An Insider’s Look at the VC Investment Funding Process for Startups

Introduction

While startups may initially get off the ground through bootstrapping, when they begin selling products and growing their customer base, more funding is needed—and fast. 

There are many methods startups may consider when they need funding to scale, from pitching to angel investors or using an online platform to crowdfund. For some startups, the VC investment process is the best next step.

Venture capital is a form of equity investment where startups can get money from VC firms in exchange for a percentage of ownership in the company. 

But what can startups expect when they go through the VC investment process? Read this guide to find out how to stand out and succeed in securing VC funding.

What startup founders need to know during the VC investment process

There are several ways for startups to raise money, whether they rely on crowdfunding, bootstrapping, angel investing, or VC investing. Very few startups will actually earn funds through the VC investment process — according to Fundera, only 0.05% of startups get funded from VCs. 

Why the low number? Well, for one, there are a lot of up-and-coming businesses out there, so the competition is high. However, many startups fail to secure funding through the VC investment process because of a lack of research, planning, and due diligence. 

Some startups are naturally better suited to VC investing, while other ideas may be better to bootstrap. For example, software-as-a-service (SaaS) startups are usually more viable to create via bootstrapping, while a company that requires expensive machinery or technology, like AI-focused startups, may be a better fit for VCs. Before you start pursuing funding, be sure to analyze your funding needs and research what method of raising money is the most compatible with your business.

For startups that do pursue the VC investment process, having a solid business plan and proving that your product makes sense in the target market are essential components investors will want to see.

“While a well-crafted business deck is a good starting point, to me, the most important point that startups should be emphasizing is customer’s validation of the product and hence, achieving Product-Market Fit (PMF).” said Benedict Tan, Senior Associate, Investments at Vertex Ventures Southeast Asia & India. “PMF is not unattainable in the future. Successful startups understand their customers well and build products that meet their needs. They dedicate significant effort to researching their target market and constantly experimenting with how best to deliver their solution to the customers.”

For startups that go beyond and above providing the right materials, doing the proper research, and connecting with VCs best suited for their market and business, the work that goes into this process can be well worth the reward. 

If your startup is ready to grow but needs an investment to do so, read on for tips to make it through each stage of the VC funding process.

Pre-Seed

During the pre-seed stage, startups are usually not yet prepared enough to reach out to venture capital firms. Instead, founders are using their own money and potentially pooling money from friends and family to just get the startup off the ground.

At this point, startups should at least have a proof of concept for their product or service and an early prototype to present. Startups may receive about $100K to $1M funding in the pre-seed stage.

Seed

Using the funding from the pre-seed, founders can develop a minimum viable product (MVP), hire vendors or purchase equipment and software needed for the business, hire new employees, or invest in marketing to bring in new customers. This is all necessary to increase the chances of success when a startup starts seeking out external funding through the seed stage.

During seed funding, startups should have the MVP, a defined target market, a business plan, and a SWOT (Strengths, Weaknesses, Opportunities, Threats) analysis.

Businesses typically raise about $3.1M in this stage.

Series A

For Series A and later funding rounds, startups will need to go through a valuation process, which will assign a value to the company based on various factors like revenue, market size, proof of concept, and client base. Another thing to have handy at every stage? A fresh pitch deck with the latest statistics from your business.

At the Series A stage, startups should be able to show real traction with high month-over-month growth of over 10% to hook investors. Funding from pre-seed and seed can also go into growing the team and preparing to scale, which investors will be looking for. 

A forward-thinking business plan will ideally draw a path of growth to $100M for the best chance of showing investors that your business is worth the investment. By this stage, your business should be bringing in revenue.

Only about 33% of startups that go through the VC investment process will earn money in series funding from Series A or later stages. For those that do receive funding, the average is around $6.4M for Series A.

Series B

At each new stage of series funding, startups can expect to earn a new valuation based on how the business has grown and changed since the previous stage, with typically 1.5 to 2 years between Series A and Series B.

By the time a startup seeks Series B funding, it should already be successful in raising revenue, even if it’s still not earning a net-profit. The startup should be seeking additional funding in order to further expand. Investors will be looking for clear growth, a strong customer base, increasing revenue, and a low burn rate.

The average funding raised in Series B is around $25M.

Series C and beyond

Series C and later funding rounds, like Series D, E, or F, are to help startups continue their success and growth and possibly move toward an initial public offering by increasing valuation. However, in some less positive circumstances, later funding rounds may mean companies have fallen short of their goals.

Either way, in Series C or later rounds, companies will need to have a continued plan and evidence of sustainable growth to attract investors. As part of the potential investors’ due diligence, they will typically ask to see individual value contributions from team members, product-market fit, a scalable business model that can work with rapid growth, financial statements, and an exit strategy to prepare for the future.

In Series C, startups raise an average of $59M. In later series funding rounds, startups can raise a median of $100M or more. 

