How to Raise Capital for Your Startup

If you’re like most founders, you’ve likely invested countless hours of your time and effort into your startup. But sometimes, your blood, sweat, and tears aren’t enough to keep your business running. 

As much as 38 percent of startups fail due to a lack of cash flow and outside investment. Though not every business needs extra money, you should know how to raise capital for your startup during hard times. 

Sometimes, a small cash injection is necessary if your startup needs to:

• Maintain cash flow to keep running during a dip in profits.
• Expand quickly to compete with other businesses for market share.
• Acquire another business or assets to accelerate growth or profits.

However, if you’re not one of the fortunate founders with connections in private equity (PE), you need to learn how to raise capital from investors and convince them your vision is worth something.

We’ve raised multiple rounds from venture capitalists (VCs) and angel investors alike. We want to help you understand what you need to know about fundraising for your startup and what to do when fundraising doesn’t work.

Should Your Startup Raise Funds Through Equity or Debt?

When most people hear the phrase “raising capital” they usually think of equity raising, where you sell shares of your business to investors in return for cash. When investors buy equity, they bet on your company’s success in the hopes that its share price will rise in value.

Common ways founders raise equity capital:

• Private equity (PE)
• Venture capital (VC)
• Family and friends rounds
• Crowdfunding
• Angel investment

The other way businesses raise capital is by selling debt. When raising debt capital, you take out a loan and repay it with interest over a predetermined period. When raising debt, your debtors are betting on your ability to repay the loan, which relies more on historical performance and consistency, not your growth ambitions.

Some ways business owners raise debt include:

• Business loans
• Credit cards
• SBA loans

Because startups usually have little past performance and are in niche tech fields, raising debt is generally less viable. Local bank managers may lend to a shop in town, but an obscure plugin or API? Perhaps not. Most small-business lenders also require at least two years of operation before they’ll lend money to you.

How to Raise Capital from Venture Capitalists for Your Startup

For years, if your business was little more than an idea, there wasn’t much you could do to raise money besides asking your friends or family to help you. You had no guarantees you could pay back debtors and no legal business in which to provide shares. That all changed with the rise of venture capital in the post-World-War-Two era.

VC firms are a form of private equity focused on helping startups grow from small businesses into large enterprises. Some of the largest and most well-known businesses including Spotify, Hubspot, and Stripe all got their start with VC funding.

Generally, founders follow these steps to raise money from VCs:

1. Create and validate a startup idea.
2. Track all metrics (ARR, MRR, Marketing ROI, founder share vesting). VCs will perform due diligence before deciding to invest.
3. Create a business plan (What are your goals and how will you achieve them?).
4. Narrow down firms to pitch based on their industry of specialization. Some firms specialize in fintech and blockchain, while others might prefer logistics startups.
5. Draft a pitch deck and practice pitching in person.
6. Research events like trade shows your target VCs might attend. Investor relationships are almost always personal, so it helps to meet them in person.
7. Keep on trying and editing your pitch until you get a bite.

Common Mistakes Founders Make When Pitching VCs

VC firm, NFX, has a great article titled The Non-Obvious Guide to Fundraising on what VCs look for when assessing startups. They state the following are all common mistakes made by founders when pitching VCs:

1. Misjudging the level of a prospective investor’s interest.
2. Underestimating how long the fundraising process will take.
3. Not understanding or accurately predicting the terms that you’ll be offered.
4. Hearing a “yes” when the investor said “maybe.”
5. Misperceiving what the investor really thinks of you.

What do VCs look for in Startups?

If you want to be one of the less than one percent of startups that successfully pitch a VC, you need to understand what they look for in investments. The same article from NFX says this about how VCs invest:

“VCs really need large exits in order to A) clear their hurdle rate and B) make up for investments that don’t work out, which there will be a high number of since startups are inherently risky investments. That’s why you must convince potential investors that the outcome of your startup can be huge.”

Broken down, VCs are banking on just one or two businesses covering the failures of the rest. That’s why they want to invest in startups with ambitious multibillion-dollar visions that are willing to let investors take a large stake in their dreams.

