Startup Funding: Where to Get it & What to Look Out for

Startup Funding Masterclass: Part Ten

startup funding in hands — Photographer: Alexander Mils

How can you make the necessary investments to build your business without any cash in the bank right now? In short, startup funding is the answer.

In this post, we’ll summarize where to get startup funding and what to look out for by answering the following four key questions:

Why is startup funding so important?
Where can you get funding for your startup?
How to deliver a successful investment pitch?
What to look out for when negotiating with an investor?

This post is Part Ten in a new Masterclass series on Startup Funding. Funding is the fuel that every business runs on. Knowing the ins and outs of funding is therefore essential if you want your startup to be successful. We searched for a compact-yet-comprehensive guide on startup funding and found it nowhere, so we decided to build one ourselves. This is that essential guide.
We bring it to you in partnership with Belgium’s largest startup and scale-up accelerator Start it @KBC, supporting and promoting more than 1.000 entrepreneurs with innovative ideas and scalable business models.

– Jeroen Corthout, Co-Founder Salesflare, an easy-to-use sales CRM for small B2B companies

For those new to the Masterclass series, please find an overview of all previous parts below:

1. Why is startup funding so important?

Building a company is hard and often requires a lot of investment.

In the beginning, you need to build an MVP based on your original idea and find your first customers, which might require you to hire your first developers.

Later, when you have a great product-market fit, you might need to build a sales organisation in order to catch the market opportunity. And let’s not forget about the infrastructure costs, development costs and marketing costs along the way either.

All this is to be paid before you can make any profit.

In fact, throughout the entire lifecycle of a business, you are required to make investments today for profits tomorrow. Without them, your business is unable to grow. Investments are the fuel of your business.

At some point, you will be profitable enough to save enough cash reserves to be able to pay for those investments, but not from the start.

In fact, not having access to the required cash is known as one of the key reasons that startups fail.

Startup funding is the tool that enables you to bridge that gap between investments and profitability and get the necessary cash reserves. That is why it is so important.

A. What are the wrong reasons to look for startup funding?

In short, if you are able to maximize the potential of your business without ever taking outside funding, then you should.

Startups and its investors have become popular in modern culture. A big part of it are the public deal announcements with lofty valuations. They speak to the imagination of every entrepreneur and are often seen as a measure of success.

Convincing investors to believe in your idea and your ability to execute is certainly a milestone, but it is not a measure of business success.

The true measure of success is the value of your share of the business, the success of your customers, and the impact on your employees.

Every time you take outside funding, you are either selling a share of the business (equity) or making additional financial costs (debt) to serve your current needs.

Don’t get misled by the announcement of startup funding rounds. With these types of deals, the devil is in the details (the terms and clauses).

Look at funding like you look at a tool. It’s one of the many tools you might need to use in order to maximise the potential of your business.

B. Know how much funding you need

Once you have decided that you need funding, it is very important that you decide on how much you need.

This process is also known as calculating your startup runway. For a detailed look at how to calculate your runway, take a look at Part One of our Masterclass, “How Long Should Your Startup Runway Be?”.

Calculate your startup runway

As a startup, you are often running out of money. It is key to understand what this means exactly. One week or twelve months… how long can you continue to work towards your goals without having problems to pay the bills?

In order to calculate this, you need to have a good understanding of your monthly cash costs and your remaining account balance.

Ideally, you also continue to grow your business, which probably means that you are required to even make additional costs. Make sure to include these when calculating your runway.

Now that you have a view on how long you can continue, it is time to take a look at how long you should extend this runway by taking startup funding.

Extending the runway

Deciding on how long to extend the runway is deciding on how much funding to raise and, in essence, this is a balancing act between two key factors.

On the one hand, you do not want to raise too much capital too early, as your business should improve in the near future. This means that if all goes well, you should be able to raise funding at better terms down the road, or even better, you might not have to raise funding again.

On the other hand, every time you need to raise funding for your startup, there is a great chance that it won’t go as planned. Either there is not enough interest in your business or it is taking too long. If you don’t raise enough capital now, there is no guarantee that you will be able to do so in the future. Additionally, your business might hit a rough patch or you might be behind your planning at that particular point.

If you force us to make you a recommendation, we would tell you to aim at a startup runway of something between 12 and 18 months. Of course it also strongly depends on what you can get at decent terms.

