The beginning stages of a new business involve high expenses and usually low revenue. Cultivating a dedicated customer base takes time and financial resources that not all founders have available from the get-go. This is why founders look for investment streams that support taking the business off the ground or scaling the business until it becomes profitable.
There is no single way for startups to fund their beginning stages. This article will cover the different paths that founders take to fund their growing business, from bootstrap investing, to accelerators, to equity positions. After reviewing the main possible investment streams for early-stage businesses, we will focus on the best practices to attract private investors to your startup.
Keep reading to learn about different investment sources, fundraiser stages, types of private investors, and the best ways to find investors to secure financing.
Why Do Startups Look for Private Investors?
You are a startup founder. It all started with a great idea. You came up with a groundbreaking vision and you developed a detailed business plan. You defined your target market and your business goals.
To start doing your magic, there’s just one thing missing – capital.
There are different options for getting that initial funding that gets the business engines up and running, which we will explore further down. Nevertheless, most startups will make an effort to find investors to get a solid base to take off. A generous starting investment allows early-stage founders to hire talented people, purchase necessary software, invest in marketing campaigns, and sustain recurring costs until the business becomes profitable.
Additionally, partnering up with angel investors or venture capital firms often brings the added advantage of getting backed up by industry experts. Startup investing is risky due to the high percentage of startups that don’t make it to the initial public offering (IPO) stage. Investors want the startups they back up to succeed, which is why they will often chime in with business advice, valuable resources, networking opportunities, and motivation to keep you on track.
That being said, there are different types of funding opportunities that early-stage startups can rely on depending on their industry, business goals, and how much decision-making power founders are willing to relinquish.
How Are Startups Funded? The 6 Main Types of Funding Sources for Startups
There is no right or wrong way to fundraise during the initial stages of an emerging business. Different options will come with their own sets of challenges, such as financial insecurity, insufficient funding, or high oversight from the funding institution.
Understanding the different ways in which startups can fund the necessary steps to financial independence will help early-stage entrepreneurs find the best option for their vision and business plan.
Bootstrapping is the process of starting a company only with personal savings, including borrowed funds from family or friends, as well as revenue from initial sales. Some entrepreneurs may choose this path when they expect to get returns quickly or when they want to avoid giving away equity. The downsides of bootstrap investment are placing an early financial strain on the business capacity and the risk of losing all investment.
Founders who are resistant to losing decision power may consider taking on business loans. This option is especially riskier for businesses that don’t have constant streams of revenue yet because it requires them to start paying it right away.
An additional hurdle to funding a business with loans is the need for an impeccable credit score. Alternatively, some entrepreneurs choose to take on a microloan while they build their credit scores.
Grants are attributed by governmental, public, or private organizations and have the undeniable advantage that they do not have to be paid back.
On the split end, grants are usually mission-driven or aim to tackle a specific problem, so not all startups will qualify for them. The application process is rigorous, time-consuming, and can take more than one year to reach its conclusion. Additionally, once granted, there is usually high overseeing and spendings monitoring by the funding institution.
Another increasingly conventional means of jumpstarting a startup is crowdfunding, where founders create an online campaign to raise funding from the general public. These can rely on promising a reward system for contributors or they can have no reward whatsoever and depend solely on making people believe in the mission statement and connecting with the audience. Crowdfunding is, therefore, better suited for startups with a strong mission statement that will resonate with the public.
According to the Crowdfunding Center, only 22.4% of crowdfunding campaigns succeed, meaning that less than a quarter of the campaigns started have reached the initial goal defined.Crowdfunding can be a high reward funding strategy but is unequivocally high effort as well, involving great investment in the mission statement, engaging with the audience, and community building.
Incubators and Accelerators
Both incubators and accelerators refer to programs that provide capital, mentorship, community, and networking opportunities for early-stage startups.
