Startup funding is the lifeblood for any aspiring entrepreneur. It’s what takes an idea from concept to reality. From a founder’s perspective, there are many credible sources of startup capital. But just like interviewing or dating, the startup funding process is a two-way street.
The founder puts together a tight pitch deck that outlines specific funding goals and articulates the startup’s value proposition. If the pitch “hooks” an investor, the conversation moves toward dollars and cents. How much money does the investor want to put in, and for how much of the pie? If an agreement can be reached on that front, the partnership can move forward with aligned incentives. Investor and founder – bound together for better or worse. Taking a step back, let’s break down the process at a fundamental level.
What Is Startup Capital?
You have a great business idea, but you can’t figure out how to get funding for your startup. You need startup capital. What is startup capital? Quite simply, it’s the cash you need to get a business off the ground. Depending on the type of company, startup capital might go towards things like licenses, office space, salaries, or raw materials. The type and the amount of startup capital depend on where a business is in its lifecycle.
The different types can be thought of as sequential startup funding rounds or stages. Below we unpack this in more depth. The most important rule of startup capital is equity. Nothing in life is free, and money is no exception! In exchange for startup capital, investors receive equity in the business – a piece of the pie. So, your share of the pie shrinks, but the pie itself becomes larger and more valuable.
Startup Funding Rounds
The startup funding process begins with a tight circle of family and friends and can (but not always) run all the way through to a public offering. Let’s look at each step in detail.
Before startup funding even comes into the picture, you need a killer idea. Some entrepreneurs go through tons of ideas before landing on “the one.” The ideation phase is so important that many consulting companies are now building out idea generation service offerings. Not to mention popular reality shows like Shark Tank that celebrate entrepreneurial ideas.
This round includes any money from family and friends of the founder or co-founders. Check sizes from serious family and friend investors will typically be around $15K or $20K, although there isn’t any rule against going higher (or lower) than that. There are rules however, around how to legally seek out the funds, and from who exactly. Always seek legal counsel if you’re not sure about how to navigate the family and friends round.
The seed startup funding stage is when the big guns start to come in. In 2018, the average seed round size was nearly $6 million. That’s a lot more than what you got from Uncle Joe! Seed funding sources range from angel investors, to accelerators, to corporate seed funds. Angels are high net-worth individuals who can afford to take on more risk and write bigger checks. Some of the most pedigreed accelerators include YCombinator and Tech Stars. Brand name companies with active corporate seed funds include Intel, Google, and FedEx.
Series A, B, C
Even bigger guns. Series A, B, and C funding is where the rubber meets the road. Some startup business funding doesn’t even reach this stage, usually because the business loses legs after the seed round. In a Series A round, investors want to see some real revenue, and a real vision for how to scale. Series A companies have valuations up to $23 million, and tend to seek $15 million in capital, on average. Startup funding companies that play in the Series A space include Sequoia Capital, Benchmark Capital, and Accel Partners. These firms are called venture capital firms, as they provide startup venture capital post-seed round.
Think of series B and C as similar types of funding for startups, just for more mature companies. Series B and C rounds raise around $33 million and $50+ million, respectively. The same series A venture capital firms provide a lot of series B funding. Series C funding begins to attract more risk-averse investors like investment banks, PE firms, and hedge funds.
The big payoff. An IPO (Initial Public Offering) means putting shares of your startup up for sale in public markets. Price per share will be based on rigorous analysis from an investment bank, sometimes with the support of a consulting firm too. As shares sell, investors from each startup funding stage recoup their investment. IPOs are the holy grail for many startups, but not for all. Some later stage startups “exit” via a sale to a corporation, or a merger. Others may remain private, not totally dissimilar to a private partnership like McKinsey, Bain, or BCG.
Startup Capital Example
Now you know how to get funding for your startup, but what does it mean for you and your ownership? Here is a “quick and dirty” startup funding example to illustrate the concept of equity dilution. As we move down the table, notice how Sally ends up with less than a fifth of the company. That stake however, becomes worth more than $450 million!
|Startup Funding Activity||Sally’s Equity Ownership (%)||Total Startup Capital Raised ($)|
|Sally comes up with a groundbreaking new smartphone app idea.||100||0|
|Sally brings on her friend from business school as a co-founder.||50||0|
|Company needs money to develop a prototype. Sally’s wealthy cousins are willing to invest for a 5% share. Additionally, she and her co-founder set side some shares for future employees.||37.5%||$15,000|
|The app shows promise – Sally and her co-founder hold a seed round at a $2 million valuation.||~31%||$400,000|
|Customers love the app! The company goes on through more and more series of funding, ultimately at a $2.6 billion valuation.||~18%||$235,000,000|
The startup business funding process is full of twists, turns, and players with different incentives. Entrepreneurship may not be for everyone, but many are attracted to the excitement and upside. Consulting careers offer plenty of exit opportunities into the startup world. All the top firms work with startup clients, and those clients often look for promising consultants who might want to come aboard. In addition, as a consultant, you’ll work with lots of smart colleagues who might be cooking up startup ideas. If you network properly, you can link up with someone at your firm to launch a business together. As the world continues to change, we need startups more than ever. The next decade promises to bring plenty of new challenges for budding entrepreneurs to tackle.