But what are the specific demographics of startups VCs choose for investment today? To answer that, we’ve pulled data from VC firm Y Combinator’s (YC’s) 2022 batch of funded startups.

Here’s what YC’s records show:

• 50 percent of the batch applied more than once.
• 43 percent of the batch was accepted with only an idea.
• 36 percent of the batch raised money before YC.
• 71 percent of the batch had zero revenue before YC.
• 7 percent had more than $50,000 in monthly revenue when accepted.
• 39 percent (the largest by far) were in B2B/Enterprise SaaS.

Our takeaways from YC’s data:

• Despite economic downturns, VCs are still interested in startups that are little more than ideas.
• Just because your idea has been rejected once, it doesn’t mean it won’t be accepted later on.
• VCs may consider previous funding rounds as validation for your idea.
• Enterprise-oriented SaaS businesses got the most attention in 2022. These are businesses targeting subscriptions from multimillion-dollar companies. Read between the lines: VCs want you to target customers with money, not the average consumer.

The Difference Between Venture Capital VS Private Equity for Raising Funds for Startups

All venture capital is private equity but not all private equity is venture capital. Venture capital is a subcategory of private equity that looks for early-stage startups needing guidance and financial support.

VC companies source their funds mostly from:

• Wealthy individuals
• Investment banks
• Other financial institutions

Private equity in the traditional sense is the big league for raising capital (think Blackstone and Carlyle Group). These firms have access to truly enormous amounts of cash usually pooling their money from large and wealthy limited partners (LPs) like:

• Banks
• Pension funds
• Insurance funds
• High-net-worth individuals

PE firms usually fund established companies that can access traditional equity markets, such as late-stage startups and full-fledged businesses. Some VCs consider private equity acquisitions an exit strategy for their portfolio startups.

Both types of institutions have one trait in common: they almost always buy shares in businesses hoping to sell them later for a high return on investment (ROI).

To show the interplay between VC and private equity for a startup we’re going to highlight the journey of online payments platform, Stripe. 

In 2009, brothers John and Patrick Collison founded Stripe in Palo Alto, California. In 2010, they received an undisclosed amount in a seed round from Y Combinator after completing their incubator program.

Over the next decade, Stripe continued to grow and raise money, becoming one of the most valuable private companies in existence. Finally, in 2021, it received its first investment from traditional private equity with a $600 million series H round. 

Stripe’s founders managed to raise capital from VCs almost every year after founding the company. However, private equity didn’t come into play until it had received a $95 billion valuation.

How to Raise Capital from Private Equity for Startups

Generally, your steps for pitching private equity are somewhat similar to pitching VCs with a couple of noticeable differences:

1. Compile all your financial and customer acquisition data – PE firms will conduct intense due diligence on your startup, so ensure all your data is as neat and concise as possible.
2. Create a pitch deck that explains your business plan.
3. Be ready to outline clear exit strategies like:
   • Selling shares during an IPO.
   • Avenues for liquidating company assets (last resort).
   • Selling your business to another company.
   • Allowing them to sell a stake in your business to another private equity firm.
   • Repurchasing equity from them.
4. Look for firms – Usually, you don’t find private equity, private equity finds you. The best way to get on their radar is to get in touch with the entities they source deals from like:
   • Investment banks and other M&A intermediaries
   • Referral sources like attorneys and accountants
   • Management team sponsors
   • Other private equity firms

In a 2007 article for the Harvard Business Review, Felix Barber, director of the Ashridge Strategic Management Center at the Hull International Business School, says this about the background of most PE managers:

“Private equity managers come from investment banking or strategy consulting and often have line business experience as well. They use their extensive networks of business and financial connections, including potential bidding partners, to find new deals.”

What Does Private Equity Look for in Startups?

To better understand what private equity looks for in businesses, it’s helpful to understand how these firms have invested historically. Throughout the past few decades, many PE firms made substantial returns by buying poorly-performing businesses and turning them around.