Mezzanine

Mezzanine is not the next step in funding rounds, but rather an alternative to equity financing, like VC investments. Mezzanine financing combines debt and equity, so startups can obtain higher loans than they might be able to get through conventional business loans as a newer, riskier business. The debt can later be transitioned to equity shares, so investors earn a portion of company profits. The terms can vary widely, so investors and startups will define exact terms on a case-by-case basis. This type of financing is often popular in real estate and development-related projects.

Like equity financing, startups will need a clear business plan and may be expected to be generating revenue before qualifying for mezzanine financing. Mezzanine financing may also be considered in addition to other forms of funding to help a startup gain enough money for a major project or expansion.

Exit

An exit refers to when the startup’s shareholders, whether founders or investors, sell their portion of ownership and leave the company. In some cases, this can be a positive step, such as when a company goes to IPO. However, exits can also happen because of bankruptcy. Acquisitions are another form of exit.

Photo by Aditya Vyas on Unsplash

Startups should have exit strategies in place early on, since that is typically a consideration investors look for during series funding.

For the exit stage, startups need to have an official exit plan document and financial documents and may also require share purchase agreements, intellectual property (IP) assignments, client contracts, employee contracts, and additional legal documents for the business, depending on the exit method.

How do VCs make money?

In addition to the returns they make on their investments, venture capital firms can make money in two additional ways. First, they will earn money from managing the firm’s pooled funding money. Investors will pay the firm a fee, usually about 2% to 2.5%, to manage the funds. VCs may be managing more than one fund at a time, earning them about 2% of the total per fund. 

Then, VC firms also make money from carries, or carried interest. When startups receive the green light for an investment from a VC firm, they agree to pay a carried interest amount as part of the return on investment (ROI). The carried interest rate is usually about 20% but can be negotiated between the VC firm and the startup.

How do venture capital firms decide which startups are worth investing in?

From finding the right founding partners to showcasing traction and scalability, there are several green flags that investors look for when deciding which startups are worth the time and investment.

One of the first things VCs consider, outside of a good idea, is the founders. Investors want to be sure that the people they’ll be working with in the long run are communicative, dedicated, and reliable.

“Especially in the early stages, we are convinced that the best indicator for a startup’s success is the founding team,” Jason Druker, Portfolio Manager at SFC Capital, told HubSpot for Startups. “We ask ourselves: ‘Why, if anyone, would it be these founders that could disrupt this sector with this idea? Are they dedicated, resilient, and skilled to push through tough times? How effective is their communication with all stakeholders?’ ”

The founding team should feature members that not just get along personality-wise but also bring multiple skills to the table.

“For early-stage investors, the founding team is arguably the most important criteria, and a good gauge would be a ‘balanced / blended’ team with both relevant technical skills and soft skills,” Tan said. “Such a team not only possesses the capabilities to execute, but also demonstrates the ability to attract top talent to the venture. Ultimately, the VC must be convinced that the identified founders have the ‘Right to Win’ and the passion and tenacity to execute.”

Startups should have more than just an idea — they’ll need a well-thought-out business plan that accounts for growth, so investors know that when the startup starts gaining more interest, it will be ready to handle a larger customer base with ease.

Potential investors will want to be sure that your startup not only fits in their portfolio (meaning startups should do their research and find investors interested in companies like theirs) but that it is also viable in the market. Startups should do a deep dive into market trends before prepping a pitch; this research can help startups time their pitches for a better chance of getting a “yes” from investors.

Of course, one of the biggest things investors will consider is the potential risk and value. The goal of investing is to help a startup succeed and, in turn, earn money on the investment. Founders will be looking at the overall potential for high ROI and long-term business sustainability, as these factors balance out the major risk of investing, considering 90% of startups fail. 

What are the top reasons VCs reject startup founders?

While a unique or disruptive idea can land a startup founder a meeting with potential investors, it’s not a guarantee that they’ll receive funding. There are several factors that can lead to a rejection, from failing to do proper research to pitching at the wrong time.

First and foremost, it’s important for startups to thoroughly research their industry, their competitors, and the investors they plan to pitch to. Failing to put in the time to research could waste far more time pitching to investors who don’t invest in your industry or pitching an idea that’s already on the market.

“Do your diligence on the type of investors that you aim to attract — speak to their portfolio and understand how they operate,” Tan said. “The ideal investor shares similarities with a trusted friend — one that has the best interest at heart (often this means, reflecting about the harsh realities), not afraid of ironing the tough winters with you and don’t ditch when the fire is out.”

Similarly, paying attention to the timing of your outreach is important. For example, if the VC firm just made a major investment in another company or the market is doing poorly, they may not be ready to invest in a business at this time. Timing the pitch just right requires some research into the potential investors and the market as a whole.

According to Jonny Boyarsky, co-founder of Literally Helping Startups, lacking anything tangible or failing to show scalability are other factors that can hurt a startup’s chances of getting funding from VCs.

“People don't care as much about you having interviewed a hundred customers. They care about paying customers,” Boyarsky told HubSpot. “They don't care that you have 10,000 downloads if you don't have active users. Across B2B and B2C, it's really, really important that you have tangible traction.”

