How Startup Funding Works (With Defintion and Stages)

By Indeed Editorial Team

Published May 23, 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.

The information era has created a fast growth in the number of startup companies. This pattern continues today, and startups may be a rewarding enterprise for the entrepreneurs who succeed in building them. Learning how startup funding works can help you understand the dynamics behind how startups get funding. In this article, we explain what a startup is, explore how startup funding works, discuss what the stages of startup funding are, and review tips for building a startup.

What is a startup?

A startup is a business that is in its development stage. One or more entrepreneurs establish it in response to a particular need for a product or service. Startups are high-cost, low-revenue enterprises, which force them to seek funding from external investors until they can generate a profit.

Related: Create a Startup Business (With Tips and Ideas)

How startup funding works

If you're interested in startups, you may wonder how startup funding works. Startup funds enable individuals or groups of individuals to obtain capital for their new business, allowing it to flourish. When investors contribute to the funding of a startup, they do so with the hope of receiving a higher return from the company in the long term. Depending on the amount invested in a business, an individual may also be able to make business choices that affect how the business operates.

Related: Working for a Startup (With Benefits and Drawbacks)

Eight startup funding stages

Here are the phases startups go through to obtain funding:

1. Pre-seed funding stage

This is the research stage of starting a business. Those involved in the startup address the following questions during the pre-seed stage:

  • Is the idea viable?

  • Has anyone ever tried the idea before?

  • How costly is the venture?

  • What kind of business model can be used?

  • How can it get started?

Oftentimes, the majority of company finance at this period comes from the founder or from their friends and family. A startup's entire worth at this stage might vary between $10,000 and $100,000.

Example: Elena has an idea for a new wheel-washing kit for automobiles. She does market research on comparable items, tests her own recipe to establish its performance, estimates the expenses of manufacturing her product, and chooses a business strategy.

Related: What Is a Corporate Job? Corporate vs. Startup

2. Seed funding stage

At this stage, the entrepreneur's concept has developed into a functioning company with some client traction. Entrepreneurs in this stage exchange firm shares for higher sums of cash from investors. Seed funding covers the following costs:

  • Product launch

  • Product marketing

  • New employees

  • Market research on product-market-fit

Startups valued anywhere from $100,000 to $6 million are eligible for this phase of fundraising.

Example: During seed funding, Elena receives input to determine her final products and targeted customer demographics. She also hires three new employees.

3. Series A funding

The Series A fundraising stage initiates venture capitalist involvement, with the business issuing shares in return for funds. This is the time at which the entrepreneur may begin preparing the firm for future development. This includes the following:

  • Optimizing the business

  • Offsetting financial losses or shortfalls

  • Further developing the product or service

  • Creating a scalable blueprint for growth

Example: Elena has demonstrated that her product is an excellent concept. Now she wants to persuade investors that she has a strong plan for future development. She chooses to venture into a new market and start selling to huge stores. The more she proves the potential to earn revenue, the more funding she may acquire.

4. Series B funding

At this level, startups typically have established a loyal user base and income sources. The entrepreneur has shown their ability to scale their idea at this phase. Investors now have the confidence to aid them in the following ways:

  • Employ advanced market reach activities

  • Increase market share

  • Form operational teams such as business development and marketing

Example: Elena uses this round of investments to open two new departments at her company, which are public relations and diversity and inclusion.

5. Series C funding

Series C funding is for a company well on its growth path and often interested in expanding globally. It may be easier to find investors at this stage, as they trust the startup to succeed. Funds at this phase are used to do the following:

  • Build new products

  • Reach new markets

  • Acquire underperforming startups in the same industry

Example: Elena received Series C cash. She begins the development of a product to clean car windshields and starts shipping her original product overseas.

6. Series D funding and beyond

There are usually two reasons a startup goes past the Series C funding round. They are:

New opportunities: A potentially lucrative opportunity appears that requires the company to act before the Initial Public Offering (IPO).

Subpar performance: The startup misses the goals set during the Series C round of funding. It then raises more funds in the Series D round to address the issues.

There is no limit to how many funding rounds a startup can go through. If a company has more advanced revenue goals, it may complete as many fundraising series as necessary.

Example: Elena intended to go public with her company in early December. But, in November, a rival in her sector was up for sale. Rather than going with the IPO, she chooses to obtain Series D funding to acquire the competition.

Related: What Is Organization Hierarchy? (With Definition and Types)

7. Mezzanine funding and bridge loans

These loans are for companies that are at least $100 million in size. For lenders, a mezzanine loan combines debt and equity, while bridge loans are for short-term funding. They bridge the financial divide between this period and the first public offering. The cash might purchase another company's management or acquire a rival. Loans are generally six to twelve months in duration and the entrepreneur can repay them with profits from the IPO.

Example: Elena's goal is to issue an IPO for her company. It's vital for her to create her product on a larger scale before an IPO is feasible. She takes out a bridge loan to buy a competitor, which increases her market share.

8. IPO

An initial public offering (IPO) is the pinnacle of startup success. It happens when the company's shares are available to the public for the first time. The initial public offering is used to raise funding for future expansion or to enable business founders to sell out their remaining shares for personal gain. Important events occur in preparation to issue an IPO. They are:

  • Formation of a public offering team comprised of SEC experts, lawyers, accountants, and underwriters

  • Compilation of the startup's information, such as financials and anticipated future operations

  • Preparation of an audit of the company's financial statements

  • Completion of the governmental IPO requirements, which include filing the startup prospectus with the SEC and formalizing the offering date

Example: Elena is ready for her hard work to pay off. She uses an IPO to sell her shares in the company, amassing her a great deal of wealth.

Tips for building a successful startup business

Here are some tips that can help a startup business be effective:

Develop a solid business strategy

The founder can create a business strategy for the company that takes into account all aspects of the venture. The business plan might contain both short- and long-term objectives, such as what it wants to achieve and how it wants to do it, and also long-term objectives, such as how they intend to expand the organization. By developing a business plan prior to launching the company, the entrepreneur can guarantee that they're ready for any unanticipated events that may occur once the company launches.

Be unique

It's vital for the entrepreneur to consider the mission of the startup. It might be beneficial to establish the firm on a novel concept that is not over-saturated in the industry they want to join. This is because launching a company in an industry with a low concentration of existing businesses may help the startup distinguish itself. Being unique also enables the company to provide items and services that people may be really interested in but may have never heard about.

Establish a broad network

The entrepreneur can begin networking by contacting other professionals in the sector. Having a strong network of industry specialists enables them to contact individuals for industry-related enquiries and to collaborate with them once the company is operational. Additionally, they may utilize networking to build a consumer base for the business.

Maintain complete records of all business and operational activities

It's important to maintain meticulous records of the startup's growth and operations. Having documentation of all activities and business decisions might aid in monitoring the growth of the company. Additionally, it may help in identifying sections of the company plan that may need change and direct it to the appropriate actions to address any obstacles.

Explore more articles