In the same Harvard Business Review article mentioned earlier, Barber adds this about PE firms in the mid-2000s:

“Sales by public companies of unwanted business units were the most important category of large private equity buyouts until 2004, according to Dealogic, and the leading firms’ widely admired history of high investment returns comes largely from acquisitions of this type.”

While asset acquisitions and flips were popular for private equity for much of the early 2000s, many firms today eagerly invest in growing businesses like late-stage startups. For example, the NBA announced in November 2022 it would create a PE arm specifically targeting startups with NBA teams as limited partners (LPs).

Private equity today looks for the following (notice there is plenty of crossover with VCs):

1. Opportunities to deploy capital – Like VCs, PE likes startups with a definite plan for how you will use their investment to grow.
2. Recurring revenue – Your startup has predictable revenue every month or year.
3. “Mission-critical” industries or niches – PE likes businesses in industries protected, funded, or fueled by laws, regulations, or societal expectations. For example, a US-based startup in power grid technologies, which is a heavily subsidized industry in the country. PE loves a “sure thing.”
4. A self-sufficient management team – Unlike VCs, PE doesn’t necessarily want to play an active role in your business’s day-to-day dealings. They are looking for passive investment opportunities in teams they can trust to do the right thing.
5. A minimum of $3 million in earnings before interest, taxes, depreciation, and amortization (EBITDA) – This is one metric commonly used by PE to assess your startup’s maturity.
6. A viable exit strategy – PE doesn’t expect one lucky investment to cover bad ones. When you approach a PE firm, you need to give them specific information on how and when they can profit from taking shares in your business.

Because of the nature of their investors (pensions funds and the like), traditional PE firms don’t like to make the same risky bets as venture capital firms. If their investments fail, millions of people may lose their retirement funds and entire financial systems could crumble.

In line with this reasoning, private equity firms are looking for even safer bets than VCs. Many only fund startups with at least three years of operation requiring large sums of money (usually at least $5 million). They also may take on a wider range of deal structures including mixtures of equity and debt.

How to Raise Capital from Other Forms of Private Equity for Startups

Family and Friends

One of the most tried and true ways of raising early-stage equity is through family and friends (F&F) rounds. This is where you promise equity to your close relations in exchange for capital.

While F&F rounds can seem informal, founders should treat these investments as a professional addition to their existing personal relationships. Draft a contract stipulating exact terms and stick to it. Clarify that it’s unlikely they’ll get their money back as startups are risky ventures.

Angel Investment

Angel investors are another form of PE targeted at early-stage startups. They are typically private, high-net-worth individuals looking to make better returns on their investments than they could in other avenues like the stock market. 

You won’t have to worry about outside pressure from angels as they usually only take small shares (up to ten percent) of businesses. These investments can range from a few thousand dollars to a couple of million.

Angels may also invest incrementally, offering you a small investment upfront with the opportunity to follow up later. Once your business takes off, they may be willing to take on a larger investment deal more akin to a VC or other PE firm.

To find angel investors you’ll either want to try to attend networking events (most of these are in Silicon Valley) or connect with them online. There are also many well-known websites pairing startups with investors. Some well-known sites include:

• AngelList
• Angel Investment Network
• Angel Capital Association

For angel investors especially (and VCs to some degree), the pitch meeting is more about the investor liking the founder as a person than it is just pitching the idea. Angels often are part of most founders’ personal networks. If they aren’t, they’ll likely require more convincing than other PE representatives as their primary business is not funding startups.

Crowdfunding

Today, a growing number of businesses raise early-stage capital through crowdfunding.

Crowdfunding, popularized by websites like Kickstarter and GoFundMe, may be advantageous to startups that want to access large amounts of capital with fewer strings attached. Raising money from the masses often means you won’t be trapped by debt or controlling equity (although equity crowdfunding has recently become legal in certain states).

The hard part of crowdfunding: You’ll need to reach large numbers of investors despite having an incomplete product, which means you need to know marketing. Also, because of its reach, a failed crowdfunding campaign can garner extremely bad press. If you fail, you’re not just letting down a handful of wealthy individuals with large amounts of capital, you’re taking money from hundreds to thousands of people.