Sometimes, a rejection can simply come down to a poor fit between the investor and the startup. From how you act in meetings to how quickly and receptively you respond to emails or requests, your regular interactions with a potential VC can make or break the deal. Be honest, communicative, and efficient to improve your shot, but keep in mind that investors and startup founders often form long-term business relationships. If personalities are clashing, it may be time to move on to pitch to someone else who’s a better fit.

How do you find the right investors?

You have a tangible product and a business plan that’s ready to scale as your startup grows. Now, how do you find potential investors to hear your pitch? Don’t worry, you don’t have to send cold emails into the void. There are several more interesting and successful ways to connect with investors.

Warm introductions

Before you start planning out a pitch or signing up for industry events, it doesn’t hurt to work your existing network. In fact, reaching out to investors via warm introductions, a.k.a through mutual connections, can be more successful than sending out a cold email or reaching out through social media. According to Y Combinator, reaching out via warm introductions is one of the best ways to connect with a VC or angel investor.

Online

Another way to expand your network of investors is to build up an enticing online presence that could even bring promising investors to you, rather than you reaching out to them. 

According to Coresignal’s predictions for trends in venture capital for 2024, having a strong digital presence for your startup will be a more popular way to appeal to potential investors. A company’s public data, social media presence, job posting data, talent data, and even online reviews from customers, can all play a part in building a more attractive digital presence.

Even if your startup is still very new, you can start gaining funding by seeking out investors on social media or at industry events.

“At the earliest stages, angels are going to be the most interested. These are people that might end up cutting $20,000 or $25,000 checks. You can find them at events, you can find them on LinkedIn,” Boyarsky advised.

Events

When you’re trying to find the time to market your startup’s products or services, partner with the right vendors, and provide top-notch customer service to new clients, it can feel like a hassle to add industry events to your already-packed schedule. 

But if startup founders are looking for ways to connect with potential investors, attending events, meeting new people, and nurturing those new relationships are an essential part of doing business.

“Try to build a relationship with a VC; go to the same events, try to get warm introductions, and enter competitions,” Druker said. 

Once you’ve made those connections, don’t neglect them, though. Druker recommends startup founders provide progress updates to potential investors about every few weeks to keep your company on their radar.

“Plug into the trade associations that are relevant to your sector, and reach out to other startups that are 18-36 months ahead of you in their journey: they have almost certainly taken investment from thesis-fit funds that you can approach with a message of ‘We love that you invested in x, we’re just like them, but here’s how we are different and special,’” Druker said.

Accelerators

If you have a strong, tangible idea, another way to connect with investors is to enter an accelerator program. Boyarsky recommends having something ready to go before applying, even if it’s just an MVP. An accelerator program can help you strengthen and scale your startup idea over the course of several weeks or months, then, at the end, you’d present the idea to potential investors at a Demo Day.

Existing Relationships

Even if you’ve connected with investors who didn’t invest in your startup previously, it’s important to still nurture your relationships — including when you’re not fundraising.

“Having been in the industry long enough, good investors are always willing to share their thoughts and insights which you can gain to iterate and refine your business further,” Tan said. “Most importantly, continuously nurturing ongoing relationships with investors is paramount — a common saying in Vertex is that the best time to speak to investors is when you are not raising any funds!”

Recent trends in VC investments

Outside of focusing on the startup’s offerings, business plan, and scalability, founders should also keep a close eye on what’s trending in venture capital if they plan to earn funding through the VC investment process. Keeping a finger on the pulse of VC investments can help founders analyze their own businesses, improve weaknesses, and play on any strengths that could be trending.

For example, startups that are incorporating or are entirely focused on artificial intelligence (AI) may find more interest from VCs alongside more competition, as investments in AI are trending.

According to Bain & Company, global VC investments have been especially fruitful for AI-, sustainability-, and clean energy transition-focused companies. That’s clear with a recent $5.2M investment in Guided Energy, a startup creating software for electric vehicle fleet operators. In California, an emissions-tracking software company called Watershed Technology has just secured $100M in Series C funding and is now valued at $1.8B.

While sustainability-related investments are popular, investments for startups utilizing AI are a hot trend, with PYMNTS reporting that AI is now mentioned in an estimated 80% of pitches to investors. 

One such company, TravelPerk, exemplified the popularity of investing in AI by securing $104M for its expansion plans, particularly involving AI development to make corporate travel more efficient.

That’s not to say that some more traditional startup ideas aren’t still able to secure investing. TechCrunch’s Equity podcast reported that industries like SaaS, edtech, and fintech might be seeing declines in the amount of money invested in these types of startups, but these companies are still pulling some VC investments. For example, Goodshuffle, a SaaS startup for the event and production industry, recently raised $5M, and SUMA Wealth, a fintech startup, received $2.2M.

Startup financing is within reach

The VC investment process is one of many ways that startups can gain funding for their business. But to succeed in this competitive space, startups need to be prepared by doing research into investors and VC firms, creating a solid business plan, showing traction, and preparing to prove scalability. For startups that are ready to take their business to the next level, tapping a financial projections template can help you prepare for the future, not only helping with investing pitches but also improving cash flow management.