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Early Stage Funding For Startups

Published on: 2/21/2024 12:00:00 PM

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Fundraising for a business startup is arguably the most important and most difficult step of any start-up’s journey. Presenting a pitch to potential angel investors takes skill, practice, and the ability to demonstrate an in-depth knowledge of your business and its potential in an engaging manner that is easily understood by your audience.

Raising money and financing a small business is tough, and just because an investor says ‘no’ to your proposition, it doesn’t mean you have a bad business or the wrong idea. It can often mean that you haven't been able to relay to the investor what exactly it is that you are envisioning and what is actually on offer. In this blog, we will cover all you need to know about early stage funding for startups, tips on fundraising, as well as why market size is important and whether you should get an investor to sign an NDA.

What is early stage funding?

Early stage fundraising involves investing funds in a business during the early stages of its development. Early stage funding for startups is split into three types of funding; seed funding, startup funding, and early growth funding. Seed funding is the money provided to help start a business before startup funding is brought in to help a business develop their business plan. From here businesses can begin the process of developing their products and marketing plan. 

Finally, there is early growth funding. This is the final level of early stage fundraising for startups and helps to promote sales and boost manufacturing. It can take time to get off the ground, and investors may need to make multiple investments to aid the company before they see any real return.

What is important to a potential investor?

The reality of funders’ decision-making is often complex and driven by factors entirely outside the control of entrepreneurs. This can include an investor’s reluctance to potentially miss out on the ‘next big thing', meaning there is constant monitoring and revisiting of your idea without actually investing. The investor may also have, and very likely does have, an existing portfolio (or planned pipeline) of investments, which could cause a conflict of interest or reduce their capacity and willingness to invest in another similar project, even if you have a great proposition. 

The potential liquidity constraints and a lack of smoothness in deal flow present further reasons an investor may choose to say ‘no’. This is not a reflection of the validity of your idea, but rather a personal calculation every investor must make. 

The importance of numerical data and evidence-based facts cannot be denied. They form a significant part of any proposition and will have a huge influence on any investor's decision making. They are the facts on which an idea and understanding of a business and its potential are based. 

However, it is sometimes the intangible (the things that make up a proposition that can’t be put into numbers and are more abstract than a data sheet or PowerPoint presentation) that investors find themselves drawn to. The way you work together as a team, the way this is displayed in how you communicate with each other and with the investor, the knowledge, understanding, passion, and insight you have that position you uniquely above the rest, the conviction and credibility with which you come across. 

An investor looks for quantifiable growth and other tangible indicators, but it is the overall feel of the team (and the belief in that team's ability to deliver what they are proposing) that ultimately determines an investor's decision.

In my experience the biggest reason, and often the ‘white elephant in the room’, is you and the team. Legendary early-stage VC investor Mark Suster of Upfront Ventures summarises perfectly the reality: 

I am fond of quoting that about 70% of my investment decision of an early-stage company is the team. My rationale is simple: everything goes wrong, and only great teams can respond to competitors, markets, funding environments, staff departures, PR disasters and the like.

Mark Suster Upfront Ventures

Understanding your competitors

Competition is always a good thing; it inspires innovation and gives you the urge to always ensure your business is working at the top of its game to stay ahead. When you are looking for early stage funding as a startup, investors will value information on your competitors. They may wish to know if the products or services you are providing have an existing market that can validate the opportunity to monetize users, clients, and/or consumers.

People looking for fundraising for a business start up will want to see potential exit opportunities. Competitors are a key aspect of investor attraction, and as a founder, you should be able to convince any potential investors of exit opportunities. The ability to respond logically is an opportunity to reinforce founder experience, knowledge, and research and potentially demonstrate network reach. Investors will always seek individuals and teams who are credible and trustworthy.

Finally, there is a clear understanding of market size indicators. Having no identified competition will imply to investors that the market is small and the risk that comes with operating in a small market may turn away potential investors, but why is market size so important?

Why is market size important?

An in-depth knowledge of your business and its markets is a given for any successful entrepreneur, and a complete understanding of your business's market size is a fundamental part of this. Market size is one of the most important factors potential investors will focus on when reviewing a start-up funding proposition. It can (and will) lead to a very quick decline if you are not prepared or the size does not sound appealing or make financial sense. 

If you are trying to enter a market that is not substantial, then, by definition, your start-up does not have the potential to be substantial either. This is of particular importance if you are planning to launch into a competitive market space. A small market size, especially if being shared, will not appear favourably to any investor - this is why the ‘Market Size’ slide should always feature early and prominently in an investment pitch for early stage funding. Being clear from the offset and giving the investor an immediate idea of the size of the market will help you justify your reasons for investment.

Should I get an investor to sign an NDA?

An NDA, or Non-Disclosure Agreement, is a legally enforceable contract that creates a confidential relationship between two people. An NDA could be used to protect sensitive information and help retain the patent rights of a product during the development process. Many entrepreneurs believe an NDA will help their proposition be taken more seriously and professionally by potential investors, strengthening their negotiating position and preventing a potential investor from investing in the competition.

An NDA has the potential to protect an idea that has value, preventing a potential investor from networking and leaking information. Most entrepreneurs are aware of this, but the reality of being able to enforce an NDA and the potential cost is something that warrants serious consideration and may outweigh the benefits.

Investors value their time. Agreeing to an NDA is time consuming, potentially expensive, and has a low return on investment activity. The possibilities of extra costs and liabilities are vast and unappealing. Reading and signing an NDA is a potential barrier before even investing valuable time in reading your pitch. The risk of legal action and potential damage to their reputation is a concern for most, if not all, potential investors.

It is very unlikely that an investor is going to steal your idea. Your secrets are not as secret as you think. Very few things are unique, and very few ideas are unique to you as a founder. Ideas are plentiful, but what investors are really looking for are market opportunities. In emerging sectors, many start-ups are focused on addressing the same or similar markets. The interested investor will naturally be reviewing similar propositions, and an NDA is simply too restrictive and creates an immediate trust red flag. You are implicitly telling the investor you don’t trust them, which is not a great start to what could be a very long relationship.

How to safeguard information without the need for an NDA

Research target investors carefully to evaluate their credibility, and ensure you review existing portfolio companies prior to any approach. Specifically, check if they have invested in your sector and potential direct competition already. You should always assume whatever you share will be shared. The solution to this is to not share anything you don’t want the world to see. 

If you feel you would like to seek early stage funding for your startup business for an idea with a deeply technical or unique competitive advantage, then you can ask for an NDA at the late stage of the due diligence process, following the issue of an indicative terms sheet.

Knowing if early stage funding is for you

If you’d like to know more about early stage funding for startups, get in touch with our team. We’re happy to discuss all business finance options available to you and your business, including venture capital startup funding, NPIF funding and equity investment crowdfunding. For more information on business start up support, contact us today.