2. Where can you get funding for your startup?

Now that we have an idea of how much funding we need, we need to find the right source.

In Part Two of our Masterclass, we have identified and discussed 9 Startup Funding Sources:

Personal savings
The business itself
Friends and family
Government subsidies and grants
Incubators and accelerators
Bank loans
Convertible notes
Venture equity
Venture debt

Making the right decision for your business starts by understanding the options, but if you are looking for a guide through the different options, we have you covered here.

White neon wallpaper — Photographer: Austin Chan

A. Funding sources quick guide

Use these questions to find a potentially great funding source fit for your startup.

Do the words early stage, idea phase, or pre-revenue come to mind when talking about your startup?

Are you considering to invest your own savings or talking to friends and family?
And/Or are you looking for a small outside investment and access to an ecosystem and advice by joining an accelerator or incubator?
And/Or would you like to get an experienced investor as a shareholder?
Perhaps, while doing so, you would like to consider one of the common instruments used in seed investing, the convertible bond?

Are you developing a new technology or thinking about launching a new innovative project?

Have you considered applying for a government grant as a cheap source of funds to support your plans?

Did you hustle your way out of the pre-revenue stage and are you looking for cash to scale your business?

Have you considered keeping all the equity and bootstrapping your way to the top?
Or are you ready to take an outside investor into your shareholder structure?

Is being cash flow positive around the corner, do you need any investments in equipment, or are you looking for ways to fund your working capital?

Have you already spoken to any of your local banks? Did you know that there are government programs supporting banks to lend to startups?

Or did you just raise a venture round and are you looking for some extra cash until you go into your next fundraising?

Why don’t you consider what Uber, Airbnb and many others have done before you, and take on venture debt as the bridge between your funding rounds?

Read on about all the details in Part Two of our Masterclass about funding sources.

VCs in Patagonia vests, you gotta love them. – Source

B. When to raise VC money

As you go through the above questions, it might be that you end up looking for a VC investment.

VCs are a very important part of the startup ecosystem, as they provide a large part of the invested capital, but they are also often misunderstood.

In order to understand if this is the right route for your startup, read up on Venture Capital in Part Three of our Masterclass “When to Raise VC Money (and when not to)”.

In summary, the most important thing to understand about VCs is how they are incentivized when making a decision.

VCs manage outside capital and depend greatly on their ability to source new capital. The key drivers in sourcing capital are the overall fund performance and the ability to source high-level deals.

Now research shows that in order to achieve good returns as a VC, you are highly dependent on a few big home runs. Often referred to as the Power Law in VC investing, this effectively means that the performance of the fund is dictated by a small number of investments with amazing returns.

What does this mean for you as a startup looking for funding? It means that you now have an idea what a VC investor is looking for and that you can see if you are a fit.

Here are some questions to guide you to assess how your startup would fit in a VC portfolio.

Does your startup classify as a “potential big win”?

Do you have a $10bn potentially addressable market?
Could your business reach +$100m in annual revenue within a 7-8 year time frame?
And if so, what would it take to get there (geographies, verticals, markets)?

Is your business insanely scalable?

Does adding new clients hardly increase the complexity of your business?
Do you have a relatively low additional cost to deliver to additional clients?
Do you have a product that is pretty much “plug and play” across markets?
Do you have a product that is ready, and is money the main blocker from getting market share?

Does your business require scale to be successful?

Are you running a marketplace, a micro-mobility provider, or any other business that benefits greatly from the additional scale?
Are your unit economics highly reliant on getting the right scale?
Or do you need a big investment up front with the promise of great scalability in the future?

Do you mind giving away control?

Do you believe that having 10% of the business with VC money is better than having 80% of the business without?
Do you not mind dealing with and reporting to professional investors?

Are you ready to sell or go public in the next 5-10 years?

Are you ready to start the clock and prepare your business for an exit within the VC timeframe?
Would you mind running a public company with all the public scrutiny it entails?
Or are you willing to sell to another industry player or a financial sponsor at some point?
Do you mind having limited leverage in the exit decision?

In case your startup does not fit these criteria, don’t worry. There are other ways to create a great business. Have you ever heard about bootstrapping? If not, check out the last section of Part Three of our Masterclass.

