How funding works: a 10-stage guide for start-up businesses

By Indeed Editorial Team

Published 11 July 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Securing funding for a start-up business may be challenging, especially if you don't know where to look. Fortunately, there are now many options available for you to gain capital. Learning the different types of funding can help you decide which is best for your start-up business. In this article, we define what a start-up business is, discuss how funding works and list ten methods that a new business can use to gain capital.

What is a start-up business?

If you want to understand how funding works, it's beneficial to know what a start-up is. A start-up business is a company in the first stages of operating. Entrepreneurs who want to develop and offer an in-demand product or service may start one. Some start-ups may only require minimum funding, whereas others start with high costs and limited capital. In this case, the company can turn to funding to help it gain access to the money required to start its operations.

Related: How much does it cost to start a business? (With details)

How funding works

Start-up funding looks at one particular aspect of the business: capital. This is the money that a start-up requires to operate and grow to generate income. It's important that business owners wanting to raise capital know what costs they require to start their business, how much they can generate once in operation and whether the target market is big enough for the business to become profitable. Owners estimate the value of the start-up by combining future revenues, potential profits and the costs of delivering the service.

This valuation dictates share prices and the level of investment required to generate the necessary capital.

Related: A guide to 18 great business ideas for new start-ups

The 10 most popular funding routes

The following are ten different methods that entrepreneurs can use to secure funding for their business:

Bootstrapping

Bootstrapping is a method of funding where all shareholders directly invest their own money to generate capital. There are no external investments, and all shareholders own 100% of the company. While bootstrapping is the choice for many start-up businesses, those who want to compete with established or venture-funded competitors directly may consider an alternative method.

Equity funding

Equity funding refers to a business that sells shares to raise capital. Investors buy a portion of the company in return for an agreed amount of profit or shareholder return. It's efficient if you're happy to share profits, losses and risks with investors. You can only secure equity funding if the start-up offers investors a high risk/high reward outcome.

Related: What are private equity funds? (Benefits explained)

Crowdfunding

Crowdfunding involves large numbers of people investing in a business in exchange for rewards. This usually happens on specific online platforms. It's a good option for product-based businesses. Crowdfunding is also a means of marketing due to the number of people that crowdfunding platforms reach. The first type of crowdfunding is 'donations', where those giving money don't expect anything in return. The second type is 'rewarded', where funders receive a service or reward for their money.

Government subsidies and grants

A government grant is a set amount of capital awarded to a business. This helps you with the start-up business while in its development stage. You don't require to repay this grant. Grant awards typically aim at advancing a specific project rather than helping start a business.

Debt financing

Debt financing involves using loans to fund a start-up. They provide the capital up front, with the business agreeing to pay this back to the investors with interest. This method is ideal for business owners who are confident in their business and happy to incur some debt until the business starts making money.

Pre-seed funding

The first step on the venture capital route is 'pre-seed' (or 'early seed'). Pre-seed occurs in the early stages of a start-up and doesn't require a company to have a proven business model or a working product. It does require a company to provide proven progress towards its goal and evidence that there is a market and demand for its product. Once proven, investors may take more significant risks, allowing the company to test its product and prove the market before completing that product.

Related: What is a venture capitalist? (With roles and examples)

Seed funding

Seed funding helps a start-up business move from product conception to implementation. It's the first investment you may receive. The investment is generally around £2 million, though this typically increases each year. Business owners use seed investments for working capital, marketing, business development or other growth needs.

Series A

You can secure Series A funding approximately 18 months after the closure of the seed rounds. It involves working with established investors to gain potentially higher amounts of capital. Reaching this stage is a major milestone for a start-up business. It indicates that the start-up has reached a certain level of product-market fit and demonstrates its ability to reach new customers through alternative channels.

Series B

Series B funding involves a company selling shares that don't give shareholders voting rights. Those shares come with a convertibility option, which means that the investors who buy the shares can choose to convert them into common stock at a later time. The main function of Series B funding is to provide a start-up with money for new hires and equipment. It also allows the company to develop a larger customer base and attract new business.

Series C

A start-up enters Series C funding with stable revenue streams and demonstrable growth history. By this stage, a company's customer base is solid and reliable. This source of funding is mainly for companies expanding their operating structure to reach a global audience or make the business appealing for acquisition.

Are there any other types of start-up funding?

Although the ten methods listed are the more popular, the following are some alternatives:

Small business grant

The government, local government or a company or individual may give a start-up a small business grant. This provides small businesses with a boost when starting. They often go to businesses that create jobs or work on projects that a more traditional lender, such as a bank, doesn't support. Grants are awards that require no repayment.

Related: 12 inexpensive marketing ideas for small businesses

Loan-based crowdfunding

Loan-based crowdfunding, or peer-to-peer lending, is a type of crowdfunding that involves people lending money to businesses. Similar to a bank loan, repayment of this loan comes with interest, though it offers more flexibility. There are other P2P options available, with some private companies offering large secured and unsecured loans to start-up businesses.

Investment-based crowdfunding

Investment-based crowdfunding offers people the chance to purchase equity or debt-based shares in a company. This allows a start-up to raise capital and turns those that have supported it into shareholders. This method is ideal for start-up businesses that aren't product-based or small companies that require raising large amounts of funding to expand. Investors receive equity in the company and are likely to invest more than a typical customer.

Family and friends

Family and friends can also help you raise capital for a start-up business. They may be flexible when it comes to repayment. Entrepreneurs take great care when borrowing money from family and friends. It's important only to ask for money from those who can afford to help you and are aware of the risks involved.

Angel investors

Angel investors invest in a start-up in its early stages. They're wealthy individuals who have successfully launched their businesses. Start-up business owners looking for investment from an angel investor usually pitch their ideas to an angel-investment network rather than approach an investor on a one-to-one basis.

Venture capital

A venture capitalist invests in a small start-up with high growth potential. Many successful start-up businesses have succeeded due to venture capitalists. This particular form of funding is rare and usually only possible for companies expanding quickly. Such companies may also have already received seed funding from angel investors.

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