In the ever-evolving landscape of startup funding, is a brilliant business idea alone enough to secure financing? Today, founders have a multitude of funding options to explore, but not all paths are equal. What should early-stage businesses keep in mind?
Let's get straight to the point: Startups require capital to grow. Initially, they don't generate revenue or profits – just ideas. To transform these ideas into scalable businesses, startups need a consistent flow of funding from internal or external sources, with equity or debt.
During this funding journey, founders encounter different options and considerations that hinge on factors like their product, funding stage, market, personal preferences, and target audience.
Before diving into funding, founders must address key questions:
- Which kind of funding is the right one for my startup?
- What is the source of the capital?
- At what stage/phase do I need funding?
- How quickly do I need financing?
- How much cash do I need?
- Do I want to sell or keep shares in the company?
- What should I pay attention to when preparing for talks with investors?
This article will tackle all these aspects, providing a clear roadmap for a startup’s funding journey.
Types of startup funding
When launching a startup, founders handle multiple responsibilities simultaneously, including creating a business plan, product development, customer engagement, website setup, and of course, securing funding.
To finance its business, startups have several options. Let’s take a look at those different types of funding for startups.
Bootstrapping, self-financing or internal funding: Control and slower growth
Bootstrapping entails funding your startup using its funds and profits – no external investments. Founders consciously bypass external funding sources, maintaining full control over their business.
While this approach is viable at any startup phase, it comes with some crucial considerations:
- They must minimize costs and strictly adhere to their budget
- The goal is to enter the operational business and generate revenues as quickly as possible
- They should break even as early as possible and generate a positive cash flow
Through self-financing and the renunciation of external investors, founders retain full control over their startups. They do not give away any shares, have no obligations as debtors to a bank or lender, and build their company without compromise according to their ideas.
However, bootstrapped companies usually grow slowly. It can put them at a disadvantage compared to VC-backed competitors. Besides growing faster, they can also access the network and expertise of their investors.
Family & Friends: Investors from your social circle
Many startups opt to secure initial funding from family and friends. This approach offers several advantages:
- The capital is available under favorable conditions
- Repayment is more flexible than with professional investors
Startups often receive money as an (interest-free) loan or as equity investment. The financing amount is comparatively small and can range between €5,000 and €20,000.
Accelerator: Boost your growth
Accelerator programs provide early-stage startups with funding, infrastructure (offices, hardware), networking opportunities, expertise, and coaching. These programs are designed to span months, not years.
As the term suggests, an accelerator accelerates a startup's business. To participate in such programs, the idea should already have taken concrete shape, and the company should be founded. With the help of an accelerator, the startup develops a functioning business model and boosts its growth.
In exchange for shares, startups receive funding ranging from €20,000 to €100,000.
Well-known accelerator programs are:
- Pro 7/Sat. 1 Accelerator
- German Accelerator
- Airbus Bizlab Accelerator
- APX by Axel Springer and Porsche
- DB Mindbox
- Founder Institute
Incubator: Nurturing startup growth
Incubators support startups in developing business ideas, business models, infrastructure, networks, expertise, and funding. Incubator programs prioritize long-term collaboration between investors and startups, often from six months to five years. In return for shares and decision-making rights, incubators assist young companies in establishing a foothold in the market.
Many incubators specialize in specific business areas. Before opting for an incubator, founders should discover which program is most suitable for their idea.
Well-known incubator programs in Germany are:
- Greenhouse Innovation Lab from Gruner + Jahr and RTL
- Hubraum from Deutsche Telekom
- Main Incubator from Commerzbank
- 1st Mover
Company builder: Startup funding from scratch
Company builders specialize in founding and developing startups, often originating their business ideas. They play an active role in the company's operations, handling core elements such as development, marketing, and scaling.
In addition to funding, company builders provide experienced management and specialized teams, making them unique in the startup funding landscape.
Well-known company builders in Germany, some of which are no longer active, were and are:
- Rocket Internet
- HitFox Group
- Next Big Thing
Business Angels: Access to network and know-how
Business angels are private individuals who invest in early-stage companies (pre-seed or seed phase), with sums ranging between €10,000 and €500,000.
Business angels are often founders, entrepreneurs, or managers experienced in building and scaling companies. Their network and the experiences they bring to the table are as important as their investment.
Through their contacts with other investors, business angels often act as a link between the different funding phases. These connections can be relevant for the startup at a later stage, for example, in preparation for their first Series A.
