The 10 Ways Startups Can Raise Capital
Everything from SAFEs to selling future cashflows and token warrants
Michael Houck
March 04, 2023
This newsletter is designed to help founders build, grow, and raise capital for their startups. And it’s been growing so much (over 17,000+ founders get it each week now) that I thought it deserved a fresh coat of paint and logo.
The lightbulb was a simple, perfect image to capture that feeling founders crave — when you know you’re onto something great. My job is to help make that easier to reach and sustain.
You’ll see this new branding going forward, including on my socials.
Recently I’ve gotten questions from a few founders on what financing options are out there. Times are still tough in the venture markets and founders are exploring other opportunities.
So this week I put together a list of 10 ways startups can raise capital ↓
Read time: 7 minutes
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Startups can break down their options to raise capital by whether they’re required to give up equity in exchange for the capital (dilutive) or not (non-dilutive).
Most, if not all, billion dollar companies raise at least one round of dilutive capital so we’ll cover that first.
Dilutive Options
As even Paul Graham notes, you don’t need to raise venture capital to be considered a startup (all you need to do is be designed to grow fast).
But equity-based fundraising is still the most common tool startups use to capture a big market quickly.
SAFE
Y Combinator developed the SAFE (Simple Agreement for Future Equity) and it has become the de facto standard for pre-seeds, and often seed rounds as well (so much so that Carta even has a page on their site where the YC SAFE is the only option in a dropdown for the doc template to use).
A SAFE is an agreement that lets the investor purchase x shares at some point in the future for a price you agree to now. Usually, SAFEs the purchase gets made as part of a future fundraising round.
YC freely shares their templates for the various types of SAFEs you can use. We’ll do a deep dive on how SAFEs work in the future, but here are some terms to know:
Pre-money vs. post-money → Two ways of describing a round. Pre-money means the value of the startup without including what’s being invested now, while post-money includes the current investment.
Most favored nation (MFN) → Lets an investor get the same terms as later investors, if the later investor received better terms than the earlier investor did (by their judgement).
Discount → Reduces the price per share paid by the investor. Can be a good incentive for investors joining the first tranche of a round.
Valuation Cap → The cap is the maximum valuation the investor will have to pay for their shares at.
Other Convertible Notes
A SAFE is just one type of convertible note where investors are buying a promise for future equity.
Founders can also use a standard convertible note or use the more common KISS note (Keep It Simple Security), which was developed by 500 Startups.
KISS notes are a bit more friendly to investors, since they can transfer their ownership stake to anyone they choose (unlike with a SAFE). However, SAFEs are far more common.
Here’s a more detailed breakdown (h/t Rubicon Law):
Priced Round
Priced rounds are when things get serious for your startup. The negotiations are a lot longer than with SAFEs since there are more items to align on, and they include creating data rooms which slow things down even further.
Additionally, priced rounds require sign-off from existing investors, unlike issuing a SAFE. Missing just one signature from an investor who’s on vacation can hold up the deal.
All of these potential roadblocks make them unappealing to do in the early stages of your startup, when speed and time are most precious.
Kirsty Nathoo, YC’s MD of finance, gives a great talk on the differences:
Accelerator
The least complicated equity-based way to raise capital is through an accelerator.
They’re programs that often have set investment terms they offer to each startup they work with. There’s no negotiating, so you can get right back to building (but with their resources at your disposal).
I love accelerators because they force you to spend time around a group of other founders at the same stage you’re at. It’s easy to underestimate the amount of extra learnings, and increase in speed, you’re able to get by doing this.
The downside is that most accelerators prefer to invest pretty early, so their terms are often not incredibly founder friendly.
However, more big venture firms (like a16z and Sequoia) are either backing or starting their own accelerators. These can be good ways to meet their partners and start building relationships early.
Community Round
According to WeFunder, a community round is a funding round that allows anyone — including your customers, fans, friends, and family — to invest a minimum of $100 in your startup.
You may be asking “isn’t that just crowdfunding but with a different name?”
There’s one key difference: the people putting money into the project get equity in the startup rather than paying for an early product. Crowdfunding is more similar to pre-sales (see below).
There are also some legal restrictions on the size of a community round, and how investors who participate through one are represented on your cap table.
Leading platforms are Republic and Wefunder. They’ll help get your round in front of potential investors, though almost all of the highly successful community rounds I’ve seen have come from startups that already had either a good sized community or audience.
Token Warrants
Quick note for crypto founders: alongside or instead of most of these, you can also issue token warrants through a SAFT as part of your round.
