The art of startup fundraising: Your guide to raising capital in 2022 and beyond
There is an art to startup fundraising.
Whether your business is in its early stages, or you’re preparing for your Series E funding round, you need a tight strategy in order to raise the capital you need to realise your ambitions.
In this guide, we’ll take you through the different types of funding available to startups and how to access them. We’ll also cover how to value your startup, how much to ask investors for and the common mistakes to avoid. Plus, we’ll speak to industry experts to get their first hand tips on how to prepare the perfect pitch.
Types of funding available to startups
First things first. Before you start raising capital, you need to choose the funding avenues that are right for your business. Here are the funding types that may be available to you.
Founders often use their own savings or rely on money from family and friends to kick start their business in the pre-seed stage. This is sometimes called “bootstrapping”.
Be aware, there are risks here. 60% of startups fail within their first three years, and you might not be able to recover your personal savings, or that of your family and friends, if your business unravels.
But if you have confidence in your idea and are in a position where you can afford to take a risk, using personal capital can help take your business from an idea sketched on the back of a napkin to something more tangible that future investors will want to get onboard with.
Crowdfunding is the process of persuading a large amount of people to invest a small amount of capital in your business.
Rather than convincing one individual to invest USD500,000 into your startup, you can try persuading 5,000 people to invest USD100. The idea is that no one is putting a large amount of capital at risk.
Social media and crowdfunding websites give founders access to a wide range of potential investors. These investors are usually ordinary people who might decide to support your business in return for rewards, equity, or simply because they like your idea and want to be a part of it.
In order to protect vulnerable people, there are some legal restrictions on who can contribute to crowdfunds and how much.
[Related: Venture capital vs crowdfunding: What’s the best call for your business?]
Incubators and Accelerators
Incubators and Accelerators provide a range of support services to young businesses, including office space, workshops, access to professional services at a reduced rate, and seed funding. In return, they will typically ask for equity in your company.
Incubators can be academic organisations (such as universities), non-profit organisations, commercial companies, or venture capital firms.
Accelerators will typically operate as part of a scheme which is backed by the government or by a corporate company.
An angel investor is an individual who invests a large amount of their own capital into a startup or small business in return for ownership equity.
Angel investors tend to be wealthy individuals with business experience who, as well as offering funding, also offer mentorship to entrepreneurs and access to a network of useful contacts.
Angel investors differ from venture capitalists in that they invest in the earliest stages of a business, even though this puts their capital at considerable risk. Angels may take those risks because they want a business to succeed for personal reasons, not just for profit. An angel investor might be a friend, or someone who strongly believes in what your business is trying to achieve.
Angel investors will typically ask for a 20 - 25% stake in your business, which is why this form of investment is usually confined to seed-stage businesses that cannot access funding from other sources, such as investment banks.
Venture capital is a type of private equity given to startups with long-term growth potential.
Unlike angel investors, who invest personal wealth into startups, venture capitalists typically work for financial institutions such as investment banks and venture capital firms.
Venture capitalists take money from accredited investors and put it into promising early-stage enterprises in exchange for equity. The overall objective of any venture capitalist is to generate profit for their investors.
The upside of venture capital is that you can secure funding for your business even if you do not have assets or cash flow. The downside is that venture capitalists may demand a large stake in your company, and even require you to relinquish some control over the direction of the business.
Debt: Business loans, credit cards and more
There are a number of funding options available to businesses looking to take on debt, and each has their own eligibility criteria.
Some avenues to consider are business loans, invoice finance, government loan schemes, credit cards and asset finance.
This type of finance comes from banks, peer-to-peer lending corporations and commercial lenders. Interest rates vary depending on the type of finance and the provider, so it’s worth thoroughly researching the options before committing to a product.
Often, the lender will require security such as a personal guarantee before agreeing to loan you money. This means you may have to secure the debt against your house or your business assets.
Only businesses that have cash flow, and are therefore able to pay back the interest accrued on their debt, should consider taking on this type of finance.
As the name suggests, private equity is a type of financing reserved for businesses that are not yet publicly trading on the stock exchange.
Unlike venture capitalists, private equity firms do not invest in early-stage startups. This is a form of investment that you should consider later down the line, for example in your Series B funding round.
Startup fundraising stages
Pre-seed funding is the first round of capital that founders raise to get their business off the ground. The amount raised in a pre-seed funding round usually totals USD50 - USD250k. You should use this initial investment for:
Market research: to validate your business model and product idea.
Prototypes: a version of your product which you can show to potential investors and stakeholders.
Patents and licensing: to protect your intellectual property rights and ensure you’re legally allowed to distribute your product.
Hiring: you may need employees to get your business idea off the ground.
Pre-seed funding typically comes from founders’ personal savings, as well as from family and friends.
Seed funding is the first round of capital that an early-stage business raises from investors.
Seed funding amounts vary between USD10,000 - USD2 million. The amount you raise will depend on what you are trying to achieve at this stage in your business’ development.
You should use the money raised to continue the work you’ve begun in the pre-seed stage and develop a minimum viable product which is ready to take to market.