Venture capital: Large tickets and loss of control
Venture capital (VC) is one of the best-known forms of startup business funding. In 2022, VCs worldwide invested more than $500 billion in startups, early-stage and growth companies.
Venture capital firms invest equity in startups, which they collect in advance from institutional investors, family offices, or companies. Through their investment, they participate in the venture capital fund. This approach offers high return potential but involves substantial risk.
Financing sums range from €100,000 to several hundred million euros. In return, VCs receive company shares, co-determination, information, and control rights. With VCs, founders often relinquish a great deal of control over their own company, facing a high cost of capital in the event of an IPO or exit.
After a certain period (usually up to ten years), the VC wants his exit, i.e., sell the investment at a profit. In 2022, the average expected return of German venture capital firms for early-stage investments was 36%.
Startups can access venture capital in different company phases. Usually, it comes into play from the seed phase onwards to finance further growth.
Well-known VCs are:
- Sequoia Capital
- Andreessen Horowitz
- Insight Partners
- Tiger Global Capital
Venture debt: Large funding, high capital costs
Venture debt is another form of startup funding that young businesses use primarily to finance growth in later phases. It is usually granted as a risk loan and is used shortly after or at the same time as financing with venture capital.
With venture debt, startups secure debt between two rounds of equity funding. In this way, they remain liquid and have to deal with less dilution of their shares. Funding amounts range from €100,000 to high double-digit millions.
Funding with venture debt is associated with high costs. Direct costs result from upfront payments after the venture debt contract is closed and interest payments (between 10 and 20%) over a certain period.
In addition, there are indirect costs, such as warrants, guaranteeing the venture debt investor the right to purchase shares in the company at a later stage. It also ensures that founders have less control over their company.
Since startups take on debt, which they must pay back – regardless of the company's economic development – they should evaluate this form of business funding carefully in advance.
Alternative debt funding: Tailor-made and non-dilutive
Recent years have witnessed the emergence of alternative debt funding solutions for startups and growth companies. These solutions rely on data-driven risk analysis and automated processes, offering funding ranging from €100,000 to several million euros. Fintechs have specialized in this. re:cap also offers this type of funding.
Alternative debt funding focuses on the actual capital needs of the company and can be tailor-made to a company's business goals. The objective is to meet the capital needs at the ideal time for the company on a monthly or even daily basis.
Alternative debt funding offers various advantages:
- Startups secure the cash they need, and that fits their business plan
- No dilution of company shares
- Startups can agree on flexible repayment terms
- Funding does not include warrants or equity kickers
- Funding can be tailored to a specific time, allowing startups to avoid unnecessary capital costs due to overfunding
Revenue Based Financing & Recurring Revenue Financing
RBF is a non-dilutive form of funding based on a company's revenues. It is interesting for startups with recurring revenues that want to finance their growth. With revenue-based financing, investors receive a predefined monthly percentage of the company's revenue in return for their investment.
Recurring Revenue Financing
With RRF, the financing amount and interest are based on the amount of recurring revenue and remain the same over the entire period. Startups usually receive capital only up to a financing limit, which depends on the annual recurring revenues.
Convertible loans: Quick solution for existing investors
With a convertible loan, startups receive debt capital as a loan. In return, the investor can convert the loan into company shares in the next funding round. In addition, monthly interest payments may be due.
Convertible loans are particularly interesting for young companies with existing investors. The existing investors know the business model and the company. This contributes to faster processing. In addition, the administrative burden is low: a convertible loan does not require notarization.
Crowdfunding: Funding from the crowd
Crowdfunding, equity-based crowdfunding, crowdlending: Startups can raise money with the support of many individual investors.
In crowdfunding, many people give small amounts and thus finance the idea of a company. The unique feature: The exchange between investors and entrepreneurs happens directly on a platform. No banks, institutional investors, or capital funds are involved.
There are usually three methods to finance a startup with the help of the crowd:
The focus is not on the investors' profit but on implementing an idea or a product. In return, the participants receive the final product, which the company has realized with the collected capital.
The investment character is much more present here. Many individuals finance the project of a startup with small amounts (often from €100). In return, they receive a predefined percentage of their investment. There are no rights of co-determination or control.
With this form of financing, people grant a loan to a startup in small amounts. The startup repays the loan, including interest, within an agreed term.
Bank loan: Suitable for established companies, not necessarily for startups
Bank loans are the most common form of financing for established companies. They receive debt from their bank, which they pay back at a fixed interest rate over a certain period. The bank has no co-determination or control rights.
Due to the predefined conditions and fixed repayment agreements, a bank loan is a type of funding that can be planned well.