Incubators are time-limited (usually 12 weeks) programs that help startups very early in development find their direction and transform their idea into a business model. Depending on the incubator, startups may go through an application process or be recommended through a referral. While being part of an incubator, startups benefit from a wide range of resources, such as mentoring, training, networking opportunities, and physical coworking spaces.
Incubators will typically be carried out in person, therefore geographical location will be a factor to take into account. Another possible downside is the possibility that the initial idea will not be fully fleshed out in just 12 weeks (or however long the incubator lasts), which could lead to not fully profiting from the resources provided. On the flip side, incubators provide valuable resources, networking opportunities, and a final stage of pitching the startup to investors.
Accelerators, on the other hand, are geared toward already running startups and aim to increase their growth. Accelerators are known for having a rigorous application process and only funding a small percentage of applications. Techstars and Y Combinator are examples of prominent accelerators. To help them achieve their goals, founders are given small investments and paired with mentors, from whom they get plenty of business advice and networking opportunities to find investors for fundraising.
Due to the geographical relevance of incubators and accelerators, founders interested in benefiting from a program like such will find that searching for accelerators in the UK, the US, or China will yield markedly different resources. Another aspect to consider is that there are incubators and accelerated targeted at specific communities, such as women of color or LGBTQIA+ founders.
Our final stop in this startup funding overview is also the most sought-after one. Most startups will opt to find investors to get the needed funding to bring their vision to life because they are under no obligation to repay the money raised in case the startup fails. This is a significant advantage over loans, which would need to be repaid plus interest regardless, creating a potential for financial insecurity.
Equity investments, simply put, mean that the investor purchased a share of the startup in the hopes that it takes off and yields high returns. Investing in startups is risky because if the startup fails, investors will lose the entirety of the invested capital. If they succeed, however, they will get a share of the profits. Because they own a share of the company, early-stage investors in high-growth startups have the possibility of extremely high returns.
Investors, therefore, have a strong interest to see the startup succeed, which is why they may want to be in a decision-making position and usually act as advisors. Getting mentoring from business-savvy investors is another advantage of equity investments and a reason why founders should look for investors that specialize in the industry.
Equity investments can be carried out by angel investors and venture capital (VC) firms. While the general principle of exchanging investment for equity applies to both, angel investors are typically high-net-worth individuals who invest their own capital in high-promising startups, while VC investors are backed up by investment firms.
Pareto finds the right investors for your fundraiser, based on your desired location, startup stage, and industry.
Looking to get backed by incubators or accelerators, or to find an appropriate grant to apply for? Pareto will find the right ones for you as well!
Fundraiser Stages for Growing Startups
From pre-seed to series D and beyond, startups attract private investors to invest in equity in different rounds. Each round relates to the startup stage in development and its specific needs.
Pre-seed is a stage without clear contours, sometimes referred to as the research stage. Pre-seed startup funding is applied mainly to testing the viability of the startup idea and its business model. During this stage, startups get their first customers but still have plenty of room for improvement.
During the seed stage, the startup should have a clearly defined business model and a customer base. The investment at a seed stage will be applied to building a team of talented professionals, conducting further market research, and developing a marketing strategy. While the product should be finalized, the seed stage could also see tweaking of the product/service as well as the target customer.
At this stage, the startup will now have a business model that can generate long-term profit. The funding will be used to further develop the product and have the means for a scalable growth strategy. Some startups will expand the product or offer complimentary services, while others will focus on developing the long-term vision.
Series B funding support established startups getting past the developmental stage and taking the business to the next level. They typically attract late-stage investor firms and fund the hiring of new talent for supporting business operations (marketing, HR, customer support, sales consultants etc.).
On a series C stage, the startup has achieved several milestones to the point that the investment is considered less risky and attracts players such as hedge funds, secondary market groups, or investment banks. The investment will push established startups to reach the next growth objectives and expand to new markets.
Series D (and beyond)
Many startups will not collect new rounds of funding after series C. Funding rounds at a series D level or beyond may be preparing the company for an Initial Public Offering (IPO). At these stages, the company has a detailed record of growth, regular and predictable revenue streams, a dedicated and stable customer base, as well as a detailed plan for expansion.