Some steps for raising capital through crowdfunding:

1. Choose your platform – Each crowdfunding platform has slightly different processes and regulations for raising funds. Research one that’s the best fit for your purposes.
2. Be specific about where the money is going – People want to know their money is making a difference and will rarely invest without knowing how you’ll spend it.
3. Market your campaign tirelessly and to the correct audience – Crowdfunding campaigns don’t share themselves. Their largest downside is that you are responsible for marketing.
4. Promise rewards (within reason) – While you don’t need to offer equity, you should offer something for donors like a free subscription. Just ensure you can afford to deliver on your promises. Nothing sours public sentiment like a shoddy crowdfunding campaign and there have been successful lawsuits against businesses that failed to deliver.
5. Post updates – People donate to crowdfunding pages because they care. If you want to keep the hype going, ensure you show where the money is going.

Cons of Raising Capital for Your Startup

There’s no such thing as free money. Any time you raise capital for your startup, you face tradeoffs to your autonomy and equity.

Here are some reasons why you might want to reconsider raising capital for your startup:

1. You want to be your own boss – If you like being an entrepreneur because you hate having a boss, raising capital may not be for you. VCs and other private equity often take between 25 and 50 percent of your company. When anyone owns more than 30 percent of a business, they’re considered a controlling shareholder.
2. You may be forced to sell (or not sell) – Your investors’ primary goal is the eventual sale of at least their shares if not your entire company. You may find yourself pressured to sell when you don’t want to or prevented from selling when you do.
3. Your reputation is on the line – VCs and other investors are a well-connected group. If your startup fails, it could hurt your ability to raise more capital later. In some of the worst-case scenarios, VCs have even tried to sue founders over misleading them (though most investment agreements protect founders provided they’re truthful).

Benefits of Selling Your Business Vs. Raising Capital

For years, private equity’s connections with the mergers and acquisitions (M&A) industry were some of the surest avenues to an eventual startup sale.

However, today you don’t need a connection to private equity to find buyers. New online marketplaces like Acquire.com let you sell your business or parts of your business easily and securely to interested buyers all around the world.

Some benefits of selling your business yourself instead of raising capital:

• You can start again with more money – If your current idea isn’t profitable, you may be better off trading it in for cash than hoping for life support from private equity or lenders. Selling allows you to start again on a fresh idea with more spare capital to propel your vision.
• All equity goes to the founding team – When you use private equity, you are likely setting yourself up for an eventual sale anyway; one where you receive substantially less of the final sale price. If you sell yourself, you and your team are the sole beneficiaries of your sale.
• You can choose what to sell – Not interested in selling your entire business? You can raise money by selling features of your startup. Maybe you have a new tool that’s cluttering your business and making it unprofitable. It may be more helpful to you in a sale.

Fund Your Dreams With an Exit on Acquire.com

If you decide you want to sell your business, we think we’ve created the best place on the internet for you to do that.

At Acquire.com we have three processes through which you can sell your startup:

1. By yourself (for free) – We’re one of the only online startup marketplaces where you can list and sell your startup by yourself with zero fees. We expect most businesses to sell within weeks, not months.
2. With a broker – If you still want the personal touch of a brokerage service but the reach and security of Acquire, we’ve created a pairing service with brokers specialized in every aspect of sales. Prices are completely transparent and usually a percentage of the sale (most pay for themselves).
3. Managed by Acquire – Do you have a SaaS startup making over $1 million a year? Do you want someone to take care of your acquisition for you? For just a small percentage of your sale, we’ll manage the entire sale process. You just choose from our curated list of qualified buyers and we’ll make sure you get the best deal possible for your business.

Ready to fund your dreams with a sale? Or are you just interested in seeing how we work? Check out our marketplace and send us a message or email if you have any questions.

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The content on this site is not intended to provide legal, financial or M&A advice. It is for information purposes only, and any links provided are for your convenience. Please seek the services of an M&A professional before any M&A transaction. It is not Acquire’s intention to solicit or interfere with any established relationship you may have with any M&A professional.