However, a loan is not an option for most startups to fund their business. It is because banks are risk-averse. They require a profitable and proven business model, steady revenues, and tangible assets such as real estate or machinery - things that tech startups usually cannot offer yet.
Therefore, a bank loan is only relevant for a few startups. If it is, a detailed business and financing plan and a certain amount of securities in the form of equity, real estate, or machinery is necessary.
Development loans: Access to public funding
Startups can obtain debt funding also from federal organizations. Those are promotional loans with favorable conditions and simplified access for young companies.
The KfW, for example, grants startup and promotional loans to early-stage companies and small and medium-sized enterprises. The amounts range from €125,000 to €25 million. KfW grants loans in cooperation with the startup's bank and assumes a large part of the credit risk or enables startup funding without equity capital.
Startup business funding through federal organizations is popular: in 2022, almost 47% of German startups used this form of financing.
Startup competitions: Get feedback and expand your network
At startup or founder competitions, young companies pitch their business idea to a jury of experts. The prize money is usually between €10,000 and 50,000.
Those competitions are particularly suitable for startup funding at a very early stage. At least as important as the money is the feedback from a jury of experts on the business idea and business plan, as well as access to a broad public and potential investors. All of this can become relevant for future financing rounds.
Politics and business often initiate startup competitions. They help to simplify the founding process. Competitions are held for startups in various business phases and industries.
University Programs: Founding while studying
It's a well-known story that many founders like to tell: We met at university and founded a startup. Universities and colleges are an ideal environment to work on ideas with others and take the first steps toward founding. It is why universities offer various programs and startup scholarships to help founders get started.
A university grant for startups usually does not provide capital but support (such as living expenses) so founders can fully concentrate on their idea. In addition, universities provide their know-how, coaching, technical equipment, laboratories, or office spaces.
Students with a business idea gain time and resources to develop a viable product, prototype, or business plan.
How do I find the funding that suits my startup?
The multitude of startup funding options can be overwhelming. To navigate this landscape effectively, early-stage companies must consider several criteria and align their choice with their current phase and goals. Relevant questions to ask include:
- What type of capital does the funding offer me, and what additional support will it give me?
- In which phase am I, and which financing is the right one in this phase?
Our overview provides some indications of how individual forms of funding can be classified.
But not every instrument is suitable in every phase: an early-stage company that generates revenues and is growing has a greater capital needs than Family & Friends can provide.
While early, growth and later stages provide a general framework for startups, they are not rigid categories. Instead, they offer broad guidance. Startups often self-determine their phase and funding requirements:
The early stage of a company can be divided into stealth mode, pre-seed, and seed. However, there are no sharp lines between these stages. Rather, a startup determines on its own in which phase it is or whether this classification makes sense at all.
Stealth Mode: Preparing in secret
Stealth mode describes the pre-founding phase. The founders work on their project in secret. They have an idea for a product or service. They develop a business plan, the preparation for the startup, and the planning of the organization begins.
Pre-Seed and Seed: Concrete Planning and First Successes
The pre-seed and seed phase includes company founding, market launch, initial sales activities, and hiring. This phase can last up to three years and includes a first round of funding.
These phases are usually capital-intensive. The startup generates only small revenues, and at the same time, the product must be developed further, and people need to be hired. The money for these investments usually comes from the founders' own funds, grants, family & friends, venture capital, or business angels.
After the successful launch of the startup, the main focus is on creating rapid market penetration and scaling the business model. The startup develops into a scaleup. In this phase, many startups struggle with growth pains. At the same time, the focus is on building marketing and sales activities.
Growth in the startup context often means burning a lot of cash (cash burn). Therefore, this phase can also be very capital-intensive.
Capital-intensive phase and more diverse capital structure
However, the mantra of "growth at all costs" no longer applies to all startups. Many—due to a changed funding environment—are taking the path towards profitability earlier. Working efficiently with the available capital has become crucial, especially when approaching new investors.
The growth phase can last several years and is characterized by ever-new funding rounds - such as Series A, B, and C. Again, there is no strict separation. In addition to equity funding, alternative financial instruments based on debt capital are increasingly appearing in the growth stage. The startup sets up its capital structure more diversely.
In the Later Stage, the startup has been successfully operating for several years. In many cases, the term startup no longer seems appropriate, as these are rather large companies with several hundred employees and fixed structures.
A startup comes of age
In this phase, this company has stable sales, has asserted itself against the competition, and has perhaps even reached break-even or acquired competitors.