This is a large topic with a lot of open questions that deserves its own issue. I’ll come back to covering this specifically in the future.
But, in short, if you’re building a startup that has or will have its own token, you can include the purchase and issuance of some of those tokens as part of or in addition to an equity fundraise.
Some investors may be less willing to participate in deals based around token warrants than they’ve been for the last few years, but crypto-native investors are still doing them frequently.
Non-dilutive Options
On the other hand, non-dilutive options are a great way to preserve ownership and autonomy for a founder.
They also tend to be more accessible options in the early days of a startup, especially for first time founders who may not have investors in their network.
However, it’s hard for companies to reach true venture scale outcomes without ever raising at least one equity-based financing round.
Future Cashflows
If your startup is generating recurring, subscription-based revenue you can likely trade the value of your signed future revenue in exchange for (slightly less) cash immediately.
This is sort of like if you win the lottery and they give you the option of getting it paid out in small increments each month until you hit the full amount you won, or one immediate lump-sum payment that’s smaller (always take the lump-sum)… except for SaaS startups and service businesses.
What you’re actually doing here is selling the agreement you have with the customer.
Potential buyers calculate the risk that the contracts will be fulfilled based on your industry and other factors, and make you an offer.
There are a few players in this space but Pipe is the industry leader. They claim the offers founders receive fall between $0.92 - $0.98 per dollar sold, and this lines up with the ones I’ve seen.
So you don’t end up losing out on much revenue at all, and the flexibility to have it upfront can make it attractive for startups at various stages.
Grants
Grants for startups have always been around, but they became much more popular in 2021 - 2022 within the web3 space.
Simply, grants are offered and awarded based on predetermined criteria by foundations, academic institutions, governments, protocols, and other entities when they want to incentivize and support specific areas of development. Your startup won’t qualify for every one.
As far as I can tell, there isn’t currently a reliable central database of startup grants online, so it may be challenging to discover what’s out there outside of very specific Google searches or word of mouth.
Maybe I’ll put one together…
Pre-sales
Sometimes founders think you have to build a product before you can sell it.
But what if you build the wrong product?
I tell every founder I work with to validate demand as soon as possible — before they build ANYTHING!
Your time is too valuable to spend even 1 second writing something the market isn't begging for.
Instead:
• Generate tons of ideas
• Validate market demand with short-form writing
• Double down only on the ones that clearly resonateTreat your writing like a startup.
— Dickie Bush 🚢 (@dickiebush)
Aug 31, 2022
Simple ways to run pre-sales and how to measure success deserve their own issue of the newsletter, but some easy places to run them are:
Small (< $100) paid Facebook and Instagram ad test
Cold email outreach to your target persona
If your pre-sale is successful, you’ll not only know what to build but also have generated some revenue to use to build it.
Venture Debt
I almost never recommend for early stage startups to take on debt unless they’re in specific industries with large upfront capital expenditures (like real estate).
The main reason for this is because debt is expensive. It puts the business (and with the worst types of debt also the founder, personally) into an even deeper hole if things go poorly.
In 2023, startups are hitting the wall. Many are down to their last few dollars. But how about a loan?
Going into debt is a mistake I am seeing more and more founders make...🧵— Francis Santora🐿️ (@FrancisPSantora)
Mar 2, 2023
Debt comes with interest, and both the principal debt and the interest need to be repaid to whoever issues you the debt.
The type of debt most commonly offered to startups is called venture debt and while there are various configurations, it typically incorporates three elements:
A fee of between 1% and 2% of the approved loan amount
An annual interest rate of between 10% and 12%
An equity kicker worth 10% to 20% of the loan amount
You can see how, for a seed stage startup generating limited revenue, this can quickly become an insurmountable hole to climb out of and force founders to shut down their startup earlier than they would have needed to with equity.
Bootstrapping
Boostrapping is when you invest some of your own money into your startup and don’t take on any outside capital.
It can be a good option if you have enough savings where you’re comfortable putting some on the line (without putting meaningful strain on your life).
It’s extremely popular with smaller projects that never plan to reach venture scale, since the capital demands for those businesses will be lower than a company servicing millions of users and employing thousands of people. Investors also often have less interest in these types of businesses, since the maximum return they could get on their investment is lower.
Important final note: don’t mortgage your future on your startup. For every cofounding team like Airbnb, who maxed out their credit cards before growth for the company took off, there are many failures where founders lose their life savings.
a16z has a fantastic article outlining 16 things to know before founders consider raising debt
Y Combinator put together this very thorough but easy to understand pdf outlining how SAFEs work in more detail
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