Startup Fundraising Fundamentals

Startup fundraising is the process of raising capital from external investors to grow a business. Unlike loans that must be repaid, equity fundraising involves selling ownership stakes to investors who share in the company's future success. The fundraising process involves multiple stages as companies grow, each with different investor types, funding amounts, and expectations. Understanding fundraising mechanics—term sheets, dilution, investor motivations, and due diligence—is essential for founders navigating capital raises and for agents providing accurate context on startup financing.

Before diving into fundraising specifics, establish: (1) the company stage (pre-seed, seed, Series A, etc.), (2) the funding instrument type (SAFE, convertible note, priced round), and (3) the jurisdiction (US norms differ from UK/EU in some key ways). This primer covers universal concepts applicable across markets; for detailed instrument mechanics see Fundraising Instruments Deep Dive, and for US-specific details see US Fundraising Primer.

Core Concepts

Pre-money valuation is the company's value immediately before new investment. Post-money valuation equals pre-money plus the amount raised. If a company raises $2 million at a $8 million pre-money valuation, post-money is $10 million. The investor owns 20% ($2M / $10M post-money). Pre-money and post-money both matter—pre-money determines share price, but post-money determines dilution.

Dilution occurs when new shares are issued to investors, reducing existing shareholders' percentage ownership. If you own 50% before a round and don't participate in the round, you might own 40% after (diluted from 50% to 40%). Dilution isn't inherently bad—if the company's total value increases more than your percentage decreases, your absolute stake value grows. A $1M company where you own 50% is worth $500K to you. If it raises at $10M post-money and you're diluted to 25%, your stake is now worth $2.5M.

Liquidation preference determines payout order in an exit (sale or IPO). A 1x liquidation preference means investors get their money back first before anyone else receives proceeds. With a 1x preference on a $10M investment, investors get the first $10M of exit proceeds. Only proceeds above that amount are split according to ownership percentages. Participating preferred adds another layer—investors get their preference back, then also participate in remaining proceeds as if they held common stock.

Pro-rata rights allow investors to maintain their ownership percentage by investing additional capital in future rounds. If an angel invested $100K for 5% in seed, pro-rata rights let them invest enough in Series A to maintain that 5% ownership (diluted pro-rata if they don't invest). This protects investors from dilution, but not all investors receive pro-rata rights—typically reserved for larger checks or strategic investors.

Term sheets are non-binding letters of intent outlining investment terms. They cover valuation, liquidation preference, board composition, investor rights, and other key terms. Term sheets are legally non-binding except for exclusivity and confidentiality provisions—the actual legal documents (purchase agreements, investor rights agreements) come later. But term sheets are where negotiation happens; once signed, the legal documentation typically follows the term sheet framework.

Funding Stages

Fundraising progresses through stages as companies mature, with each stage serving different purposes and attracting different investor types.

Pre-seed is the earliest institutional capital, typically $100K-$500K, raised when the company is still validating product-market fit. Investors include accelerators (Y Combinator, Techstars), angel groups, and pre-seed funds. Use of funds: product development, initial customer acquisition, building a founding team. Companies at this stage often have a prototype but limited traction.

Seed rounds range from $500K to $3M, raised once companies demonstrate initial traction (users, revenue, or clear product-market fit signals). Seed investors include seed-stage VCs, angel syndicates, and family offices. Funds typically cover 12-18 months of runway for hiring, product iteration, and revenue growth. Many companies raise multiple seed rounds (Seed, Seed Extension, Seed+).

Series A is typically the first major institutional round, ranging from $3M to $15M, raised when companies have proven product-market fit and demonstrate scalable growth. Series A investors are institutional VCs looking for companies with $1M+ ARR or equivalent metrics showing repeatable growth. Funds support 18-24 months of scaling—hiring across teams, expanding market presence, and building operational infrastructure.

Series B and beyond represent growth capital for scaling proven businesses. Series B typically ranges from $10M to $50M; Series C+ can exceed $100M. These rounds fund aggressive expansion—new markets, new product lines, or market consolidation. Investors include growth equity funds and later-stage VCs. Companies at this stage have established revenue, clear unit economics, and predictable growth trajectories.

