If you're a new startup founder or leader, it's essential to grasp the basics of the startup financing cycle. It’s where you establish your financial groundwork. Without securing funding, your promising ideas are likely to fail.
From preparation to execution, understanding each step in the startup financing cycle will start you off on the right foot.
This article will give you a basic idea of each stage in the financing cycle, how to prepare at every step, and things to watch out for as you progress.
How To Prepare For The Startup Financing Cycle
Early-stage startups don’t typically have revenue or profit to help them pay their bills or expand. Luckily, there are several ways startups can get the money they need.
But before you start applying for loans or scheduling meetings with potential investors, you should prepare.
Creating a business plan, doing market research, and learning about your funding options can help you set your company up for fundraising success.
Establish a Solid Business Plan
A business plan gives you a clear direction for your startup and offers investors a roadmap of your goals, strategies, and, most importantly, the potential for profitability. It needs to be specific and thorough.
Investors want to see a detailed business plan before handing over startup capital. Include a clear description of your products or services, provide financial estimates or projections for potential profits, and discuss your target market and potential competitors.
Also, include financial breakdowns that dig into specifics. Investors will be more interested if you project how much it will cost to acquire each customer, their lifetime value, and churn rates for similar products or services.
Conduct Market Research and Validate Your Idea
While it will be part of your business plan, market research should begin when you start developing your idea. Market conditions, such as a saturated or declining market, will inform both whether to develop a product and how to develop it.
Completing the initial stages of market research and making sure there’s a market for your product is just the start. Become an expert in your market. Know who the players are, their profits, and how the space is evolving and likely to continue to evolve.
When raising funds, you’ll deal with investors who know the market inside and out. The last thing you want is to walk into a room with investors and know less than they do. You must be ready to field in-depth questions about market growth, secondary and even tertiary factors impacting the market, who your competitors are and how they operate, and how you will differentiate yourself.
Know What Stage Or Milestone Of Funding You Fit Into
Knowing what stage or milestone of funding your startup fits into helps you align your financing strategy with the appropriate funding sources and investor expectations. Different stages have distinct requirements, risk profiles, and investor preferences.
Review the stages and milestones below to target the right investors, tailor your pitch, and increase the likelihood of securing funding.
Seed Funding Round
In the early stages of your startup, you'll seek seed funding to support the research and development stage. Angel investors or venture capitalists often provide initial capital during the seed round.
You may also consider pre-seed funding if you need further development before the seed funding stage. It's important to showcase a prototype or minimum viable product to potential investors during the seed funding round.
Series Funding Rounds
You may have come across terms like "Series A" or "Series B" when researching funding options. Series funding rounds occur after the initial funding stage.
The Series A round typically funds additional research, development, or market research. Series B and beyond will secure funding for the growth or expanding an established product.
Initial Public Offering (IPO)
The IPO is a significant milestone. Your startup goes public at this stage, and shares become tradable on a stock exchange.
This opens up a new funding stream because you can sell shares to more investors. Initial investors can recover their investments by selling their shares, although some may choose not to.
Debt financing involves taking out a loan to fund your startup. Startups at any stage can pursue debt financing.
This may be an option if you can’t find investors or you need more money than your investors gave you.
Debt financing can also help pay for initial startup costs while you're developing your product. Some founders also prefer debt financing because they do not have to relinquish ownership or control.
Unlike investors, creditors don't have a direct stake in your company. However, unlike selling shares to investors, debt financing means taking on financial obligations that require repayment.
Merger or Acquisition
Once your startup has established itself, you might consider acquiring another company. Alternatively, you may explore the possibility of being acquired.
Many startup founders, especially serial entrepreneurs, found companies with the specific goal of eventually being acquired.
Regardless of your position in a merger or acquisition, conducting thorough due diligence is essential to ensure the deal is mutually beneficial.
Exit or Liquidity Event
An exit or liquidity event is when initial investors can sell shares or make a profit, such as an IPO or an acquisition. Some founders create startups specifically for the exit or liquidity event, while others want to see their startup through to future growth.
It's crucial to understand your investors' and partners' plans and expectations and how they relate to your own. Factors such as your startup's growth trajectory, market conditions, and stakeholders' goals significantly impact the timing and nature of an exit or liquidity event.
Bootstrapping Your Startup
Depending on your personal finances and aspirations for your startup, you may choose not to seek outside investors. Bootstrapping a startup involves using your existing resources, such as personal savings, family contributions, or even mortgaging assets like a home, to cover your initial costs.
Bootstrapping limits outside ownership and control over your vision but may also restrict your growth potential. Some entrepreneurs opt for a combination of bootstrapping and outside investment. They start by self-funding to establish their venture and later seek additional funding to facilitate scaling and growth.
External Financing Options
External financing options can provide the capital to fuel growth and expansion when funding your startup.
Understanding these options and their unique characteristics can help you make informed decisions that align with your startup's goals.
Venture Capital Funding
Venture capitalists and private equity firms specialize in investing in startups. They seek a clear return on their investment and often place as much importance on founders and their abilities to deliver as they do on a startup’s ideas.
Angel investors are usually high-net-worth people investing their money in a startup. They typically have some experience in your marketplace and can provide valuable advice, expertise, and mentorship.
Crowdfunding involves offering the opportunity for any member of the public to help fund your startup. This may be done through a platform such as Kickstarter or by directly reaching out to people and offering a small ownership stake or other rewards.
Crowdfunding has gained popularity as a financing option because founders can retain more control than when using other external funding sources. It can also help you generate buzz around your idea or supplement other funding.
Maintain greater control over your company and ideas by tapping into bank loans. However, startups may face limitations in borrowing capacity, which can impact growth potential.
Small Business Administration (SBA) Loans
Small Business Administration (SBA) loans are government-backed loans. However, they are still taken out through the same financial institutions that handle typical business loans.
The government guarantee enables lenders to make loans to businesses that would otherwise not qualify. SBA loans also usually offer better interest rates than other loans. You will still need to meet specific criteria for an SBA loan, such as demonstrating time in business and liquidity.
Manage Your Startup Finances With Ease
Whether you’re pitching to venture capitalists or applying for a loan, you’ll need detailed financial records. Even if you bootstrap your startup, accurate bookkeeping and accounting can help you manage your company's funds better.
Financial automation is becoming essential in every industry, and startups, in particular, benefit greatly from technological solutions. Get started on the right path by automating your financial operations.