Sharing is caring — Photographer: Toa Heftiba

C. How to split startup equity

Before you can go out there and raise funding for your startup, it is important to get your house in order.

One of the key parts is to make a decision on how you will split your equity among the founders, employees and advisors.

For a detailed view on how to split the equity the right way take a look at Part Four of our Masterclass “How to Split Startup Equity the Right Way”.

Beyond deciding on how much to allocate to whom, it is also very important that you do it in the right way, protecting yourself and your business for when it does not work out as expected.

This is also very important to the investor, who will become a co-owner of your business. Not protecting your business thus also means not protecting your investor.

Here are some tips to work with before going into an investor meeting.

Think before you allocate

Are you convinced that the advisor/employee/co-founder can deliver on the promises?

Have you spoken to previous employers/employees/partners?
Did you see any previous projects?
Did you have enough time to truly assess the ability to deliver?

Do you have a similar view on future cooperation?

Do you share similar priorities and goals?
What will happen in the medium term, do you see a role for both?

Work with reverse vesting

Founders often receive their equity in the beginning, but what happens if it does not work out and one of your co-founders leaves?

You are still at the beginning of the road and now you have this founder with a piece of control over your business.

This is where reverse vesting comes in, by making the equity gift conditional on the founder staying in place. If not, part of the equity is returned to the company.

Set up good corporate governance

What happens if you and a co-founder disagree?

Who comes in as the tie break? Or do you just have more voting rights? These are questions to consider.

One of the ways to tackle these issues is by having a good board of directors which will be part of the most important decisions.

Keep control over who owns the shares

One of the key risks of giving away a lot of equity is that it might fall in the wrong hands.

You can protect yourself by using either a Right of First Refusal or a Blanket Transfer Restriction which allows you to buy the shares first or limits the selling altogether.

Set up the right equity incentive program for employees

Startups are a risky business and they attract a certain form of employee. One of the key methods to reward this employee is through equity incentive programs.

Investors will ask you to reserve enough equity (probably out of your ownership) to reward and attract the necessary talent to build your business.

Read up on the differences between shares and options and take into account the local habits.

When setting up an equity incentive scheme take with you the following tips:

Understand your employee’s needs: Not all markets nor employees have the same appetite for equity. Understand the needs and adjust.
Employees talk: Never forget that employees across firms and industries talk about their compensation. Try to stay close to market standards.
Be transparent: Equity is not always as simple as it seems. Make sure that you are transparent to employees so they understand the real value and downsides where needed.

D. Understanding the different startup funding rounds

Another important aspect of getting investment in your startup is understanding in what funding stage you currently are. Because one does not simply fuel up once.

With each stage come different challenges and needs, but also different requirements in terms of progress.

Read up on all the different stages in Part Five of our Masterclass “Startup Funding Rounds: The Ultimate Guide from Pre-Seed to IPO”.

In order to have an idea of where you are, you can ask yourself the following questions:

Did you just create a business plan or technical idea and are looking for funding to build an MVP?

-> Pre-seed / Seed

Did you just launch your MVP and are you seeing the first customers appear? Are you now looking for funding for your first key hires to truly develop your initial product and prove your product market fit?

-> Seed

Did you just figure out your product market fit, develop a scalable and repeatable product, and lay the foundation to create scale in your sales? Then it is time to super-fuel your growth.

-> Series A

Are you in the midst of crazy growth and can’t keep up with the generated demand?

-> Series B

Are you running a startup valued at $100m or more with several years of strong growth behind you? But you are not ready to go public and need a bit more time to finetune your business?

-> Series C or more

Are you and your investors ready to sell some shares? Does the company have the reporting and management structure in place to go through life as a public company?

-> IPO

map measure — Photographer: Alexander Andrews

E. Last but not least: selecting the right investors

Now that you have a good idea of how much funding you need for your startup, know what sources you would like to use, and understand what round you are looking for, it is time to discuss how to find these elusive investors. And how to find the right ones.

For a detailed and practical overview of how to find and select the right investors, take a look at Part Six of our Masterclass “How to Find the Right Investors”.

First of all, there are two different stages when it comes to raising capital. A networking mode and a fundraising mode.

Why this distinction?

