Startup funding

The main difference between startups and small businesses lies in their objectives and the ways they’re funded. 

Objectives of startups

The primary intention behind a startup is usually to be a market disruptor. Startups want to shake up a market by gaining new customers and attracting the customers of their competitors in an innovative way. Sometimes, startups create entirely new markets by offering new business ideas that don’t sit within any existing markets. 

Most startups don’t intend to be a startup forever. They aim to grow as quickly as possible. Usually, their ultimate goal is to become an impactful corporation either by going public or through a buy-out by a large company.

By contrast, small businesses don’t usually target big markets or new markets. They aren’t trying to dominate a market. Instead, they’re trying to profit within an existing sector. Their ultimate goal is to secure a place in the market and to generate steady long-term revenue. 

How startups are funded

While it’s typical for both startups and small businesses to initially be funded by their founders, they tend to seek different types and amounts of funding beyond this. 

In general, startups look for major investments to get them off the ground. This early stage of investment tends to involve angel investors (ie high net worth individuals who invest in startups and entrepreneurs) and venture capital firms (ie firms that specialise in funding and supporting startups and other new businesses). In exchange for their investments, investors are often given equity (ie shares, and therefore part ownership) in the business, and they become co-owners of the business. 

Giving up control over their business (ie by issuing shares and voting rights to venture capitalists or angel investors) isn’t ideal for small business owners. Instead, small businesses tend to opt for debt financing (ie instead of giving their investors equity, they give them a legally binding promise to repay the money that’s been invested). For example, they may take out  bank loans, which are usually for a smaller amount than the investments sought by startups.

For more information on how to fund a new small business, read Funding your business.

Crowdfunding 

This involves raising capital from a large pool of people, including friends, family, and other networks. It’s also a great way to gauge public interest in your product, service, and business. Crowdfunding often takes place via online platforms set up for this purpose. 

If your business involves goods, you may raise funds through rewards-based crowdfunding. This is where a business promises certain rewards (eg products or vouchers) in return for a specific level of investment. For example, you could raise capital by pre-selling your product to those who are interested in it.

Alternatively, you may raise funds through equity crowdfunding. This involves giving investors shares in return for their investment. Since investors in this instance are likely to be a multitude of individuals, equity crowdfunding may allow startups to avoid giving over a significant amount of control over their business, as they may find themselves doing if they receive comparable investment from a single venture capital firm.Equity crowdfunding is beneficial in that, since the return for their investment is dependent on your business’ success, investors will be motivated to see through your startups’ success (as opposed to eg rewards-based crowdfunding, where investors won’t necessarily have any interest in your business once they receive their reward). 

Business loans

A loan is a type of debt financing, whereby the business takes on debt with their investor (ie forms a legally binding agreement to pay back the amount borrowed, usually with interest). There is generally no transfer of equity. Generally, large banks would be reluctant to issue loans to new businesses. However, private lenders, such as Funding Circle, are often willing to assist new companies. As with bank loans, you’ll have to repay the sum borrowed with interest. 

Angel investors

Angel investors are high net worth individuals that seek to invest in new businesses at an early stage in return for equity (ie shares in the business). They’re usually accustomed to making risky investments in this capacity (often they will also have a portfolio of more stable investments too). It’s not uncommon for an angel investor to invest based on their support of an individual entrepreneur behind a startup, rather than based purely on the prospects of the business itself. Angel investors tend to already have (or have invested in) successful businesses, and they’re usually well-versed in the industries they’re investing in. They can also bring in resources (eg expertise) as they tend to be well-connected.

Angel investors usually join together to form angel investor networks. Pitching your business to a network is beneficial as it introduces the business to multiple investors at once. Even if the network as a whole decides not to invest in your business, you may attract a specific investor.

Venture capital firms

Venture capital firms invest in new businesses with strong long-term growth potential in exchange for a stake in the business (ie equity). Venture capital firms are usually established professional institutions with multiple employees who carry out their investment activities - as opposed to individual angel investors. Venture capitalists will often be asked to be on a company’s board of directors. Their goal is to make high-risk investments for very high returns by way of an eventual acquisition (ie by being paid well if the business is eventually bought by another, larger business or entity) or via an Initial Public Offering (IPO) (ie when the business is floated on a stock market and the public can buy shares for, hopefully, high prices).

It can be challenging to persuade these firms to invest in your business unless you can show that your product is a product-market fit (ie customers are buying your product at a high enough rate to sustain your business’ growth and profitability). Therefore, it may be wise to raise capital via other means to establish your business somewhat within your market before applying for venture capital funding (eg by seeking funding from angel investors or crowdfunding). 

