Properly balancing the equity capital in a startup or high growth venture can be complex…
Getting your startup funding is an essential skill for most tech startup founding teams. However fundraising is not always a predictable or regimented process.
1) Starting out - the "Friends and Family round"
There are a number of options that startups can use to source their initial round of funding – usually in the range $20k to $100k in exchange for 10% to 15% equity.
Friends and family – Startup funding often comes from the founders’ own resources (savings, credit cards, mortgages) or from close family and associates – the so-called friends and family round.
Seed or Angel funds – There are a number of Seed or Angel funds that will invest the initial capital in very early stage startups (often before the product or service has been fully defined). These types of funds may also provide business mentoring support or services such as accounting, legal support and so on.
Incubators – These groups offer a package of initial funding – from $25k to $100k – combined with the use of a co-working space, an entrepreneur-in-residence (usually a seasoned founder) and a network of mentors and advisors. Arrangements vary widely between providers.
2) Getting serious - Seed funding
Once a startup starts gaining traction – the product has been launched, initial customers acquired and revenues starting to be earned – it’s ready for its first round of fundraising from professional investors, the “Seed” round. This round is typically in the range of $500k to $2m in exchange for 10% to 20% equity. This round is intended to “light the fire” to ramp up sales, market the product more widely and gear up the technology and infrastructure for higher volumes.
There are a number of providers of Seed funding including Venture Capital funds (VCs), Angel funds, Corporate Venture funds (i.e. funds run by large corporates such as Telcos and Banks) and Family Offices. It’s possible that regional funds or even US funds may participate, particularly in conjunction with a local fund.
3) Ready for take-off – Series A funding
Once a startup reaches significant revenues ($2m +) and is looking to scale globally it may look to a Series A funding round. Series A refers to the first substantial institutional funding round, in the range $3m up to $15m for 10% to 15% equity. In addition to large local VC funds, offshore funds may also participate.
4) Further funding rounds
For startups attracting significant global interest and growing revenues quickly, further funding rounds (Series B, Series C) may be undertaken to transform the business from a local or regional player into one with a global presence. Funding at this level will often exceed $10m.
5) Crowd sourced equity funding
Crowd sourced equity funding (CSF) is a relatively new funding avenue. CSF allows startups to raise funding by issuing shares to a “crowd” of non-professional or retail investors via an equity crowdfunding platform. Legislation to enable CSF was enacted in Australia in early 2017 and contains the rules that govern who can access CSF, the amount that can be raised and the supporting regime.
CSF has been used by a range of startups from early pre-revenue stage to larger businesses seeking expansion funding. The amount raised has ranged from $100k to $2.5m for 10% to 15% equity. See our separate equity crowdfunding article for more information.
6) The concept of dilution
“Dilution” refers to the reduction in a shareholder’s ownership interest as further shares are issued to new shareholders.
- For example:
- Shareholder A holds 1,000 shares representing 10% of the shares in a company with 10,000 shares issued in total.
- The company issues an additional 1,500 shares to a new investor.
- After the issue of new shares, shareholder A has a % ownership of 1,000/(10,000+1,500) shares = 8.7%.
- Shareholder A’s ownership interest has been diluted to 8.7%.
This is particularly relevant to startup founders who initially have large shareholdings – as more shares are issued in each funding round the founder’s shareholdings become further diluted. In some cases, the founder’s interest can fall below 50%, where they may lose effective control of the business. Shareholder dilution therefore needs to be carefully managed at each funding round (see also our articles on Founders Shares and Startup Equity Capital).
“Bootstrapping” refers to funding a startup without external funding. Bootstrapping is achieved when a startup reaches profitability before its initial capital is used up, and then utilises its internally generated capital to fund its ongoing development and growth. Probably the most famous Australian example is Atlassian, which only raised external funding after 8 years in business.
For founders, bootstrapping is the most profitable strategy at exit (i.e. an IPO or Trade sale), as it avoids founder dilution and the overheads of external fundraising.The potential downside of bootstrapping is that growth may be comparatively slow, introducing the risk of being overtaken by a heavily funded competing business.
Fundraising is more art than science, and there are often no clear rights or wrongs. Startups need to carefully weigh up the pros and cons of introducing external funds at each step in their journey and make a call accordingly.
If your team requires more expertise around startup funding reach out to the seasoned team at Fullstack.
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Stuart Reynolds is the founder of Fullstack Advisory, an award-winning accounting firm for businesses leading the future. He is a 3rd generation accountant who specialises in tech companies, crypto and entrepreneurs.