Some companies will never need further investment beyond the seed funding stage. Others will need to continue raising money in order to achieve long-term growth and profitability.
To successfully raise Series A funding, you need to show investors that you have a strategy for long-term profitability.
Seed A funding typically comes from venture capitalists that will be looking for proof that your business is going to generate returns. Although it’s worth noting that venture capital is not the only route to Series A financing, crowdfunding is another option for businesses that fail to gain interest from venture capital firms.
Less than 10% of seed-stage companies will go on to raise Series A funding. So how do you give your business the best chance of success?
Approach investors because you’re ready for your next stage of growth, not because you’ve run out of money. Remember, raising capital takes time, so ideally you want to have a runway of 6 - 12 months before you start the process.
Make sure you get in front of the right people. Build a list of venture capital firms that have invested in companies similar to yours. These firms are more likely to be interested in your proposition.
Build relationships by attending events. Make connections with peers who can introduce you to their investor network. Cold emails are likely to be ignored by venture capitalists, but a recommendation from a trusted contact will get you far.
When it comes to pitching, you must provide evidence that you have reached product market fit, are on top of your unit economics and have a plan for scaling your business towards profitability. At this stage, having a great idea is not enough, you need to show that your company is on track for long-term growth.
Eran Galperin is the founder of Gymdesk, his advice to businesses seeking funding is to find a network of investors that suit your enterprise. “Find a network that shares similar philosophies to yours. It's no use pitching or moulding your company to fit the money. It has to be a hand-in-glove arrangement in order to maximise your chances of success and sustained growth.”
If your pitch impresses a venture capitalist, they will carry out due diligence to check that your financial projections make sense and perform a valuation of your company to determine how much it will be worth in a given timeframe.
Successful Series A funding rounds will raise between USD2 million and USD15 million. In the US, the average amount raised in a Series A funding round in 2021 was USD13 million, although this number was inflated by the high valuation of companies in the tech industry.
In return for Series A funding, you can expect to give up between 20 - 25% of your company in the form of common or preferred stock. The investor will also expect to be involved in company proceedings going forward, and will likely request a seat on your board.
You should use the money raised in your Series A funding round to progress towards your long-term growth goals.
At this stage in your fundraising journey, your business should be well established with a proven business model.
Part of your Series B funding may come from the same investors that provided capital during your Series A round. You can also pursue new avenues such as later-stage venture capitalist firms who are more likely to be interested in your business now that it has matured.
Series C funding and beyond
If you’re looking into Series C funding, your business must be enjoying some success. At this stage, you may be looking for funding to support global expansion, develop new products or acquire a competitor.
As you progress in your funding lifecycle, the balance of risk versus opportunity begins to tip in your favour, making it easier to get investors onboard. At this stage private equity firms, hedge funds and investment banks are likely to become interested in your company.
[Related: From Seed to Series E: Understanding funding rounds]
How to pitch to an investor
Once you’ve secured a meeting with an investor, it all comes down to your pitch. We spoke to some industry experts to find out how founders can best impress potential investors.
Jason Porter is a Senior Investment Manager at Scottish Heritage SG. His advice is to play to your strengths and keep your proposed solution clear.
“Investors will believe in your potential to thrive if you have a strong track record as a founder,” says Jason. “If not, you'll have to demonstrate your worth in other ways. Be honest and true to yourself. Investors are interested in your journey, how you reached your current position, and what motivated you to achieve your goals.”
Jason stresses the importance of demonstrating your startup’s ability to address a market need or problem. “If your brand is well-known and has a strong personality, but you are unclear about the solutions you are providing to the market, it is unlikely that you will be able to attract investors or secure enough cash,” he says.
Sophia Jones works as an Investment Analyst at PiggyBank. Her advice is to make sure you have a clear understanding of what you're trying to accomplish and how you plan on doing it.
“It's important to be able to explain your goals in a way that makes sense to investors who may not be familiar with your industry or technology,” says Sophia. “Create a realistic budget for what you want to accomplish with your funds. Investors want to know that you can use their money wisely and effectively. Finally, if possible, find early adopters for your product or service. This will help demonstrate that there is demand for what you're doing and provide some proof of concept for future investors.”
Diego Kafie is the CEO and co-founder of Playbite, a mobile games platform backed by prominent venture capitalists like M25. His advice is to prepare.
“Prepare your pitch, prepare your answers. Prepare to be rejected countless times, and sometimes even get strung along for a while to no fruition,” says Diego. “Prepare to course correct: you'll learn from every meeting, and should apply those learnings to your pitch. Prepare to have to make tough calls as you inevitably have to pass on investors.”
[Related: 10 key business metrics every startup founder needs to know]
Valuing your startup
Valuation is an essential part of a startup fundraising strategy. There are several ways to do it. Here are some options:
This valuation method, sometimes called peer group analysis or “comps”, involves finding companies that are similar to yours and looking at how they are valued by the market.
The multiples that analysts use when performing comparable analysis vary by industry, but typically include:
Enterprise value/sales (EV/S)
Enterprise value/earnings before interest taxes depreciation and amortisation (EV/EBITDA)
The only drawback of this valuation method is that, for early-stage startups, it can be difficult to find companies that are comparable.