Venture capital firms are able to introduce you to their network and other opportunities, for example partnerships. They can also offer guidance in crucial areas including recruitment, marketing, financial management, technology, and legal matters. This is sometimes a core part of the support that they offer to your business.

Government schemes and loans

There are a series of Government run or backed initiatives that help to fund new businesses. Some key initiatives are:

• the Seed Enterprise Investment Scheme (SEIS)

• the Enterprise Investment Scheme (EIS)

• the Start Up Loan

The SEIS and EIS are Government-backed initiatives that incentivise investors to invest in new businesses by offering them tax benefits (eg tax reliefs). The SEIS is suitable for companies at an early stage while the EIS is appropriate for established companies. For more information, read Seed Enterprise Investment Scheme (SEIS) and Enterprise Investment Scheme (EIS).

The Start Up Loan is a Government-backed personal (rather than business) loan available to new businesses. If you apply for a Start Up Loan and are successful, you’ll also receive help writing your business plan and free mentoring for up to 12 months.

For more information on the Government's efforts to help fund businesses, use the Business finance and support finder.

Small business grants

Grants are a type of funding which generally does not have to be paid back. Various grants are available to startups, for example the Innovate UK Smart Grant, a Government-backed grant for innovative ideas.

You can use the business finance and support finder (select ‘grants’) to find more grant options available for your business. 

Business incubators

Incubators are programmes that assist you in business development. This can include helping you to secure early-stage investments, providing office space or co-working space, and offering mentorship. Before applying to a particular programme, you should make sure that it caters to the industry you’re seeking to enter.

These programmes can also help grow your network as you'll be surrounded by other ambitious entrepreneurs that are growing their businesses.

There are four stages of funding that a startup will usually follow:

1. pre-seed funding

2. seed funding

3. series funding

4. initial public offering (IPO)

Pre-seed funding 

This is the stage at the beginning of a startup where founders use their own resources to get their idea off the ground. Friends and family may also contribute. 

At this stage, you should ensure all of your legal matters (eg intellectual property matters and Founders’ agreements) are in order, to reduce the likelihood of legal issues arising later on. 

Seed funding

This is where other investors get involved (eg angel investors) by providing capital for your business in exchange for equity. It’s at this stage that your business gathers sufficient funds to develop and launch its product. You may also conduct further market research to evaluate your product’s prospects and to see whether further product development is required.

Series funding

This can be separated into sub-categories: Series A funding, Series B funding, Series C funding, and beyond. 

Series A funding is for startups that are seeking to scale their business, improve their teams, and execute their Business plan. At this stage, they would already have a fully developed product with a consumer base that’s generating steady revenue. At this stage, it’s important to show that you have a business strategy in place and that your business will generate long-term profit so that investors will benefit from their investment. Funding at this stage often comes from angel investors and some venture capital firms. 

Startups that progress to the Series B funding stage would have already established their success and will have proven their ability to generate a steady income stream. The funds raised through this stage will be used to further expand to meet consumer demand and to boost the business’ competitiveness. This stage usually involves venture capital firms that invest in well-established startups.

Lastly, Series C funding is used by startups that are seeking to expand their product line in order to reach new markets or to acquire other startups. They have proven themselves to be successful and would no longer be considered as high-risk investments. As such, this stage involves investments from other types of investors (eg banks, hedge funds, and private equity firms).

Following a Series C funding round, startups that have not achieved what they intended to achieve by this stage may undergo further funding rounds (eg Series D funding and so on). Further funding rounds may also be used to generate a final capital boost before an initial public offering (an IPO). 

Initial Public Offering (IPO)

An IPO is when a business makes its shares available for purchase by the general public for the first time by floating them on a stock market. Startups that reach the IPO stage are either trying to access a new source of capital or their founders are seeking to exit the company.

An IPO involves transforming your business from a private company to a public company, thereby allowing members of the public to purchase issued company shares. 

You should start by determining how many shares you would like to issue. Then, you should check your Articles of association to ensure that you and/or your directors have the authority to issue new shares. If no such authority exists, the shareholders will have to pass an ordinary resolution to grant you authority. 

During this process, it’s also important to alter or disapply any shareholders’ pre-emption rights (or ‘pre-emptive rights). Pre-emption rights usually require that leaving shareholders first offer their shares to the remaining shareholders and/or that existing shareholders are offered the first opportunity to purchase newly issued shares. You must also make sure that the share issue complies with any restrictions imposed by your business’ articles of association or by any Shareholders’ agreement.

Once you’ve received payment from the investors, you must update Companies House about the changes you’re making to your share structure. You can do this online. You must do this within one month of your issuance and you must update your register of shareholders. Share certificates must also be issued to the new shareholders.

For more information, read Share transfers and issuing new shares.