Startup Financing: How It Works and How to Get It

Startup financing is out there if you want it: 2021 was a record year for venture capital financing, both from the perspective of deal volume and the number of deals.

DealRoom works with firms looking for startup funding and the companies that fund them.

In this article, we look at how these transactions tend to play out and the best ways to achieve startup funding.

Why is startup financing important?

Startup financing is the lifeblood of startup companies.

When companies develop a minimum viable product, look to build a niche in the market, and grow into that niche, they burn through cash (hence the expression ‘burn rate’).

The more talented the team, the more complex the technology, and the more ambitious the market, the greater the burn rate will be.

This is where startup financing comes in.

It enables companies to pass through the pre-revenue period and the period which follows where revenue isn’t enough to sustain the high costs required to grow the company.

This money typically helps startups to hire more engineers, get help from various product development services, expand sales, expand their marketing team or involve a marketing agency to help.

Of course to get this money you have to pass through the startup due diligence process.

Statistics underline this importance quite clearly CB Insights data show that 38% of startups failed because of a lack of cash or failure to obtain startup financing.

How big is the startup financing market

The nature of sources of startup financing (family and friends, credit cards, entrepreneurs’ own funds, payment in kind, etc.) makes acquiring exact figures for startup financing impossible.

However, if we use venture capital funding as a proxy, we can say that in the United States alone, startup funding reached $329 billion in 2021.

This funding was spread across over 15,500 separate transactions and was over twice the amount of funding reached in 2020, which was a record deal at the time.

So, the startup financing market is huge and growing. For startup founders with commercially viable ideas backed up by strong teams, there has arguably never been a better time to seek financing.

What are the options for startup financing?

Just as with mature companies, the more cash that a startup requires, the stronger its value proposition will need to be.

The reason most pre-seed startups opt for funding from family and friends is often that the funds required to develop a minimum viable product (MVP) aren’t as large as those required to go from MVP to a fully market-ready product.

The experience of DealRoom is that many startup sites advise founders that business credit cards are an option for startup financing. This is equivocally not the case. Any startup should not be funded with credit cards - a road to financial ruin.

The options which follow are viable, however:

• Family and friends: Unless you’ve exhausted this option, many more sophisticated investors will wonder why they should extend you funds when your nearest and dearest won’t. In essence, a founder’s business idea should be attractive enough to make it an investment opportunity for those in their inner circle.
• SBA Microloans: The Small Business Association (SBA) offers ‘microloans’ of up to $50,000 for small businesses for the acquisition of materials, supplies, equipment, or for paying working capital. In 2021, 4,510 of these loans were extended. Be warned, however: The SBA only extends these loans to companies with cash flows.
• Bank loans: There are several forms of bank loans ranging from personal loans to business term loans and business lines of credit. Of these, a personal loan is the most viable for startups, with interest rates still competitive enough to make them viable (although moving fast on this one is a good idea…).
• Crowdfunding: There are a plethora of crowdfunding platforms for startup founders to choose from, enabling entrepreneurs to pitch their concept to a crowd. This is a relatively low risk way of establishing whether the concept has legs before investing too much time and money on the concept. Just be careful about the exposure if you’re looking to protect some aspect of your business model.
• Private debt: The sheer scale of funds available at private debt companies now makes them more open to startup investments than ever. The business plan will need to be near perfect, and you’ll need to show a path to steady returns within 2-3 years, but private debt companies are sitting on so much dry power that now is a one-off time to pitch a business idea to them.

How much startup financing is required?

The only answer to ‘how much startup financing is required’ can be found through a well structured business plan accompanied by a month-by-month financial model outlining the sources and uses of funds.

Investors like to see a company that’s going to need cash (as that means higher returns) and to see where it’s going to be used and how it will be repaid.

Here are some precedents, which give some idea about the relatively small scale of startup financing that some well-known companies received early on in their journeys.

Preparation is key

Wherever a company is in its journey, all of its interactions with investors, banks, or even family and friends, will need a professional set of documents.

These could include one-page teasers, pitch decks, business plans, extended business plans, financial models, cap tables, and more.

The stack of documents adds up quickly. Talk to DealRoom about how we can help you through this journey with our award-winning project management platform.