Well if you have ever engaged in fundraising you will be able to attest to this: it dominates everything. From the moment you wake up to the moment you go to bed, it will always be top of mind. It is hopelessly distracting and that is why you should limit it to the shortest period of time possible. Get in, get your cash, get out.

That does not mean however that you should stop talking to new people and meeting investors in a very informal setting. Hence, the networking mode. But the moment that you get into a room to pitch your startup, you are in fundraising mode. Be careful, investors love to drag you into fundraising mode, as it provides them with an opportunity to invest in you before anyone else.

Once you have decided that it is fundraising mode it is essential to do your research and be structured.

To us, there are two key steps.

First, create a list

Start out by collecting a list from the following resources:

Network: Ask fellow entrepreneurs and people in the scene (they might have a list).
Incubators and Accelerators: If you are part of one, don’t forget to leverage your participation. If not, asking never hurts.
Government agencies: In a lot of countries, the government has set up agencies specifically to help out starting entrepreneurs. They typically have this kind of information.
Universities: Contact alumni networks, entrepreneurship support groups and university staff for leads.
Directories: Big directories like CrunchBase and AngelList can be a great resource.
LinkedIn: Identify and connect with high net worth individuals and investors. Don’t forget to search for keywords like “investor”, “venture capital”, “angel”, “member of board”.

When creating this list try to be as complete as possible, while also not creating needless work. If a name does not make any sense right from the beginning, then just leave it out.

Tip: Do not underestimate what you can get by leveraging your network.

Now filter your list

Now that you have this huge list, you need to narrow it down to those investors with the highest probability of success.

To do this there are three key criteria:

Is the investor interested in your company?
Can the investor invest in your company?
Is your company interested in the investor?

Read up on Part Six of our Startup Funding Masterclass for a step by step approach and practical tips on how to judge each of these three very important questions.

Karri Saarinen presenting at Nordic Design — Photographer: Teemu Paananen

3. How to deliver a successful investment pitch?

Once you have locked down the investors that you would like to invest in your startup, it is time to convince them.

It all starts with creating the right pitch.

In Part Seven of our Masterclass “How to Make the Perfect Pitch Deck” we discuss at length how to create the perfect pitch following the Airbnb example.

In summary, we would give the following tips.

A. Understand your audience

You are speaking to a very specific audience and you should know its characteristics:

They have limited time for your pitch
They are looking at several pitches every day
They are looking for opportunities by finding clues of successful businesses (investor mindset)

In order to be successful, you need to offer those clues in a clear and concise fashion.

B. Understand the purpose of the pitch

When creating your pitch, never lose sight of what you are trying to do. You are trying to convince an investor to invest in your business.

Investing in startups is a very risky business and most investors are heavily reliant on a limited amount of big wins. A big win, that is what the investor is looking for. You need to show how you can be that next 10x investment.

The pitch deck is one of the most important documents you will use to convince investors, but it is also not the sole document. Refrain from including every possible detail and metric. It is all about getting the investors excited and setting yourself up for more detailed discussions.

C. Key items to include

In order to convince investors, you need to convince them of the following key items:

Market opportunity
Ability to execute
Scalability
Competitive advantage
Positive momentum

Market opportunity

Any company’s upper limit is its addressable market. So in order to convince an investor of the potential of your business, you first need to convince them of the market for your product.

A good market opportunity is typically a combination of the following factors:

A relevant problem that needs to be solved
Existing products/companies that do not provide the right solution
A timing component that enables a new solution (regulation, customer behavior, etc.)

Ability to execute

Once you have established that there is an attractive market opportunity, the question arises if you are the right team for the job.

Investors are looking for teams that are able to execute.

In fact, a lot of investors would rather invest in an A team executing a B product than the other way around (trusting an A team to eventually move to the right product).

Scalability

If the market opportunity exists, you also need to be able to serve it.

The ability to acquire, grow and serve customers in a scalable manner is critical.

Therefore your pitch should provide as much evidence as possible that your business is scalable. Be it in your product or in your business model.

Competitive advantage

Any good market comes with a number of competitors. That is why investors are looking for startups that can compete in the long term.

Highlight your unique competitive advantage; whether it is a network effect, hard-to-replicate technology, or the ability to out-execute everyone else.

Positive momentum

Finally, investors want to see that the market and customers agree with you. That in fact, you are building a business that can win.

