💸How does startup investing work?

Before exploring how a round of funding works, it is necessary to identify the different participants. First, there are the individuals hoping to gain funding for their company. As the business becomes increasingly mature, it tends to advance through the funding rounds. It is common for a company to begin with a seed round and continue with A, B and then C funding rounds.

On the other side are potential investors. While investors wish for businesses to succeed because they support entrepreneurship and believe in the aims and causes of those businesses, they also hope to gain something back from their investment. For this reason, nearly all investments made during one or another stage of developmental funding is arranged such that the investor or investing company retains partial ownership of the company. If the company grows and earns a profit, the investor will be rewarded commensurate with the investment made.

Dilution

Dilution is the decrease in equity ownership by existing shareholders that happens each time you issue new shares, like during a fundraising or when you create an option pool.

For example, let’s say you’re the sole owner of your company and you own 10,000 shares. Your company is doing well, so you decide to create an option pool of 1,000 shares for future employees. You also give an investor 2,000 shares in return for some much-needed capital. In total, there are now 13,000 shares of company stock—and just like that, you now own only 77% of your company (10,000/13,000) instead of 100%.

1. Family & Friends Funding

When you're trying to get a new venture started, friends and family funding is often the first place you turn to raise some capital. In essence, friends and family investors are a form of crowdfunding. You might take small amounts of money from several family members or close friends, to raise a more significant overall sum. Friends and family investors may be willing to put money into your business venture on an interest-free basis. Alternatively, you might draw up a friends and family investment agreement that promises interest, an equity stake or some other form of reward for lending you the money you need.

2. Pre-Seed Funding

The earliest stage of funding a new company comes so soon in the process that it is not generally included among the rounds of funding at all. Known as "pre-seed" funding, this stage typically refers to the period in which a company's founders are first getting their operations off the ground.

3. Seed Funding

Seed funding is the first official equity funding stage. It typically represents the first official money that a business venture or enterprise raises. Some companies never extend beyond seed funding into Series A rounds or beyond.

You can think of the "seed" funding in the same way as planting a tree. This early financial support is ideally the "seed" which will help to grow the business.