Raising capital for a startup involves securing funding to support the growth and development of a new business venture, turning an innovative idea into a viable enterprise. Startups often require substantial funding to cover initial expenses such as product development, market research, staffing, and operational growth.

Below, we’ll describe how to raise capital for startups, including fundraising stages, common sources of funding, and funding plans that work for your startup’s goals and stage of development.

What’s in this article?

• What are the funding stages of a startup?
  
• The importance of fundraising for each stage of a startup
  
• Sources of funding for startups
  
• How to build a funding plan for a startup
  

What are the funding stages of a startup?

The funding stages of a startup represent different phases in a company’s lifecycle, each with distinct characteristics, goals, and types of investors. They also come with different levels of funding: Crunchbase reported that the average seed round in the first quarter of 2023 for US startups was $3.6 million, while the average Series A round was $18.7 million. Here’s an overview of these stages:

• Pre-seed funding
  This is considered the earliest funding stage. It typically involves the founders using their own resources or funds from friends and family to launch the business. Pre-seed funding often precedes product development.

• Seed funding
  Seed funding is the first official funding stage, typically taking place after a startup has a small amount of traction. Investors in this stage include angel investors, incubators, and venture capital firms specializing in early-stage investments.

• Series A funding
  At this stage, startups have developed a track record (an established user base, consistent revenue figures, or some other key performance indicator). Venture capital firms are the primary investors in Series A rounds, and these firms expect a developed business model and clear strategy for turning a profit.

• Series B funding
  Companies that reach this stage are well-established and seek to expand their market reach. Series B funding usually comes from venture capital firms.

• Series C funding and beyond
  These funding rounds (Series C, D, and beyond) are typically larger as the company has a proven track record. These rounds may involve private equity firms, investment banks—and in some cases—hedge funds. The end goal of these funding rounds is often to prepare the company for an initial public offering (IPO) or an acquisition.

Each stage reflects a step in the growth of a startup, from idea conception to market expansion, and requires different amounts of capital and types of investors. The expectations, risks, and investor involvement vary significantly across these stages.

The importance of fundraising for each stage of a startup

The needs of a startup change at different stages, and any fundraising venture should consider the maturity of the business. Here’s an overview of the different stages of startup development and how each one influences the fundraising decision-making process:

• Pre-seed and seed funding
  At these initial stages, startups typically lack the capital to turn their ideas into tangible products or services. Fundraising finances basic activities such as conducting market research, developing products, and building a minimal viable product (MVP). Startups also use these funds to hire the first key employees and establish a business model. The capital raised helps validate the business concept and prepares the startup for future growth.

• Series A funding
  Once a startup has developed its MVP and obtained more traction (demonstrated through user numbers, revenue, or other key performance indicators), it uses Series A funding to scale the business. This stage of fundraising is focused on refining the product or service, expanding the customer base, and developing effective marketing strategies. It funds the transition from a startup with a validated idea to a company with a scalable business model.

• Series B funding
  At this stage, startups are ready to expand significantly. Series B funding enables these companies to grow their market reach, invest in talent acquisition, enhance technology or infrastructure, and potentially expand into new markets or segments. The funding supports the startup’s efforts to dominate its existing market or capture new markets, staying ahead of competitors.

• Series C funding and beyond
  As startups progress to Series C and further rounds, they are typically well-established in their markets. Series C funding supports additional scaling, developing new products, or pursuing other growth opportunities such as acquisitions. These funding stages help solidify the company’s market position and expand its reach at a larger scale, such as global market penetration or diversification of offerings.

• Exit strategies
  Many startups have the long-term goal of exiting through an IPO or an acquisition—especially those with venture capital backing. Fundraising at later stages can help build the company’s valuation and make it attractive to public market investors or potential acquirers.

Sources of funding for startups

Beyond securing capital, fundraising can help startups build credibility, network with industry experts, and gain valuable insights and mentorship from experienced investors. What you’re most interested in gaining from a funding round will determine which sources of capital are the best fit. For startups, there are plenty of options. Here’s an overview of the main sources of funding:

Self-funding and bootstrapping

• What it is: Self-funding and bootstrapping refer to the practice of starting a company with your own financial resources instead of external funds. The company then reinvests its initial revenues back into the business to continue growing.
  

