Raising Funds For Your Startup: Venture Capital, Venture Debt & Non-Dilutive Funding

Often, startup funding rounds are covered by the media as though they’re major sporting events. Scroll through TechCrunch, and you’re assaulted with victorious, multimillion dollar funding announcements.

When you’re looking to secure funding for your own startup, that kind of hype can feel overwhelming. It’s a high stakes game—how are you supposed to get in on the action?

For one thing, not all funding has to come from venture capital (VC). First, let’s look at the lay of the land, so you know what your options are. Then, we can walk through the process of securing funding for your startup.

The types of funding available to your startup fall into three broad categories:

1. Equity funding: Investors pay now either for preferred stock in your company, or for the opportunity to buy stock later, after the business is valuated.
2. Venture debt: A financial institution lends you money in the long- or-short term, based on how much equity you raised during your last round.
3. Light funding: An investment company gives you a small loan with a quick turnaround. This is ideal if you have stable recurring revenue.

The three main forms of equity funding are priced fundraising rounds, convertible notes, and simple agreements for future equity (SAFEs).

In a priced round, you sell preferred stock in your company to investors in order to raise money. This method requires the most paperwork and preparation—your company must come to agreement with investors on the valuation of the Company before you can sell shares.. This valuation may include preparing models to determine the share price based on the accounting position of your company along with certain assumptions.

Compared to other options, it also gives investors the most control over your company. They may get voting rights or a board seat Institutions that invest in your company may take on a leadership role, liaising between you and smaller investors.

Priced funding rounds are a good choice if you have confident financial projections for your business, you can afford the paperwork and accounting involved, and you need to raise a large amount of capital.

When you issue a convertible note, you receive a short-term loan (secured or unsecured) from an investor in exchange for the chance to convert that debt to equity at a later date—typically, your company’s valuation prior to a priced funding round. Like any loan, this one comes with interest—usually 4% to 8%.

It’s like the investor is placing “dibs” on preferred stock in your company before you make a more public appeal for funding. Your lender is typically a seed investor or angel investor.

If your company fails before a note converts, the loan you received for it takes priority over equity shares, as well as most other debts you owe.

The main benefit of convertible notes is that you don’t need to go through the involved process of pricing the stock of your company your company before you can begin fundraising.

SAFEs function similarly to convertible notes, but they’re a recent invention—first created in 2013 by Y Combinator. Like convertible notes, SAFEs are a good choice if you have not yet determined a valuation for your company.

You could think of SAFEs as simplified versions of convertible notes. They’re five pages each, and the main negotiable item is the valuation cap; otherwise, they’re boilerplate.

Simplicity isn’t the only thing that’s attractive about SAFEs. Unlike with convertible notes, the money you receive for a SAFE isn’t debt—so it doesn’t accrue interest.

Once you complete a round of equity funding, you have the opportunity to fund your business with venture debt.

Venture debt is a loan from a financial institution, based on your most recent round of funding. Typically, you can expect to get about 30% of the value you raised in your last round of funding.

Your loan will come with a warrant that would grant the lender the right to purchase anywhere from 5% to 20% (typically) of the equity of your company. That’s because it’s a risky loan—venture debt comes with little collateral, and usually isn’t based on your cash flow. Your company is only as good as its last round of funding, so the lender is taking on significant risk.

Under this category fall the numerous small scale lenders that have popped up to help seed bootstrappers, individual creators, and other non-giant ventures. Major examples include Clearbanc, Earnest Capital, and Lighter Capital.

Benefits promised by these types of investors include:

Alternative funding models

Unlike with other options, you may not be required to provide shares of your business in exchange for funding. For instance, Clearbanc charges a flat fee to fund your company; and Earnest Capital makes money through a shared earnings agreement, in which they collect a portion of what founders earn.

Transparent funding

If you’re overwhelmed by the process of securing capital, light investors may simplify the process. Most of them promise transparent funding models with no hidden fees, and they’re open about how their funding works. It seems they want to reassure new founders who are just getting the hang of running their own startups.

Quick approval

At least some of these institutions use AI-based processes to filter applications and speed up funding. Rather than putting together a pitch deck and individually approaching investors, you could get approval in a number of days.

Light funding is a good choice if your capital needs are relatively low, and you’re just beginning to seed your venture.

A VC fund represents other investors called limited partners (LPs)—such as pension funds or universities. The LPs have signed on to make a lot of money over the life of the VC fund —typically seven to 10 years. In order to meet that demand, the VC needs to invest in startups that are wildly successful.

Since so many startups fail, the VC’s profits from a single successful company often cover the cost of other, bad investments. If a VC fund invests in you, they expect a clear exit strategy—an IPO, acquisition, or follow-on round where their shares are purchased—that will net them a big return.