Get Investors to Believe in Your Startup by Following These 7 Rules
We’ve all heard the statistic that 9 out of 10 startups fail, which is why investing in startups is considered a risky investment. How can a new startup convince investors that they are the real deal?
Knowing what investors look for in a startup to invest in is the first step to developing a fundraiser strategy that will get you to the next stage.
Why Investors Will Bet on Your Startup
Investors look for startups with high growth potential to add to their portfolio, but there’s more to finding the right investors than a great business idea. For the best chances of getting your ideal investors on board, prepare the fundraiser beforehand:
- Calculate your funding needs. Before asking for money, determine how much you will need, based on expected production costs and estimated business value, that is, the calculation of a business's economic value, based on criteria such as tangible and intangible assets, profitability, liabilities, and industry-specific metrics. Also take into consideration burn rate, the speed at which a business is spending its venture capital before becoming profitable.
- Have a thorough business plan. Be specific about how you’ll put that capital to use and have realistic expectations for the future of the business. Investors will want to look at financial projections, projected team growth, and detailed marketing plans.
- Find product market fit. Investors are unlikely to put their trust in new businesses without proven demand for the service/product. Besides performing market research, demonstrate that customers see the value in what you are offering and that it solves an industry pain point better than the competition.
- Demonstrate leadership and innovation. Investors don’t invest in ideas, they invest in passionate founders who are willing to innovate and think outside the box. Demonstrating forward-thinking, willingness to break established patterns, and original ideas can go a long way in warming up investors to your startup.
Why Investors Won’t Invest in Your Startup
Similarly, finding clear flaws in the startup planning process, organization, execution or business model will turn off investors from betting on your startup. Avoid common mistakes and put your best entrepreneurial foot forward! Here’s why investors will not choose your startup:
- It is overpromising. If the business goals seem too promising and detached from market trends… investors will understand that there’s a high potential to underdeliver and not meet targets. Keep predictions realistic and remember that when you underpromise you can overdeliver.
- It’s not forward-thinking. If there is no clarity on how your product/service is different from existing solutions, you may lose investors' interest. You don’t have to reinvent the wheel, but your vision should add something to your industry. See if there is any overlapping product or service and make sure you are innovating.
- It doesn’t have a plan B. Entrepreneurship means accepting the possibility that many variables will not follow a script. Are your business plans realistic? Running a risk assessment and implementing mitigating strategies will increase the potential investors’ trust in your abilities as a business owner.
Where to Find Investors for Your Startup Fundraise
Now that you have explored different funding options and decided to attract equity investment, you have set your startup up for success with potential investors, all you have to do is find them! So where can you find equity investors?
The first step is networking, networking, and then networking some more. Expanding your network and achieving increased visibility means increasing the chances of getting noticed by the right investors. Attend industry events, accept all possibilities to speak about your startup, and make yourself and your ideas known.
It may take some time before your networking efforts bear fruit, so be proactive in reaching out to potential investors. Some common websites to look for investors are AngelList, SeedInvest, Wefunder, and Crunchbase. Make sure you know what investment profiles you are looking for, by filtering by industry, specialization, and location.
Social media platforms are also useful resources to find investors when used well. By searching for relevant keywords and hashtags for your industry, you could get in touch directly with your desired investors. Of all social media platforms, LinkedIn and Twitter seem to be where investors typically spend most of their time.
Another aspect to consider when browsing for investors is the geographic location. Investors will typically specialize in companies of the same country or neighboring countries. Therefore, you may want to be specific by including the desired geographical location in your search. For example, if your company is based in the UK, you may want to search for UK investors specifically, or if you have a significant market in Israel, you may want to search for Israeli investors.
Looking for the right investors for your startup fundraiser is time-consuming. Pareto will find investors that specialize in your startup stage and industry and source contact lists so you can start pitching your startup right away! Sign up and try Pareto with a project pilot.