Pros

• Complete control: Entrepreneurs retain full ownership and control over their business decisions and direction without influence from external investors.

• Focus on sustainability: Bootstrapped businesses often focus on slow and steady growth, which can lead to more sustainable long-term business practices.

• No repayment pressures: Without loans or external investors, there are no pressures to meet repayment deadlines or return on investment expectations.

• Strong signal to investors: Demonstrating the ability to successfully bootstrap can be a strong signal to future investors of the company’s potential and the entrepreneur’s commitment.

Cons

• Limited resources: Self-funding can limit the amount of money available, potentially slowing down growth and scaling opportunities.

• Personal financial risk: Entrepreneurs put their own capital at risk, which can be a heavy burden if the business fails.

• Opportunity cost: The money and time invested could have been used elsewhere, with the potential for higher returns or less risk.

• Potential for slow growth: Bootstrapping might lead to slower growth since reinvestment is limited to the business’s own revenue generation.

Self-funding and bootstrapping are particularly effective for startups that can be launched and grown without significant up-front capital. It’s ideal for entrepreneurs who wish to maintain control and for businesses with a clear path to profitability.

Self-financing can be useful for service-oriented startups or those with minimal initial capital requirements, as it permits entrepreneurs to scale operations at a self-determined pace. However, for ventures that are capital-intensive or need to grow rapidly to secure market dominance, this approach may be less effective.

Friends and family

• What it is: Friends and family funding involves seeking financial support from personal connections. This type of funding is often one of the first sources entrepreneurs consider because of the trust and personal relationships involved.
  

Pros

• Simplicity and speed: Raising funds from friends and family can be less complicated and quicker than formal investment channels, with fewer formalities and legal requirements.

• Flexible terms: Loans or investments from friends and family can come with more flexible repayment terms and lower interest rates compared to traditional loans.

• Emotional support: Friends and family can provide emotional and moral support, which can be invaluable during the challenging early stages of a startup.

• Strengthened trust: These investors already know and believe in the entrepreneur, which can lead to a stronger mutual commitment to the success of the business.

Cons

• Potential relationship strain: Mixing personal relationships with business can lead to tension or conflict, especially if the startup struggles or fails.

• Limited funding potential: Friends and family may not have the means to provide large amounts of capital, which can limit the growth potential of the startup.

• Lack of business expertise: Unlike professional investors, friends and family may not be able to provide the valuable business expertise or networking opportunities needed for growth.

• Equity management: Accepting investments from personal connections can complicate equity distribution and future investment rounds.

Friends and family funding is effective for early-stage startups that need a relatively small amount of capital to get off the ground or reach the next milestone. It’s ideal for entrepreneurs who have a strong personal network willing to invest in their vision. It is less well-suited for startups requiring significant capital, those wanting to avoid personal relationship risks, or those needing strategic business expertise and connections.

Angel investors

• What it is: Angel investing involves affluent individuals providing capital for a business startup, usually in exchange for convertible debt or ownership equity. Angel investor groups invested approximately $950 million in 2021. These investors typically offer expertise, mentorship, and access to their networks—along with financial support.
  

Pros

• Mentorship and guidance: Angel investors often have entrepreneurial experience and can offer valuable advice and mentorship to help startups navigate early obstacles.

• Networking opportunities: They can connect startups with potential partners, customers, and future investors through their established networks.

• Less formality and quicker decisions: Unlike traditional financing, angel investing can be less formal and faster in decision-making, allowing startups to access funds more quickly.

• Potential for additional rounds: A successful angel investment can lead to further financing rounds and increased credibility in the market.

Cons

• Limited funding amounts: Angel investors may not be able to provide large sums of money, which might be insufficient for startups with high capital needs.

• Equity requirement: Startups often have to give up a portion of their equity, which means a loss of some control over the company.

• Alignment of interests: Investors and founders need to strongly align on their interests and expectations, or there could be conflicts.

• Dilution of shares: Future investment rounds may dilute the angel investor’s share unless proper agreements are in place.

Angel investing is particularly effective for early-stage startups that need capital to prove their concept or reach a certain milestone. It’s ideal for startups that can demonstrate potential for high returns and are open to mentorship. It’s less ideal for ventures that need large amounts of capital right away or those that wish to retain complete control over their business.