• Big checks. VC funds are able to accommodate funding from as low as $250,000 and as high as $100 million or more.
• No repayment terms. You don’t need to pay back VC investments in your business. So, if things go bottom up, you’ll be stuck with less debt. [ I do not understand this bullet -- if the business goes under the debt is irrelevant. This gives the impression that there is personal debt or guarantees.
• Advice and Mentoring. Most VC funds have extensive experience with startups and can provide advice and insights to the leadership teams at the companies in which they invest. This “been there, done that’ experience can be invaluable to a startup.

• Limited industries. VCs focus on the industries they know are most likely to turn a profit. A fintech company, in their eyes, may be a good example. A chain of bakeries may not.
• High bar for entry. Your typical VC processes thousands of applications for funding per year. But during the fund’s entire lifetime, they may invest in no more than 30.
• Loss of control. Remember, the VC is buying shares in your company. If you agree to sell them 50% of your shares, they could end up with management control. Even if you sell them less, they may have a significant say in how your business is run.
• Experienced startups only, please. You can’t rely on VC funding to get your business off the ground. Initial capital will need to come from friends and family, or angel investors. You’ll need some kind of minimum viable product before VCs consider you, a good idea isn’t enough.

When it’s time to decide whether or not to approach an investor, ask yourself the following questions.

Does their philosophy match yours?

Some investors only invest in SaaS, or clean technology. Some have a mandate to invest in companies run by people underrepresented in their industry. Do they understand what you are trying to accomplish? Does your company fit the bill?

Are you at the right funding stage?

Maybe you’re entering your second round of funding, but that angel investor you’re considering has only ever placed bets on startups just getting off the ground. Or maybe it’s the other way around. Make sure your company is at the stage a potential investor is interested in funding.

How much capital do you need?

Your typical VC fund may only start writing checks at $250,000, and no lower. If you need less than that, you’d better go elsewhere. On the flipside, what’s the most that angel investor you’re considering has ever invested in a company? Make sure you fall within the right range, in terms of check size, for the company you’re considering.

Where are they based?

Some investors only invest in businesses local to their city, state, or country. Make sure you’re clear on these limits before approaching them.

Do they have conflicts of interest?

In some cases, an investor may already be funding one of your competitors. Or, if they’re an individual, they may sit on the board of a company whose market share you aim to take a bite out of. Do your research before you attempt an intro.

General tip: Warm intros are better than cold. If you can, try to approach potential investors with whom you already have a contact in common—preferably one who can introduce you.

Barring that specification, these are the main places to go and window shop investors for your startup.

LinkedIn is your best route of first approach. Search “partner” or “investor,” limiting results to once or twice removed on the shared connections chain.

AngelList is the first place to turn as you begin the search for an angel investor. Signal should be your next stop.

Twitter is gaining popularity as a networking platform among investors, especially in the age of covid. Check out Larry Kim’s list of 17 Venture Capital and Angel Investors to Follow on Twitter.

FoundersNest will play AI matchmaker, and try to find the investor whose visions and goals are the best fit for your business.

Product Hunt gets a lot of investor eyeballs, and it’s a great place to show off your product once development is far enough along.

Email is the best medium through which to introduce yourself to investors. And that email should be a double opt-in.

A double opt-in is an introduction in which someone in the investor’s network gives you the seal of approval—saying, essentially, you’re worth their time. To achieve this, reach out to a contact you and your potential investor have in common. It’s best if they’re a founder, like you—it lends more credibility than an intro from another investor or a lawyer. If you have multiple individuals to choose from, pick the one who is closest to the investor.

Then, send your contact an introduction email to forward. Send one introduction email for each of the investors you’re approaching—even if they belong to the same firm or sit on the same board.

In the event you’re turned down, do not ask the person you approached for a reference to another investor. You are unlikely to succeed and it makes you look desperate.

Brief is best—respect the time of the people you’re approaching.

Your subject line should be straightforward, something like: “Intro to INVESTOR at FIRM.”

Then, the structure of the email should roughly follow this template:

Intro, one or two sentences. Explain why you’ve chosen to approach this investor specifically. Flattery, within reason, is not a bad idea. Check out their LinkedIn for inspiration and the VC fund’s website for it’s successful investments .

Company description, two or three sentences. What is the value you offer? How are you shaking up your industry? How do you earn revenue?

Current stage and signoff, two or three sentences. Explain where you are in terms of funding, and what your short term goals are—how you are planning to use capital to help your business compete. Then politely sign off.

It isn’t rocket science—but focusing on brevity and clarity goes a long way towards having your introduction taken into consideration.

Learn more about how to pitch your idea to an investor