it has a principal amount (the amount of the investment), an interest rate (usually a minimum rate of 2-5%), and a maturity date (when the principal and interest must be repaid). This note would convert to equity when the company does an equity financing. These notes will also usually have a “Cap” or “Target Valuation” ( the maximum effective valuation that the owner of the note will pay) and / or a discount (usually 20%). A SAFE is like convertible debt but without the interest rate, maturity, and repayment requirement. Sometimes startups raise early equity round – the trick is that you have to set a valuation for your company and a per-share price, and then issuing and selling new shares of the company to investors.
Valuation: What is your company worth? There is no magic formula that will give you an answer – so why do some companies seem to be worth $20M and some $4M? Because founders convinced investors that this was what they were or will be worth. To get a ballpark number, you can choose a valuation by looking at comparable companies who have valuations. The objective is to find a valuation which you are comfortable with, that will allow you to raise the amount you need with acceptable dilution, and that investors will find reasonable and attractive enough. Important to keep in mind: it is not about valuation, it is about growing a successful business.