Discounted cash flow (DCF)
This valuation method looks at the future earning potential of a company in order to determine how much an investment will be worth.
The DCF method takes a company’s forecasted cash flow over a set period of time, then uses a discount rate — usually weighted average cost of capital (WACC) — to determine the present value of that cash flow.
Investors can then gauge whether the value of their investment over time will be higher than the initial cost of the investment.
Cost to duplicate
To work out your cost to duplicate, you need to calculate how much it would cost to build your business again from scratch. To do this, you need to look at how much you have spent to date on costs like equipment, product development and research.
Cost to duplicate gives a fair valuation of your business’ current assets, but it doesn’t take into account your company’s future earning potential. For this reason, it is not the best valuation method for companies looking to persuade investors of their growth potential.
How much funding should you ask for?
There are a few things to consider before deciding how much capital to ask for in each funding round.
1. Your company valuation
Understanding your company’s valuation is crucial to understanding how much capital you should ask investors for. Investors are looking to make returns between 10 - 40 times their investment amount, so by analysing your company’s future worth, you can work backwards to see how much you should ask for in exchange for the equity you’re offering.
2. How much equity you are prepared to give away
The more money you ask for, the more equity an investor will require in order to earn returns. Be careful not to give away too much of your company in the early stages.
3. The amount each investor is looking to offer
Angel investors typically invest between USD25,000 and USD500,000 (although some invest more). Venture capitalists won’t get out of bed for anything under USD2 million. Asking for either too much or too little will put investors off, so make sure you do your research.
4. The stage your company is at and how much capital you need to achieve your next phase of growth
When you pitch to investors, they will expect you to share how you plan to use their funds. The amount you ask for should match the cost of what you’re looking to achieve (with a reasonable buffer built in).
5. How long you have to raise the capital you need
Fundraising takes time. The more you’re looking to raise, the more time it’s going to take. If you don’t have a huge runway, it might be best to opt for a smaller fundraising target in the knowledge that you can raise more capital in your next round.
6. The number of investors that have shown an interest in your company
Like many things in life, being in high demand is going to make your company look more attractive. Your ideal scenario is for investors to enter a bidding war.
Common startup fundraising mistakes and how to avoid them
If you’re new to fundraising, here are a few common mistakes that you need to be wary of.
1. Don’t give away too much equity in the early stages of your business
The moment an investor shows an interest in your business is exciting, but it’s important not to get carried away and give away too much of your company in exchange for what may in the long-run be a small financial investment. If you give away too much of your business in the pre-seed and seed stages, you won’t have as much leverage when it comes to later funding rounds. An accurate valuation of your business will help you understand how much a stake in your company is really worth.
2. Don’t approach the wrong investors
Not every investor is going to be a good fit for your enterprise and approaching the wrong individuals is a waste of your time and their's. Likewise, successfully securing investment from someone you don’t want to work with for the next three to six years can be disastrous for your business. Make sure you do your research and source investors who are a good match for your vision.
3. Be confident but don’t oversell yourself
Telling everyone that your business is the new Microsoft isn’t going to make it true, and is likely to elicit an eye roll from jaded investors. Make sure your claims are based on hard facts and solid financial projections.
4. Don’t ask for too little
You might think it’ll be easier to raise a small amount of capital, but this isn’t always the case. Investors are looking to make a decent return on their investment, and if you’re only asking for a few thousand dollars, investing is hardly going to be worth their time. Be bold with your growth ambitions and ask for the amount you need to achieve them. If investors think it’s too much, they can always negotiate you down.
5. Don’t ask for too much
On the flip side, be wary of asking for unreasonable amounts of capital. Look at how much the investor usually puts into businesses at your stage of development. Explain clearly what you will use their money for and how their investment will lead to solid returns.
6. Sell your idea
Before you get into the weeds with your financial projections and unit economics, don’t forget to sell yourself and your business. Investors need to believe in both you and your idea before they part with their money. A really strong pitch will communicate the ‘why’ of your company, so investors walk away understanding how your business is going to appeal to your target market.
7. Don’t go in unprepared
It should go without saying, but make sure you have your facts straight before you pitch. You should be prepared to answer questions on how you plan to scale your business over the next 12 months, the size of your target market, what your monthly burn rate is, your financial projections for the next two years, your unit economics, marketing strategies and more.
8. Don’t underestimate how long it takes
According to Alejandro Cremades, author of The Art of Startup Fundraising, when it comes to securing Series A investment, the due diligence process alone can take months. And even if you do secure investment it can take 90 days from your initial pitch to the money hitting your bank account. The moral of the story is that you should make sure you have a cash runway of 6 - 12 months before you start fundraising.
Manage your global finances with Airwallex
If you’re on your way to securing the investment you need to accelerate your startup, you may also be searching for the best way to manage your global finances.
Here’s where Airwallex can help.
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Tilly manages the content strategy for Airwallex. She specialises in content that supports businesses in their growth trajectory.
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