Startup Fundraising, Part 1: Fundraising 101

January 9, 2023

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Fundraising is undoubtedly one of the most important stages of the startup life cycle. And yet, especially for early-career entrepreneurs, fundraising remains a major stumbling block.

With this in mind, we asked 2022 Future Founders Fellow Chris Cherian, founder and CEO of Gatherly.io and self-proclaimed fundraising nerd, to help us create a comprehensive guide designed to demystify the startup fundraising process for founders who are just beginning. 

Each month, we will publish a piece of Chris’s wisdom that breaks down a different aspect of the startup fundraising journey, step by step, from start to finish:

Part 1: Fundraising 101

Part 2: What is Venture Capital (and is it for me)?

Part 3: So VC isn’t for me. What about bootstrapping?

Part 4: How do I start raising?

Part 5: What will my raise look like?

Part 6: So I’ve raised. Now what?

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Part 1: Startup Fundraising 101

If you aren’t already a millionaire, launching a business can seem daunting. Without capital (money to invest in building up your business), your business can’t get off the ground.  If you don’t have the capital you need to start selling your product or service and setting your company up to grow, you need to find it elsewhere.

That’s where fundraising comes in.

If you need to raise funds to start your business and help it grow, chances are you’re working on a scalable startup.

• Scalable startup: an early-stage business that aims to become high-growth and high-profit; in order to grow as quickly as they want to, scalable startups require external funding (capital)

The good news is that, as an entrepreneur, you have options when it comes to raising:

• Bootstrapping/Bootstrap Financing: the process of financing a startup using only personal funding, operating revenue, and other non-investment means. This type of funding is considered non-dilutive since it doesn’t require the founder to give up any equity stake in their company. Types of non-dilutive funding include grants, pitch competition winnings, and more. Founders who bootstrap their companies rather than relying on outside investment may feel increased financial strain, but retain more control over their company as it grows.

• Angel Investors: high net worth individuals who invest their own money in an early-stage startup in exchange for ownership stake (equity) in the company. Typically, angel investors are more interested in helping startups get off the ground than possible profits they stand to make; as a result, the terms of angel investment deals tend to be more favorable than VC or other lending options.

• Venture Capital (VC): financing provided by private investors to startups, usually at an early stage of development. Typically, VC deals involve entrepreneurs selling ownership chunks (equity) of their startup in exchange for the funding (capital) they need to get started.

We’ll cover these fundraising methods in more detail in subsequent articles. For now, let’s take a look at some other concepts and lingo you’ll need to consider as you plan your raise:

Important Terms & Acronyms 

 

Pitch Deck

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Traction

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Burn Rate

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Runway

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Churn Rate

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CAC: Customer Acquisition Cost

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LTV: Lifetime Value

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Market Size (TAM, SAM, SOM):

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MMR: Monthly Recurring Revenue

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ARR: Annual Recurring Revenue

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SAFE: Simple Agreement for Future Equity

When raising a SAFE Note, your business is really raising a type of “convertible debt,” or debt that will eventually convert into equity. In other words, you are agreeing to give an investor equity in your company proportional to the amount of their investment at some point in the future. This conversion happens upon a “qualifying event”, which typically is a priced round/equity round (which is the direct sale of stock to an investor–more on that in subsequent articles) or an acquisition.

SAFEs are quick and low-cost ways of quickly financing a business. They typically require less due diligence and less time to execute, as the form is relatively standard (the Y-Combinator (YC) safe note is the most common template). There are a few terms to negotiate, however:

• Valuation Cap
  • When raising on SAFEs, you are not actually setting the valuation of the business, but rather a cap. The valuation cap is the highest price that the SAFE will convert on, not the actual value of your business.
  • If a business raises $500k at a $5M valuation cap (10%), and then proceeds to sell to an acquiring firm for $10M dollars, the investor’s SAFE note will convert into equity before the sale (the qualifying event) for 10% of the company’s shares, diluting the other shareholders.
  • This does not hold true if the business sells below the valuation cap, though. If that same business sells to an acquiring firm for $4M, the $500k SAFE note converts into equity at a $4M valuation, or 12.5% ownership stake, instead.

• Discount Rates
  • Some SAFEs provide discount rates as a perk to the investor. A discount rate is essentially a percent off coupon for the next financing round, rewarding early believers in your company for investing their money early. If a SAFE note provides a 10% discount and raises the next priced round at a $20M valuation, the investor is welcome to purchase shares in that round at an $18M valuation (10% off of $20M).

• MFN: Most Favored Nation Clause
  • A provision in your agreement with early investors that later investors will not receive better terms than they did. For example, if Investor A signs a SAFE note for a $200k investment at a $2M valuation cap with an MFN clause, and then the startup signs a $500k investment at a $1M valuation cap with Investor B, the startup is required to inform Investor A of the SAFE note signed with Investor B, and Investor A may request that their initial $200k investment be brought to a $1M valuation cap.
  • MFN clauses help startups attract early investors and demonstrate success to later, usually bigger and more established, investors down the road.

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Cap Table, or Capitalization Table

A spreadsheet or table that shows the equity capitalization of your business. In other words, your cap table shows a breakdown of your company’s equity ownership: who owns what percentage, and at what market value per share. The cap table is an essential tool for calculating and making decisions based on your company’s market value.

Sample Cap Table (Future Founders)

 

This is just the beginning.

This may seem like a lot (and it is!), but don’t worry. At Future Founders, we believe that entrepreneurship is for everyone. We’re dedicated to creating a world in which our businesses reflect our people, and in which opportunity, choice, and economic freedom are available to all. 

To that end, over the next few months, we’ll be digging more deeply into each step of the fundraising process with the goal of making it a bit less daunting and a bit more accessible. Good luck!