Typical dilution per round: 15-25% at seed, 20-30% at Series A, 10-20% for Series B+. These ranges vary by market conditions, company traction, and investor competition.

Financing Instruments Overview

Startups use different instruments at different stages, each with distinct mechanics. SAFEs (Simple Agreement for Future Equity) are contracts that convert to equity in a future priced round, typically used for pre-seed and seed. Convertible notes are debt instruments that convert to equity, similar to SAFEs but with interest and maturity dates. Priced rounds involve selling equity at a fixed price per share, typical for Series A and beyond.

The choice of instrument depends on stage, market conditions, and complexity needs. SAFEs dominate seed-stage US fundraising due to simplicity and low legal costs. Convertible notes offer maturity dates and interest (traditional structure). Priced rounds provide immediate equity ownership and are required for institutional investors who can't invest in debt instruments.

For detailed mechanics on how each instrument works, conversion terms, valuation caps, and discounts, see Fundraising Instruments Deep Dive.

Term Sheet Components

Term sheets outline key investment terms before legal documentation. Understanding these terms helps founders evaluate offers and understand what they're negotiating.

Valuation sets the company's worth. Pre-money valuation determines share price (pre-money / outstanding shares). Higher valuations mean less dilution but higher expectations for growth and exit outcomes. Investors seek valuations that provide appropriate returns given risk—seed investors often target 10-100x returns, meaning they need companies to achieve valuations 10-100x their investment.

Board composition determines who makes major decisions. Investors often negotiate board seats as part of financing. A 3-person board might include: 1 founder, 1 investor, 1 independent. Larger boards add more investor or independent seats. Board control matters for major decisions (acquisitions, CEO changes, major pivots).

Vesting schedules apply to founder and employee equity. Standard is 4-year vesting with 1-year cliff (no vesting for first year, then monthly thereafter). If a co-founder leaves after 6 months, they forfeit all equity. This protects remaining founders and investors from equity dilution if key people depart early.

Anti-dilution protection protects investors if the company raises money at a lower valuation (down round). Broad-based weighted average is standard—it adjusts the investor's conversion price based on the down round's terms and the amount raised. Full ratchet (less common) would adjust to the down round's price regardless of amount—extremely punitive to founders.

Investor rights include information rights (financial reports, board materials), right of first refusal on future rounds, and drag-along rights (forcing minority shareholders to sell in an exit). These rights provide ongoing visibility and influence beyond just board seats.

Exclusivity provisions prevent founders from shopping the term sheet to other investors for a period (typically 30-60 days). This protects the investor's time investment in due diligence.

Term sheets reference legal concepts—see Contracts Primer for broader contract principles. For US-specific term sheet norms, see US Fundraising Primer.

Cap Table and Dilution Basics

A cap table (capitalization table) tracks who owns what percentage of the company. It shows all shareholders: founders, employees (option pool), and investors. Cap tables start simple and become complex as companies raise multiple rounds.

How dilution works: If a company has 10M shares outstanding and raises $2M at $8M pre-money (20% dilution), the new round creates 2.5M new shares. Total shares become 12.5M. A founder who owned 30% (3M shares) now owns 24% (3M / 12.5M)—still 3M shares, but a smaller percentage of a larger pie.

Option pools are reserves of shares set aside for future employees. Investors typically require option pool creation before their investment, which dilutes existing shareholders. A $8M pre-money valuation with a 20% option pool means the effective pre-money is $6.4M—the option pool dilutes everyone before new money comes in. This is why option pool size matters in valuation negotiation.

Preference stack matters in exits. If multiple rounds have liquidation preferences, they stack in reverse chronological order (most recent investors paid first). Series B with 1x preference gets paid before Series A's 1x preference, which gets paid before common stock. In a $20M exit where Series B invested $10M and Series A invested $5M, Series B gets $10M, Series A gets $5M, leaving $5M for common shareholders (founders and employees).

Understanding dilution math is essential for founders negotiating rounds. A 20% dilution sounds significant, but if the company's valuation doubles, your stake's absolute value can increase even with dilution. The key question: does the capital raised enable growth that increases the company's total value more than your percentage decreases?

For detailed instrument mechanics affecting dilution (SAFE conversion, convertible note conversion, anti-dilution calculations), see Fundraising Instruments Deep Dive.

Investor Types

Different investor types participate at different stages with different motivations and check sizes.

Angel investors are high-net-worth individuals investing their own money, typically writing checks from $10K to $250K. Angels invest for financial returns but also often provide mentorship, connections, and domain expertise. They're common at pre-seed and seed stages. Angel groups pool individual angels for larger checks and shared due diligence.

Seed-stage VCs are institutional funds focused on earliest-stage investing, typically writing checks from $250K to $2M. They're comfortable with early risk but seek companies showing initial traction. Seed VCs provide structure, connections, and follow-on support. Many seed funds invest from accelerator-stage through Series A.

Early-stage VCs (Series A/B) are institutional funds investing institutional capital, typically $2M-$20M per round. They lead rounds, take board seats, and provide strategic guidance. Early-stage VCs seek companies with product-market fit and scalable growth models. They typically invest in 10-20 companies per fund, targeting significant returns from a few winners.

Growth-stage VCs invest in proven businesses scaling rapidly, typically Series B+ rounds of $10M+. They focus on accelerating growth through capital rather than product development. Growth VCs often specialize in specific sectors or business models (SaaS, marketplaces, consumer).

Strategic investors are corporations investing from their balance sheet. Unlike VCs seeking financial returns, strategics often seek strategic benefits—access to technology, market insights, or partnership opportunities. Strategic investments can provide credibility and partnership opportunities but may complicate future fundraising or exit options.

Family offices are private wealth management firms for high-net-worth families. They invest directly in startups or through funds. Family offices often have longer time horizons than VCs and may seek both financial returns and legacy-building opportunities.

Each investor type brings different value beyond capital: VCs provide structure and connections, angels provide mentorship and speed, strategics provide partnerships and market access. Founders should consider what value they need beyond just the check size.

Due Diligence Process

Due diligence is the investor's investigation of the company before investing. This process verifies claims, identifies risks, and ensures legal and financial compliance.

Business due diligence examines the product, market, customers, and competitive position. Investors review product demos, customer interviews, market research, and competitive analysis. They verify traction metrics, revenue quality, and growth assumptions. This is the deepest dive—investors want confidence in the business fundamentals.

Financial due diligence reviews financial statements, revenue recognition, burn rate, and financial projections. Investors examine accounting methods (cash vs accrual), revenue quality (recurring vs one-time), and cash management. They verify the company has clean books and realistic financial projections. For financial statement fundamentals, see Accounting Primer.

Legal due diligence examines corporate structure, contracts, intellectual property, and regulatory compliance. Investors review incorporation documents, cap table, employee agreements, customer contracts, and IP assignments. They verify the company owns its IP, has proper employee agreements, and isn't exposed to legal risks.

Reference checks involve speaking with customers, partners, former employees, and advisors. Investors seek independent validation of claims and insights into company culture, execution capability, and founder behavior. Negative references can derail deals even if other diligence passes.

Typical timeline: Seed rounds can close in 4-8 weeks. Series A rounds typically take 8-12 weeks from term sheet to close. Series B+ can take 12-16 weeks. The timeline depends on company complexity, legal issues, and investor processes.

What founders should prepare: Clean financials, organized cap table, customer references ready, IP documentation, employee agreements, and key contracts accessible. Good preparation speeds the process and signals professionalism. Companies that aren't prepared face delays and may lose investor confidence.

Key Numbers

Typical check sizes by stage: Pre-seed $100K-$500K, Seed $500K-$3M, Series A $3M-$15M, Series B $10M-$50M, Series C+ $20M-$100M+. These ranges vary by market conditions, sector, and geography.

Typical dilution per round: Pre-seed 10-15%, Seed 15-25%, Series A 20-30%, Series B 10-20%, Series C+ 5-15%. Market conditions significantly impact dilution—competitive rounds mean less dilution, difficult markets mean more.

Typical fundraising timelines: Pre-seed 2-4 months, Seed 3-6 months, Series A 4-8 months, Series B+ 6-12 months. These include time from initial conversations through close. Faster is possible with momentum; slower is common when fundraising is challenging.

Typical runway from a round: Pre-seed 6-12 months, Seed 12-18 months, Series A 18-24 months, Series B+ 24-36 months. These assume typical burn rates. Companies should start fundraising 6-9 months before running out of cash to allow for the fundraising process and potential delays.

Valuation ranges vary enormously by stage, sector, and market conditions. Seed valuations can range from $3M to $20M+ pre-money depending on traction and investor competition. Series A valuations typically range from $10M to $50M+ pre-money. Market conditions significantly impact valuations—strong markets see higher valuations, weak markets see lower valuations or down rounds.

Common Misconceptions

"Higher valuation is always better." Higher valuations mean less dilution, but they also mean higher expectations. Raising at $20M pre-money when you're worth $10M means investors expect you to become a $100M+ company quickly—if you can't meet those expectations, future fundraising becomes difficult or requires down rounds (raising at lower valuations, which is painful). Accepting a reasonable valuation that aligns with realistic growth expectations is often smarter than maximizing valuation.

"Dilution is bad." Dilution reduces percentage ownership, but if capital enables growth that increases the company's total value, your absolute stake value can grow despite dilution. Owning 30% of a $10M company ($3M) is worse than owning 20% of a $50M company ($10M). The focus should be on absolute value, not percentage ownership.

"We can raise more money later if we need it." Fundraising isn't guaranteed—markets change, traction may not materialize, and investors may lose interest. Companies should raise enough for 18-24 months of runway to avoid frequent fundraising distractions. Raising too little means you're fundraising again in 6 months, taking time away from building.

"All investors are the same." Different investors bring vastly different value beyond capital. Some VCs provide strategic guidance and connections; others are hands-off. Some angels provide mentorship; others are silent. Choosing investors based only on valuation or check size ignores the value of good partners.

"Term sheets are final." Term sheets are legally non-binding (except exclusivity/confidentiality), but backing out after signing damages reputation and relationships. Term sheets should be treated as serious commitments. Negotiate before signing, not after.

"SAFEs are simple and don't need legal review." While SAFEs are simpler than priced rounds, they still have legal implications and terms that matter. Founders should have legal counsel review SAFEs, especially valuation caps, discount rates, and conversion terms. Standard templates reduce but don't eliminate legal risk.

"We'll figure out the cap table later." Cap table mistakes are expensive to fix. Issuing equity incorrectly, misallocating shares, or creating tax issues can create legal and financial problems that persist for years. Get cap table management right from the start, ideally using professional services or software.

Progressive Disclosure

This primer covers universal fundraising concepts applicable across jurisdictions and stages. For deeper dives:

• Instrument mechanics: See Fundraising Instruments Deep Dive for detailed explanations of SAFE conversion, convertible note mechanics, priced round structure, valuation caps, and discounts.

• US-specific details: See US Fundraising Primer for US market norms, SAFE term specifics, QSBS tax benefits for investors, and Delaware C-corp standard structure.

• Related knowledge: Term sheets are legal contracts—see Contracts Primer for contract fundamentals. Investors review financial statements during due diligence—see Accounting Primer for financial statement basics. Tax implications matter—see Tax Primer for entity structure and tax considerations.

Key Principles for Fundraising Assistance

Always establish company stage before providing specific guidance. Advice for pre-seed differs from Series A advice.

Understand the instrument type—SAFE mechanics differ from priced round mechanics. When discussing dilution or terms, clarify which instrument applies.

Recognize that fundraising norms evolve. Market conditions change, term sheet standards shift, and investor preferences vary. Verify current market standards for specific stages and instruments.

Jurisdiction matters for some details. US fundraising norms (SAFEs, Delaware C-corps) differ from UK/EU norms (convertible loan notes, SEIS/EIS tax schemes). When jurisdiction-specific details matter, reference appropriate sub-primers or note that legal counsel should be consulted.

Distinguish between universal concepts (dilution, term sheets, investor types) and instrument-specific or jurisdiction-specific details. Load the main primer for general concepts, then load sub-primers for specific mechanics.

Never provide legal or financial advice. Primer knowledge helps ground responses in accurate concepts, but specific deals require professional legal and financial counsel.