Now it is time to further professionalize the company structures and push ahead with expansion. The step to the stock exchange can make sense here. The capital raised with an IPO can be used for restructuring, further diversification of its products, and entry into new markets.
For which funding phase is which form of financing suitable?
Early, Growth and Later Stages are rough guidelines for startups—no more and no less. Only a few startups can be planned linearly, and end in a successful IPO.
Rather, startups must react flexibly to the funding of the individual phases and evaluate exactly which instrument is the right one.
After all, whether a startup is financed internally or externally, with its funds, with debt or equity: at a certain point, it must ask itself which funding case it wants to be and what best fits its ideas and visions. A venture-backed company must meet different external growth expectations than a bootstrapped startup.
That question about funding is closely related to whether the startup:
- Gives up company shares,
- retains company shares,
- takes advantage of a grant,
- takes a loan, or
- aims for a funding case with different financing instruments.
There are advantages and disadvantages for each case. Founders must assess in advance whether building their business is more capital-intensive or it is not.
For example, if a company is active in a market with a lot of competition, it must spend more time on product development to differentiate from other startups. In that case, it may make sense to sell shares in the company to finance this product development with a larger sum of equity.
How to prepare for a startup funding round
Before any startup business funding, there are several tasks that the startup must complete. Whether funding or starting a business: It all starts with the business plan.
It all begins with the business plan
Whether a startup wants to finance itself internally or externally, the business plan is mandatory. It not only must convince investors, banks, and other capital providers. The business plan also helps founders to position their ideas within an entrepreneurial concept and the economic environment.
A business plan includes:
- The Executive Summary
- Information about the business model and the idea
- Information about the founders
- A market and competition analysis
- Information on marketing and sales
- Product development planning
- Information on personnel planning
- A SWOT analysis
- The financial plan
The finance plan is the heart of the business plan
The finance plan is the core component of a business plan. It answers the question of how much money a startup needs.
Therein, the founders explain based on estimates and projections:
- How much capital their startup will need to cover all costs.
- How much their startup can expect to earn with their business idea.
The financial plan gives investors and banks an indication of whether an investment is worthwhile and whether they will get their money back (including return or interest).
The pitch deck contains the most important information
When startups present their idea to investors, they "pitch" their business model. This presentation is called a pitch—and it requires a pitch deck.
A pitch deck is based on the most important facts and information about the business model. Information that does not help explain the idea is unnecessary. The pitch shows potential investors what the product and the market environment offer, ideally backed up with figures.
The deck names the problem and the corresponding solution provided by the startup. It also shows its unique selling proposition (USP) and if there are already competitors. The pitch deck should make investing " tasty" for investors and show them which opportunity they might miss.
Addressing investors and elevator pitch
The approach to investors is closely related to the pitch deck. Before approaching investors, founders need to be clear about what they want:
- Are the founders risk-averse or risk-averse?
- Do they want to face the pressure of VC funding?
- Do they want the company to grow quickly or slowly?
A realistic self-assessment of which type of founder you are helps here.
In the end, this also determines how founders approach investors. After all, discussions with a venture capital fund differ from those with a family office or a business angel. For banks, on the other hand, different things are more relevant than for public investors.
When talking to investors, the founders must be able to condense the most crucial points and communicate them in just a few minutes. It is called an elevator pitch. The elevator pitch summarizes the business and financial plan and the pitch deck.
Company valuation: How many shares do I sell?
Whether pre- or post-money valuation, venture capital method, or discounted cash flow: part of the preparation for any external startup funding with venture capital is that startups think about their company valuation.
This involves determining the amount of funding needed based on the financial plan and the number of shares to be offered in return. Realistic valuations are crucial for investor discussions, as setting the value too high can scare off investors, while undervaluing the company may result in excessive share dilution.
The following factors influence the valuation and give startups initial pointers:
- Founder's reputation: Have they already shown they can build a startup?
- An experienced team that knows the target market and the business environment
- First sales successes
- The potential to expand into other markets
- The USP of the product and the business potential that comes with it
Startup business funding is complex, but yet essential
Securing funding for a startup is a complex yet essential journey. Beyond business development, the availability of capital is paramount to its growth and success. With multiple financing options at their disposal, the path founders choose should align with their business model, market environment, and personal aspirations and objectives.
At the same time, external factors, such as a weakening VC business or an expensive interest rate environment, can also play a part. Startups have little influence on these.
What remains is that startups should think carefully about which path they take regarding their funding. Whether with debt or equity, alternative or traditional instruments: Funding decisions can have long-term effects. The founding team should evaluate these carefully.