Try to show your positive momentum by delivering on your business plan, showing positive developments in your product and of course customer traction and growth.

To learn how to take these tips and build your own perfect pitch deck, take a look at Part Seven of our Masterclass “How to Make the Perfect Pitch Deck”.

D. Nail your investor pitch

When pitching to an investor a good pitch deck is important, but so is the way you deliver the pitch.

People are simply not good at giving attention nor remembering.

Learn how to use storytelling to grab the investor’s attention and make your pitch stick in Part Eight of our Masterclass “How to Nail Your Investor Pitch and Get Funded?”.

Man writing on paper — Photographer: Adeolu Eletu

4. What to look out for when negotiating with an investor?

You have pitched to investors and some of them are interested.

Now it is time to start discussing the term sheet, one of the most important documents you will ever sign.

What is a term sheet?

A term sheet is a non-binding written document that includes all the important terms and conditions of a deal. It summarizes the key points of the agreement set by both parties before executing the legal agreements and starting off with time-consuming due diligence.

Why is it so important?

This document can dictate how much you will enjoy seeing your startup grow, as it outlines the key terms of your deal with investors.

As an entrepreneur, you are looking to build a business, not negotiate a term sheet.

But you also want to raise capital at the best conditions possible. You don’t want to lose upside and control or take on inappropriate downside risk.

The term sheet is the place to make sure this doesn’t happen as it is all about dividing this upside, control and risk between you and the investors.

Go beyond discussions and learn all about the various terms and clauses, as for a term sheet the devil is in the details.

To make matters worse, you will probably negotiate a term sheet for the very first time while the party on the other side has already done 100s. So you have to be prepared.

Start off by understanding all the building blocks in Part Nine of our Masterclass “The Ultimate Term Sheet Guide – all terms and clauses explained”.

Tips and Tricks

Term sheet negotiations are going to be a stressful time and, depending on the success of your business, you might have more or less leverage.

Before you commit, realize that the negotiations are a great way to see how the VC truly operates. If you really don’t like the process, then you should take this in consideration before committing long term to this investor.

Follow these tips when negotiating a term sheet:

Hire a good lawyer: Raise enough money to cover the legal fees and hire a solid firm with experience in your local VC ecosystem.
Know what to fight on: After years of negotiating contracts between VCs and companies a number of clauses have become standard practice. A good lawyer will redirect your focus to the clauses that are worth fighting over.
Keep it simple: A good contract is a contract for which both sides fully understand the impact at all times. Push back on clauses or on a deal that is hopelessly complex.

Clauses that are worth fighting over are the following:

Investment size: One of the important drivers of the deal and your future growth possibilities is the investment size.
Valuation: The valuation has a direct impact on your future upside. Don’t go overboard on trading valuation for a complex deal structure. You need to make sure that you and the investor remain fully aligned in the future.
Liquidation preference: In a non-seed deal, a liquidation preference of 1x non-participating should be achievable. This clause has a massive impact on your and your employees’ upside.
Founder vesting: There are multiple ways for VCs to protect themselves from a founder leaving. One of them is a buyback, which is certainly more attractive for you than reverse vesting.
Anti-dilution: A form of anti-dilution will certainly be included, but there is a big difference between full-ratchet or weighted-average. Push back on full-ratchet or limit the amount of the investment that is protected. Anti-dilution is directly linked to valuation. The harder you push on valuation, the harder the investor will push on anti-dilution.
Redemption rights: Fight back hard, as they can be a ticking time bomb for your business. If you do need to let them in, make sure the conditions give you enough time and try to restrict the amount.

The clauses that are probably non-negotiable are the following:

Right-of-first-refusal & Co-sale Rights: Make sure that the rights are drafted in a form that is aligned with the standard practices.
Pre-emptive rights & pro-rata rights: These rights might limit your ability to bring in other investors down the line.
Board governance: A good board is more than a fight for control between you and the investor. Structure your board well, get quality experience on board, and your board might become a valuable source of advice.
Voting rights: Understand the real impact of voting rights and why the investor wants to include them. Check with other portfolio companies to see what is included and how they are used. Here, an experienced lawyer can really add value.

BOOM! 💥 You’re ready to raise funding like a pro.

To go into more detail on one of the topics, check out the corresponding topic below: