investor

Fundraising can be a particularly difficult part of building your startup.

There are many nuances to what kind of funding you should be pursuing and when, and misunderstanding these nuances can lead to a lot of wasted time and effort. Therefore, understanding where you are in development is vital to finding the right funding sources. Below, we’re going to connect the broader Prototype Stages from the Manufacturing Readiness Level (MRL) methodology to the appropriate funding sources to pursue at each stage. While the MRL methodology touches on financials, it does not provide a comprehensive framework for pursuing external capital and the significant body of knowledge required to be successful.

Concept Stage

The Concept Stage roughly corresponds to MRLs 1-3. It is the ideation phase; you are still doing research, still testing out ideas, and still trying to establish product-market fit. At this stage, prototypes are either nonexistent or only proof of concept. From a financing perspective, this is the stage with the most risk and many sources of funding will simply be unavailable until you can establish proof that there will be a future return on investments. Because of these difficulties, many grant and accelerator programs are targeted at this early stage to help. 

Some of the most common grants startups take advantage of are from the Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) programs. These are government programs that provide funding from different federal agencies to support research and development (R&D) into novel and innovative technologies. They are both broken into 2 phases with funding from $50,000 – $250,000 for the first phase and $1,000,000 for the second phase. Because these programs are handled individually by each agency, it is important to find the one that is most relevant to you and stay up to date on the details of their program. For particularly early-stage ventures, the National Science Foundation provides more general funding than other agencies like the Department of Energy or Defense. Outside of these programs, many other sources of grant funding will vary based on what local and federal programs are currently being supported. It’s important to stay connected to the organizations that distribute this funding to stay up to date on new opportunities.

Realistically, it is the founders’ time and money that will start a venture, and friends and family can provide some invaluable early support. Association with academia, either as a student or as faculty, can also provide an opportunity to explore new technologies, potentially with funding as well. Some grants, like STTR, also require contracting research work from an academic institution using a certain percentage of the award. For these reasons, many ventures involving new technologies will have individuals with an academic background on their team. Finally, crowdfunding can provide another potential source of funding at this stage but can be a very involved process with many pros and cons to consider.

At this stage, it is imperative to both create a proof of concept prototype and establish proof of product-market fit as leanly as possible to open up further sources of funding and make steps towards securing revenue.

Prototyping Stage

The Prototyping Stage roughly corresponds to MRLs 4, 5, and 6. This is the stage where you are developing Works-like and Looks-like prototypes and bridging the gap between the proof of concept and the customers’ expectations. At this stage, you’ve eliminated the biggest risks in your technology and product market fit, and are now aiming to run pilot projects with potential customers. From a financing perspective, you have unlocked the possibility of early-stage venture capital (VC) and hopefully established a short history of securing grant funding to help with any more grant applications you might apply for. 

At this point, it becomes possible to pursue angel investors that are appropriate to your venture. Angel investors typically lend a lot of domain experience both in technology and fundraising to help at this early stage. However, because these investors will be joining you at a very early stage, it becomes especially important to assess whether they will be a fit for your team. Consider the alignment between your technology, skill gaps, and other needs and the investor’s experience and network. While looking for the right investor to work with, it’s also important to consider what they’re looking for as well. They’re likely to have certain requirements for the startups they’ll work worth and will tend to be inflexible on these requirements. Trying to understand their portfolio by looking into previous investments and talking with them about their requirements early can save everyone time. In some cases, you might end up talking with someone that would be a good fit, but only at a later stage in your development or a different time for their portfolio. In those cases, it can be beneficial down the road to maintain a good relationship for the future. Some startups even maintain a mailing list of potential investors and send out regular updates before any actual investment to stay in communication.

Some alternative forms of financing include seeking out Single Family Offices (SFOs), High-Net-Worth Individuals (HNWIs), and companies with investing arms that might have an interest in your technology. Typically SFOs and HNWIs will have fewer requirements than other VCs about the stage and particular technology but may have more specific requirements in other areas.  It’s important to note that they may not be able to bring the same network capabilities or level of expertise as other investors might. Seeking out investment from an investing or venture arm of a company that might be interested in your technology is another possibility. This kind of investment is considered a sort of R&D expense for them and, depending on your technology and your team, can provide a path to acquisition, if that is your goal.  

At this stage, it is important to produce proof that you have achieved product market fit and traction through things like pilot projects, sales contracts, partnerships, investments, and revenue. Funding sources will start to be less interested in the details of technical development and much more interested in the details of business development, which can be a jarring shift for some teams. 

Validation Stage

The Validation Stage corresponds to about MRLs 6 and 7 onwards. This is the stage where you are finished with or finishing your engineering prototypes and the associated Design for Manufacturing, DFM, and other Design for X, DFX, processes. Technology development has mainly become a process of validation at progressively higher production levels and resolving any issues that appear in that process. Business development has mirrored this through progressively larger and more impactful pilot projects and sales. On the fundraising side, grant funding is generally being phased out as the ROI on the team’s time is less valuable than other funding avenues. Some longer-term angel and pre-seed / seed stage investors have been secured and are providing valuable guidance, and the team is either conducting or planning series X rounds. Revenue has generally been established at this stage, and the team is looking at the final steps to move over from financial support through fundraising to self-sufficiency through revenue.

After building your business to this point and with regular revenue and customers as an added layer of financial security, new sources of funding will become available to you. Previously non-dilutive grant funding and equity-based venture capital were all that were readily available. While any non-dilutive funding will always be a boon, equity-based financing can be supplemented with debt-based financing to avoid losing valuable equity. Venture banks specifically work with startups to provide debt-based financing, assuming you can provide some collateral and have generally mitigated financial risks significantly. Their risk tolerance is markedly lower than VCs, and utilizing this type of financing leaves the majority of the financial risk on the shoulders of the startup, unlike VCs who share both the highs and the lows. Venture banks tend to have higher interest rates as well, but preserving equity can make it well worth it. Lastly, if you’ve built a sufficient proof of financial reliability, debt financing through a bank can be a much easier and faster way to flex your cash flow than other forms of funding. 

Once you’ve reached a certain stage, going public with an Initial Public Offering, IPO, can also become a consideration. This is a form of equity-based financing where you sell shares of your company to investors. An IPO can be a lengthy and complex process with many implications for your organization and how it is run, the overwhelming majority of which is beyond the scope of what is presented here. Financial expertise should be consulted throughout the process and many parts of your organization will have to weigh in on the decision, Board of Directors, Board of Advisors, shareholders, founders, etc.

Finally, there is another option for debt-based financing. You can issue bonds to investors to spread your costs out over time. Similar to loans from venture banks, these bonds will carry significant interest and will also require a record of financial stability to even attempt to issue. Identifying investors to purchase these bonds may also prove difficult as the market for startup-issued bonds is much smaller than for other financial tools at your disposal. Generally, venture banks will provide an easier means of debt financing.

At this stage, your goal is to achieve some kind of financial stability, but what that looks like is up to you and your company to decide. For some that might be a financially sustainable, privately owned company. For others, their goal might be to grow the company as large as possible with an IPO. Many aren’t interested at all in running a company for the long term and are simply looking for a successful acquisition. In the case of an acquisition, you may never actually reach the Validation Stage in some aspects of your business. In any case it is important to have conversations about this with your co-founders and investors early on to ensure there is alignment on these tremendously important decisions.

In conlcusion

Throughout growing your startup you’ll utilize many sources and methods of fundraising. Early on, grants will be your primary source of funding and any gaps will have to be supplemented by the founding team. The SBIR and STTR programs are nationwide and fund a swathe of new technology ventures, but there may be many local grants to take advantage of as well. It is important to stay in touch with local support organizations to keep up to date on these. Once you’ve advanced past the Concept Stage, venture capital will become an increasingly large part of your funding. It can be very helpful to start with angel investors that have a network and expertise in your industry as they often provide significant support throughout their involvement. Seeking financing from venture arms of larger corporations can support fundraising efforts and secure a path to acquisition. At the Validation Stage, venture capital becomes less personal and many alternative forms of financing become available. As you approach this stage it becomes increasingly important to have alignment with your team on your long-term goals to determine what success looks like. Regardless of whether you’re looking for an IPO, an acquisition, or just to build your own company, fundraising will be an inevitable part of the process.