One of the biggest obstacles to launching a tech company is securing funding. About 33 percent of startups begin with less than $5,000 in capital—under half the amount required to succeed.
Before launching your tech venture, it's crucial to understand how to raise capital and the challenges you'll likely encounter. Here's an overview of the startup financing process and five strategies for securing funding.
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Before raising money for your startup, you must know what funding could look like throughout its lifespan.
Your business may go through several funding stages as it evolves and grows, including:
- Pre-seed funding: Initial capital that covers expenses before formal seed funding. It often comes from sources like personal savings, friends, and family, without giving up equity in return.
- Seed funding: The first formal round of funding that primarily supports costs related to market research, recruiting staff, and developing products or services.
- Series A: The second round of funding, often reserved for when your company has a strong business model and demonstrated progress and growth but still has modest revenue.
- Series B: Funding typically supplied when your company is well established and progressed past the development stage with a solid user base. Investments at this point are intended to scale your business quickly and effectively.
- Series C: Provided when your business has tens of millions of dollars in potential revenue and can grow through product launches, acquisitions, and market expansion.
Obtaining seed funding is immensely challenging, let alone progressing to series A, B, and C. To navigate the financing process effectively, you must understand the different types of capital.
Types of Startup Funding
Before asking for funding, it's crucial to know the different types and how to use them.
“Raising startup capital is more of a science than an art,” says Harvard Business School Senior Lecturer Jeffery Bussgang in the online course Launching Tech Ventures. “There’s a well-defined checklist that investors are looking for—and that founders need to be aware of—to achieve more predictable outcomes during the fundraising process.”
Here's an overview of the most common types of funding your startup can receive.
Venture Capital
A venture capital (VC) firm supports and helps promising startups gain traction in return for equity. Such firms often play active roles in the companies they back to help them grow and succeed—providing capital, expertise, mentorship, and industry connections.
VC firms have four primary roles:
- General partners decide which investment opportunities to pursue and sit on company boards.
- Principals train to become general partners and support existing ones.
- Associates support general partners and principals but don’t have the authority to make investment decisions.
- Entrepreneurs in residence are typically past or future startup CEOs who have a rapport with the firm and provide expertise in exchange for funding.
“To truly understand the motivations behind VC firms, remember that they’re professional investors,” Bussgang says in Launching Tech Ventures. “They’re accountable to their investors—called limited partners, or LPs—such as university endowments, pension funds, or wealthy families. Their objective is to generate the maximum return for their LPs, and they have a dual fiduciary duty to their investors and to the company.”
Bootstrapping
Another common form of business financing is bootstrapping, in which your income directly correlates with your company's success. This method limits your salary—as well as your co-founders’ and staff’s—to the amount generated through customer revenue.
“This is an ideal model if you can develop a product or service without a large amount of investment in time and capital and, ideally, if you can charge customers upfront,” Bussgang says in Launching Tech Ventures.
Bootstrapping isn't for everyone. Since only 40 percent of startups are profitable, it could mean that you and your employees don’t get paid consistently. If you plan to finance your company using this method, ensure you have sufficient savings to mitigate risk.
Friends and Family
A common way to obtain pre-seed and seed funding is through friends and family. Approximately 10 percent of entrepreneurs receive this type of support, and it’s a good way to obtain financing quickly and easily.
Family and friends often have lower expectations for returning their investment and are likelier to let you run the business without pressuring you for results or updates.
However, it's a good idea to treat them like other investors and record loan terms in legal contracts. Check with an attorney before accepting these types of investments—even an informal loan can provide shareholder voting rights on the approval of major corporate actions.
Angel Investors
Funding can also come from angel investors—wealthy individuals who invest their own money. For example, if your startup promotes a cause an investor believes in, they might finance it for emotional reasons without expecting much in return, even if it comes with high risk.
“They typically invest for emotional as well as rational reasons,” Bussgang says in Launching Tech Ventures. “They want to be helpful and supportive but also want to make money.”
Most investors won’t risk more than 10 percent of their entire portfolios. If you’re considering financing through angel investors, ensure you know how much ownership and involvement they want.
Incubators and Accelerators
Incubators and accelerators are similar in that they're specifically designed to help startups grow and succeed.
- Startup accelerators enable you to learn, receive guidance and mentorship, and access resources that aid your business in its early stages.
- Startup incubators help you develop and refine ideas for your potential startup.