Venture capitalists

• What it is: Venture capitalists (VCs) are professional investors or firms that invest pooled funds from high-net-worth individuals, corporations, pension funds, and other sources into high-growth potential startups. In 2021, VCs invested $671 billion globally. Venture capitalists typically provide more than just capital; they also offer mentorship, strategic guidance, and access to a broader network of partners, clients, and future investors.
  

Pros

• Large capital amounts: VCs are capable of investing significant sums, often necessary for rapid growth.

• Expertise and mentorship: They bring valuable industry experience, business acumen, and operational guidance.

• Networking opportunities: Access to a wide network of industry contacts, potential customers, and partners can be invaluable for growth.

• Credibility and prestige: Association with well-known VCs can enhance a startup’s credibility in the eyes of customers, partners, and future investors.

Cons

• Equity and control: In exchange for their investment, VCs usually require a share of equity. This equity share can be substantial, potentially reducing the founders’ control over the company.

• High expectations for growth and returns: VCs invest with the expectation of a high return, usually through an exit strategy such as an IPO or acquisition. This can pressure startups to prioritize rapid growth.

• Rigorous due diligence process: Getting venture capital funding is highly competitive and involves a thorough vetting process.

• Alignment of interests: Founders must ensure that their vision aligns with that of their VC investors to avoid future conflicts.

Startups that have a proven business model, demonstrated growth potential, and are in need of significant capital to scale quickly are best suited for VC funding. It is particularly relevant for technology startups—especially those in industries such as biotech, healthtech, and fintech, where large capital investments are often required for growth and development. VCs are generally not as well-suited for small businesses or startups with modest growth ambitions, as well as those in the very early stages of development without a clear path to profitability.

Crowdfunding

• What it is: Crowdfunding involves raising small amounts of money from a large number of people, typically through online platforms. There are different types of crowdfunding—rewards-based, equity-based, donation-based, and debt crowdfunding.
  

Pros

• Market validation and customer engagement: Crowdfunding allows startups to test market demand for their product or service and build a customer base before launching.

• Marketing and exposure: Launching a crowdfunding campaign can generate significant media attention and public interest, serving as a powerful marketing tool.

• Flexibility and accessibility: It offers a more accessible way for startups to raise funds without traditional investors or lenders.

• Potential for overfunding: Successful campaigns can raise more than the set goal, providing additional capital.

Cons

• Success is not guaranteed: A significant number of campaigns fail to meet their funding goals.

• Requires compelling presentation: Startups must create a persuasive pitch and attractive rewards to stand out, which can be time- and resource-intensive.

• Platform fees and costs: Crowdfunding platforms typically charge a fee, and there are additional costs for marketing and fulfilling rewards.

• Intellectual property risk: Publicly sharing your idea or product can increase the risk of it being copied.

Crowdfunding can work well for startups that have a compelling story or innovative product and want to validate their concept with a wider audience. This is especially true for startups offering consumer-focused products. But for startups that are in the ideation phase without a concrete product or those that require large amounts of capital for research and development, it might not be as appropriate.

Government grants and subsidies

• What it is: This funding source entails financial support provided by government entities. They typically offer grants for specific projects, research, or initiatives and don’t require repayment. Subsidies may include tax breaks or other financial advantages to support businesses in certain industries or regions.
  

Pros

• Nondilutive funding: Grants and subsidies don’t require an equity share, allowing founders to retain full ownership of their startup.

• Support for innovation and R&D: Many grants focus on promoting innovation, research, and development, which can be particularly beneficial for tech or science-based startups.

• Credibility and validation: Receiving government support can increase a startup’s credibility, making it more attractive to other investors and partners.

• Financial relief: Subsidies such as tax breaks can ease the financial burden on startups, improving cash flow and profitability.

Cons

• Highly competitive: Grants and subsidies often have a lot of competition, making it challenging to secure funding.

• Complex application processes: The application process can be lengthy and involved, requiring detailed proposals and compliance with specific guidelines.

• Restrictions and accountability: Funds are usually earmarked for specific purposes, and startups may need to demonstrate progress and results.

• Inconsistent availability: Availability of grants and subsidies can depend on government priorities and budgets, which can change over time.

Startups focusing on sectors such as technology, health care, education, environmental sustainability, and social enterprises are often favored for government grants. They’re particularly beneficial for businesses engaged in research-intensive projects or those contributing to societal goals. Subsidies might be more accessible to startups in designated industries or regions targeted for economic development.

Bank loans and lines of credit

• What it is: This involves borrowing money from a bank or financial institution. A bank loan is a fixed amount of capital that is repaid with interest over a predetermined period of time. A line of credit is a flexible borrowing limit that can be used as needed and is often used for short-term working capital requirements.
  

Pros

• Predictable payment structure: Loans have fixed repayment schedules, making financial planning easier.

• No equity dilution: Unlike equity financing, loans don’t require giving up a share of the business.

• Credit building: Timely repayment of loans can build the business’s creditworthiness.

Cons

• Collateral requirement: Loans often require collateral, which can be risky if the business fails.

• Strict eligibility criteria: Banks typically have stringent requirements for credit history and business viability.

• Debt burden: Interest payments and the obligation to repay the principal can be a significant burden, especially for startups with unpredictable revenue.

Startups that have a steady cash flow or existing assets to use as collateral are better suited for bank loans. Lines of credit are useful for businesses needing flexible access to funds for operational expenses. This funding source is ideal for founders who want to retain complete ownership and control of their company but are confident in their ability to generate revenue to repay the loan. Bank loans and lines of credit are less suited for very early-stage startups with no revenue or assets to leverage.

How to build a funding plan for a startup

Creating a funding strategy for your startup involves developing a comprehensive approach that matches your business ambitions, risk appetite, and growth path. A thoughtfully crafted plan serves as a roadmap, guiding how your startup obtains and uses financial resources to meet immediate goals and attain its long-term ambitions. Here’s how to approach it:

• Understand funding needs
  First, you need a clear picture of what you’re funding. Start by crafting a detailed budget that covers initial setup costs, operating expenses, and a runway that extends until you predict the business will generate sustainable revenue. Ground this budget in rigorous market research and realistic assumptions about growth rates and sales.

• Map funding stages
  Next, consider the stages of your startup’s development and the corresponding funding needs. Early stages may involve seed capital from personal savings, friends, family, or angel investors. This capital typically covers product development and initial market entry. As the business matures, funding from VCs might become a possibility—targeting more aggressive expansion and scaling efforts. Beyond this, funding could transition to strategic investments, private equity, or even public markets through an IPO.

• Diversify funding sources
  Relying on a single source of funding can be risky. A savvy funding strategy involves diversification. Combine traditional equity funding with grants, loans, or even revenue-based financing where repayments align with income streams. This reduces dependency on any single investor or lender and can reduce the cost of capital.

• Align with business milestones
  Your plan must link funding rounds with key business milestones. Investors want to see how their capital will lead to value-creating steps, whether that’s a product launch, user acquisition target, or profitability goal. Milestones also provide a framework for evaluating performance and making adjustments to your funding strategy.

• Prepare for diligence
  Investors conduct due diligence before committing funds. Prepare by organizing financial statements, business plans, market analyses, and legal documents so they’re ready for review. Transparency and preparedness can significantly improve a startup’s credibility and appeal to funders.

• Negotiate terms
  Terms should protect the startup’s interests while also providing incentives for investors. This might involve negotiating valuation caps, voting rights, or liquidation preferences. Be ready to walk away if terms would put the startup at a disadvantage.

• Continuously monitor and adjust
  Regularly review your financial performance and adjust your funding plan accordingly. Market conditions change, and so will your startup’s financial needs. Flexibility allows you to capitalize on opportunities and mitigate risks as they arise.

• Foster investor relations
  Funding relationships are long term. Maintain open communication with investors, providing regular updates and fostering a sense of partnership. This can lead to further funding down the line and valuable strategic advice.

• Consider the exit strategy
  Finally, consider the exit strategy as part of the funding plan. Whether it’s an acquisition, IPO, or another form of exit, the strategy will influence the type of funding you seek and the investors you engage with.

When funding your startup, align your financial strategy with your long-term vision, business goals, and growth plans. Whether it’s bootstrapping, angel investors, or venture capital, each option has its own benefits and trade-offs. With a thoughtful approach to funding, your startup can build a strong foundation for future growth and success.