Strategic Funding

Alternative approaches to early-stage financing

Happy Thursday, 👋

One of the most common concerns for startup teams is how to fund a new venture. Typically, the first step many new teams take after deciding to launch a company is to spend weeks creating a presentation and scheduling calls with potential investors.

We prefer to focus on investing in post-revenue companies because we value businesses that are committed to building a product or service, not just a pitch deck. Instead of immediately seeking outside investment, we encourage new teams to prioritize generating their first dollar of revenue. Too often, we have seen companies with impressive presentations fail because there was no market demand for their ideas.

The True Cost of Early Capital

While some industries and ideas may require initial capital, the majority of startups should try and reach the revenue generation stage before accepting investor funding. Securing even a few initial paying customers confirms a level of market demand and makes subsequent investor conversations more productive.

Startups also need to consider the high cost of early-stage funding. On average, dilution for a Seed Round is 20%, meaning that investors take a significant ownership stake in exchange for their capital.

As illustrated in the chart above, the earliest funding stages reflect the highest dilution due to the increased risk for early investors.  A startup team beginning with 100% ownership will see that share reduced to 80% after a Seed round. With subsequent rounds, such as Series A, ownership may drop to 60%. The impact of dilution makes early capital particularly expensive, highlighting the need for strategic decision-making about when to bring in outside investors.

Creative Alternatives to Early Funding

For early-stage teams, exploring revenue generation strategies or alternative funding sources can be a more cost-effective option. Two approaches we often recommend are offering early customer discounts or pursuing grant opportunities.

When starting a new business, founders usually have an idea of who their initial customers will be. These early customers are often close contacts from previous employment or long-established industry relationships. Consider approaching these early customers with an offer to pay upfront for the new product or service in exchange for a significant discount. The goal is to generate just enough cash flow to support early product development efforts. Even if these initial sales are only break-even, it can be a win for the startup as it’s able to fund initial product development without costly third-party investor capital.

Government grants offer another avenue for early-stage funding, providing non-dilutive financing. The U.S. government administers over 1,000 grant programs, representing more than $500 billion in annual awards. While securing a grant requires substantial research and documentation, and not all companies will qualify, studies suggest that 20-40% of grant funds remain unused. This represents a significant opportunity, especially for teams willing to navigate the grant application process.

Future Funding Hurdles

While accepting an early investment can streamline a company’s growth path, it’s crucial to understand the hurdles a company must clear once it steps onto the capital-raising track.

The average step-up valuation from Seed to Series A is just over 3x. For example, a company raising Seed capital at a $5 million valuation would need to reach a $15 million valuation before attracting Series A investors. Achieving this increase in valuation (assuming a 10x revenue multiple) involves growing annual revenue from $500,000 to $1.5 million, which typically requires adding new team members and expanding the customer base.

We advise founders to think ahead about the requirements for subsequent funding rounds. If a company raises $1 million in a Seed round, that capital usually needs to last about two years - the average time between a Seed and Series A raise. Founders should carefully weigh the trade-offs between raising early third-party capital or pursuing creative options like customer discounts or grant programs.

Additional Thoughts

The decision to raise initial Seed capital is significant, often resulting in 20% dilution of the founding team’s ownership. While founders may consider raising capital as the first step in growing a company, those who explore alternatives like early customer discounts or grants may find these more strategic options a better fit for funding initial product development.

Ideally, a startup should hold off on raising third-party capital until the founding team can no longer support customer demand. While early capital can facilitate scaling, it also sets a runway filled with financial hurdles.

Can the company sustain itself for two years on its initial capital raise? Is there a clear path to a 3x increase in valuation? Considering these questions can guide founders in choosing the best strategy for early funding. Sometimes leveraging customer discounts or grant programs can become the foundation for a much stronger future capital raise.

Wishing everyone a great weekend,

-The Caymont Ventures Team.