“Both are usually quite selective in who they allow into their programs and then typically take a percentage of ownership—often five to 10 percent—in exchange for their services and modest capital,” Bussgang says in Launching Tech Ventures.
Other Funding Options
Alternative forms of obtaining the capital to start your business include:
- Self-funding: Covering expenses out of pocket
- Crowdfunding: Leveraging an existing fan base or platforms such as Kickstarter or Indiegogo to finance your endeavors
- Small-business loan: Requesting a loan from a bank or credit union
Each has benefits and drawbacks. It’s vital to research which funding sources best meet your business’s needs.
5 Strategies for Securing Startup Funding
Understanding funding sources is vital but won't benefit you unless you present a strong case for financing your venture. Here are five strategies to increase your chances of attracting investors.
1. Build a Strong Team
The team you build is vital to whether you succeed or fail. For this reason, ensure yours has a strong founder-market fit.
“Founders with strong founder-market fit identify closely with their users and often have an ‘earned secret’—a unique insight into a problem that very few others have discovered,” Bussgang says in Launching Tech Ventures. “Investors love to work with founders well positioned to exploit earned secrets—particularly founders who continue to test and validate all aspects of their business model.”
Strive to boost your team’s performance by:
- Delegating
- Including colleagues in decision-making
- Avoiding micromanaging
- Communicating effectively
- Giving and soliciting feedback
Building a strong team will go a long way toward boosting investors' confidence in your business.
2. Pursue a Massive Market Opportunity
Most investors don't focus on making slightly more money than they spend but rather on getting a large return.
According to Launching Tech Ventures, VC firms aim to make 10 to 100 times the amount they invest, hoping the entrepreneur will ultimately sell the company or take it public. It's important to pursue a massive market opportunity—a total addressable market (TAM) and serviceable addressable market (SAM)—measured in billions.
In the course, Bussgang defines the total addressable market as “the size of the market available to the company based on a simple equation: total number of possible customers times the amount of money they’ll pay you each year.” SAM is a subset of TAM that Bussgang says “forces you to think critically about what portion of the total number of target customers you could reasonably serve.”
While this may sound intimidating, many VC firms that invest in your company will provide support and mentorship.
3. Strategically Plan Financing
Your goal shouldn't be to raise as much capital as possible at any cost—make it a point to involve an element of strategy. During the financing process, try to secure just enough to move into the next valuation inflection point—when your company’s valuation reaches the next milestone.
“There’s a typical rule of thumb that you should avoid selling more than 20 percent of your company in any single round of financing,” Bussgang says in Launching Tech Ventures. “That rule isn’t precise. Perhaps you might push it to 25 percent, or even 30 percent in some cases, if you’re really keen on the money and the financial partner. But, generally, this ‘rule of 20’ holds.”
4. Effectively Communicate with Investors
When pitching to investors, keep in mind that they're not just looking for projected numbers; they also want to understand your business goals. It’s crucial to communicate your vision, ambition, and strategy execution plan.
Doing so can help build confidence in your business and convince prospective investors that you won't abandon ship at the first sign of trouble.
5. Generate Competitive Tension with Multiple Investors
If you're fortunate enough to attract multiple investors, you can create competitive tension to negotiate the best possible deal. Competitive tension occurs when two or more investors know they're not the only party interested in backing your business. As a result, they may offer better terms to increase the chances you’ll accept.
For example, on the popular investment show Shark Tank, successful pitches often result in multiple investors creating compelling offers. The entrepreneur can then select which offer, if any, would be best for their company.
Avoid becoming greedy in these situations. If a potential investor knows their offer is superior—and the other investor isn't willing to negotiate—they may revise it to be better than the alternative but less than what they initially presented.
If an investor you can work well with offers a good deal, then creating competitive tension may be unnecessary.
Ready to Turn Your Idea into a Business?
Securing funding is critical to launching your tech venture but involves much more than raising capital. You must also find product-market fit, develop a go-to-market strategy, and navigate the startup landscape’s complexities.
One way to prepare is by taking an online course, such as Launching Tech Ventures. Doing so can enable you to learn from industry experts’ real-world experiences and gain the tools needed to lead your company to success.
Ready to become a tech entrepreneur? Enroll in Launching Tech Ventures—one of our entrepreneurship and innovation courses—and download our e-book about getting started on your entrepreneurial journey.
