Top Funding Sources for Startups

Need funding for your vision? We walk you through the basics.

Every unicorn begins life as a caterpillar coding in a garage. But at some point, the hungry caterpillar needs cash to transform itself. Your amazing idea gives your startup life, but it’s cash that helps it grow. But where does a startup find sources for funding? It all depends on your stage in the startup lifecycle. For first-time founders, this article will be a primer, while for perennial founders, it may provide some new ideas — including some from the blockchain space.

What Stage Are You At?

Table 1 below is an approximate guide to help you determine what funding stage your startup is at find the description, valuation, and funding required that best matches your startup or where you want to be. 

The following sections will then look at these stages and the potential sources of funding for each stage in more detail. Of course, not every startup will reach every stage, but yours might — to infinity and beyond!

Table 1: Determining Your Startup’s Stage

Pre-Seed Funding Stage

These are the early days. You have an idea, have scribbled down a business canvas with market research, and are testing your value proposition in the market through several Minimum Viable Product (MVP) experiments. You need some cash to cover mounting costs, but it’s too early to offer big slices of direct equity in your company. So what are your options?

Pre-Seed Stage Funding Sources

1. Bootstrapping

At the very start, sweat equity and your own wallet will probably be your main source of funds. 

Many famous entrepreneurs begin their startup as a side hustle — funding their work through their day job. Famous examples here include Steve Jobs and Steve Wozniak who were working at Atari while starting Apple. Instagram founder Kevin Systrom began coding while working as a product manager at another startup called Nextstop.com, which itself was bought by Facebook.

Credit cards and small bank loans can also fill the initial funding gap. The co-founders of Cisco Systems, husband and wife Leonard Bosack and Sandy Lerner, maxed out all their credit cards and mortgaged their house to keep the company growing. After talking to over 80 Venture Capital (VC) firms, they finally received funding from Sequoia Capital. 

Sweat equity is key. Living off a minimal or no wage, many pre-seed entrepreneurs reinvest their profits straight back into their startup, compounding their early gains until they reach a scale where big investors take notice. Early startup employees are also often paid a low wage (if any at all), but are promised big returns in later funding rounds. 

2. Friends, Family, and Fools

Not every founder has family or friends willing and able to help them. But for those who do, such early help is priceless. Whether it is your great aunt or an old family friend that hit the big time, be clear whether the money is a gift, loan, or equity, and be sure to temper expectations. Remember that these relationships are personal first and business second.

3. Crowdsourcing

Crowdfunding is a legitimate source of funding, and it's not just board games like Exploding Kittens that are raising millions. Well-known companies like Oculus got their big start with crowdfunding. 

The first recorded use of crowdfunding was in 1997 by a British rock band who emailed fans to raise $60,000 for a tour. But crowdfunding became serious with the arrival of IndieGoGo in 2007 and Kickstarter in 2009. In 2020, the crowdfunding market was estimated to be worth around $17.2 billion.

Crowdsourcing comes in two main flavours: product crowdfunding and equity crowdfunding.

Product crowdfunding is where you promise to deliver a product or a service to investors in return for capital. It is also called pre-selling. 

It has the inbuilt advantage of a loyal fan base that can act as evangelists for your product. But like any funding source, it is increasingly competitive, and great ideas with even better communication do best. Top product crowdfunding sites include Indiegogo and Kickstarter.

Equity crowdfunding is where you provide equity in your company in return for capital. The focus is on building your company rather than delivering a limited run of a product or exclusive access to a service. 

The big breakthrough for equity crowdfunding came in 2012 when the Obama administration effectively legalised equity crowdfunding for startups with the introduction of the Jumpstart Our Business Startups Act. Today, startups in the US can raise $5 million annually from equity crowdfunding.

Equity raised can take the form of preferred or common stock but typically comes as basic convertible notes that can be converted into future stock, for example SAFE and KISS convertible notes.

Top equity crowdfunding sites include WeFunder, StartEngine, and SeedInvest. It pays to research the differences between platforms, including what securities are offered and fee structures.

4. Incubators

Incubators are companies that offer programs designed to help pre-seed startups take their first baby steps. They are typically located in co-working spaces and provide mentorship and help with everything from company formation and co-workers to business plans. They are funded by universities, governments, and VC firms. Unsurprisingly, many also offer limited funding to promising startups to cover initial expenses. 

Incubators are not really a source of funding for startups but are invaluable with their early help. Many are also linked to Accelerator programs.

Seed Funding Stage

You have a product that people want and need, but do you have a good product-market fit? In other words, how much demand is actually out there? 

This is when you commercially launch your product and try to make an impact. You want to show that there is a market and that you have the potential to capture a large share of it.

This is also when you begin to employ people and to spend serious money on product development. This of course requires a more significant investment than the pre-seed round, which means you need to talk to larger investors and investment firms. They are more likely to be interested in more sophisticated convertible notes than SAFE and KISS and will insist on preferred stock.

Seed Stage Funding Sources

1. Angel Investors

Angel investors are high-net-worth individuals and “accredited investors” who invest their own money into startups in return for equity. They often invest in groups. The term was coined from Broadway, when wealthy investors would champion a production.

Angel investors are often former founders who like to help early startups. They will often seek out startups or are associated with accelerator programs. There are also platforms like AngelList that match startups to Angel investors.  

Famous Angel investors include Fabrice Grinda, Wei Guo, and Mark Cuban.

2. Early Stage Venture Capital Firms (VC)

VCs are private equity firms that invest in emerging startups. They draw funds from wealthy individuals, institutional investors, investment banks, and pension funds. 

Partners and VC employees tend to be experienced business people who are wanting and willing to take a hands-on approach to startups. 

In return, VCs want large equity slices of a startup. The first VC was American Research and Development Corporation, which was founded in 1946.

Not every VC invests at the Seed stage; instead, this is often reserved for specialists.

Famous VCs include Sequoia Capital (past investments include Apple, Oracle, Google, Nvidia, and Stripe), Accel (Facebook, Verizon, Cisco, Raytheon, Walmart, and Adobe), Kleiner Perkins (Amazon, Twitter, Sun Microsystems, Spotify, Waze, and Slack), and Adressen Horowitz (Instagram, Zynga, Airbnb, Facebook, and Lyft).

3. Accelerators

Accelerators are companies that offer programs to accelerate seed-stage startups to the series level. They typically take the form of a course with experienced mentors and opportunities to meet potential investors. Apart from covering some basic expenses, accelerators do not typically fund startups, but are backed by VCs and Angel Investors and have wide networks of potential investors.

Well-known accelerators include Y Combinator (Airbnb, Doordash, and Coinbase), Techstars (DigitalOCean, DataRobot, and Outreach), and 500 Startups (Udemy, Canva, and GitLab).

Series A Funding

At this stage, you have captured some significant market share and shown the potential to scale up even further. Extra funding will help in developing your product further and building out your team.

Series A Stage Funding Sources

Groups of plain vanilla VCs and super Angel Investors with one investor act as the lead or anchor investor. The investors, amounts, equity, and stakes are all larger than the seed stage. 

Series B Funding

At the Series B stage, you are looking for funds to scale up your business and turn your beachhead market share into a leading market share.

Series B Stage Funding Sources

The sources are rather similar to Series A, except that you are now attracting VCs who specialize in larger startups. 

Series C and D Funding

At the Series C stage, you are a bonafide success story. You have gone from your garage to Silicon Valley. Your product is selling like hotcakes and is one of the leading brands in your segment. Now you are looking to increase your growth by investing in adjacent products and markets. This may take the form of in-house development or acquiring smaller startups, for example like Facebook acquired Instagram and WhatsApp.

Investors are now taking big stakes in your company and probably eyeing a potential listing. Even plain vanilla Private Equity funds, hedge funds, and investment banks are taking an interest given your returns and reduced risk. You are all grown up and can leave your startup tag behind.

Series D is a special round to help fund mergers, acquisitions, or large but lucrative new developments.

Series C and D Stage Funding Sources

1. Late Stage VCs

These are your VCs that specialize in the later rounds or have the funds and cache to participate.

2. Private Equity Funds

Private equity funds are similar to VCs but no specialists in startups. They will typically invest with some set exit strategies in mind including a public listing, a Leveraged Buyout, or a private placement.  

3. Hedge Funds

Hedge funds are large investment funds that invest in hedging strategies in the equity and bond markets. In theory, these strategies make money on both bear and bull markets, but in reality, many suffered during the 2008 financial crisis. Some large hedge funds like to tip their toes a little into the PE and VC space. Series funding would however never constitute a large part of their portfolio.

4. Investment Banks

Investment banks play an intermediary role in complex and large financial transactions such as IPOs and debt issuance. They invest in Series C, intending to participate in future transactions. They fund themselves through profit, bonds, and by creating investment funds. Well-known investment banks include JPMorgan Chase and Goldman Sachs.

IPOs and SPACs Funding

This is the big time. An Initial Public Offering allows you to raise even more money by listing as a publicly-traded stock on a stock exchange. It also puts a tangible dollar value on your company because shareholders can now trade your shares on a liquid market. This is why founders are said to become millionaires or billionaires overnight when their companies list.

A SPAC is a backdoor method of listing on a stock exchange. IPOs are long and costly processes so many companies looking to list will instead merge with a SPAC. 

SPAC stands for Special Purpose Acquisition Company. It’s a company that raises money through an IPO with the sole purpose of acquiring or merging with an existing private company, except that the target company is generally not identified at the time of the IPO. 

STOs: A New Source of Funding for Startups

Security token offerings (STOs) are the new IPO. Using blockchain technology and PKI encryption, companies can now issue security tokens rather than traditional shares on crypto exchanges. 

STOs also have the advantage of being cheaper and faster than a traditional IPO. 

Security tokens are also programmable providing greater compliance and scalability. They also have greater transparency because blockchains provide a complete audit trail.

The first STO only happened in 2017, but already the instrument has begun maturing, with security tokens recognised as transferable securities in the US, EU, and a growing list of other countries. For example, the SEC allows companies to raise up to $75 million via an STO. 

Final Thoughts

Startups climb up a well-known funding ladder if they continue to grow. From friends and family to IPOs and SPACs, startups can find the right intermediaries and financial instruments for their current stage of growth. 

STOs however offer a new choice for startups across the growth cycle. Using new technology already accepted by many national regulators, STOs will open up new investors and sources of funding for startups. Finally, tech startups have the fundraising technology to match their own level of innovation.

STOKR TEAM