How Does a Startup Raise Money?
For the last six months, you’ve been thinking about starting a business.
The only problem? You don’t know what business to start.
Then one day, while travelling to university, an idea comes to you. You take out your phone and write it down.
You get home and start planning. You research the market, talk to a few people, build a business plan and convince yourself that this could become the next big Sri Lankan company.
Congratulations! 🎉
But there’s one small problem.
You need money to get started.
You have some savings, but not enough to build the product, develop a website, hire people and market the business.
So you sit down with your family and explain your idea. Most of them aren’t convinced.
But your uncle believes in you.
He agrees to invest LKR 1 million in exchange for 20% of your company.
It might sound like a small investment, but there’s something important happening here.
Your uncle has just valued your business at LKR 5 million — even though you don’t have a proven product, customers or revenue yet.
You register the company and issue 100,000 shares.
You keep 80,000 shares and give your uncle 20,000 shares.
Now you own 80% of the company and your uncle owns 20%.
You use the money to build your website, develop your product and get the business started.
But Then You Run Out of Money…
A few months later, your money is running low.
This time, things are different.
You no longer have just an idea. You have a product, some early customers and evidence that people are interested.
So instead of going back to your uncle, you start looking for outside investors.
You approach angel investors.
Angel investors are individuals who invest their own money into early-stage businesses they believe have the potential to grow.
Think of them as the real-world version of the investors you see on shows like Shark Tank.
But getting an investor isn’t easy.
You need to convince them that your business can succeed, that there is a large enough market and, most importantly, that you and your team can execute the plan.
After speaking to several investors, you finally find one who is interested.
But now comes the negotiation.
Pre-Money vs Post-Money Valuation
You hear two terms:
Pre-money valuation and post-money valuation.
Don’t worry. It’s simpler than it sounds.
Pre-money valuation = What the company is worth before the investment.
Post-money valuation = Pre-money valuation + New investment.
Let’s say the investor agrees to invest LKR 10 million at a LKR 20 million post-money valuation.
That means the investor will own:
LKR 10M ÷ LKR 20M = 50%
So the investor gets 50% of the company.
But what happens to your shares and your uncle’s shares?
They get diluted.
You don’t lose your existing shares. Instead, the company issues new shares to the investor.
Before the investment:
- You: 80,000 shares = 80%
- Uncle: 20,000 shares = 20%
- Total: 100,000 shares
After issuing new shares to the investor:
- You: 80,000 shares = 40%
- Uncle: 20,000 shares = 10%
- Investor: 100,000 shares = 50%
- Total: 200,000 shares
Everyone’s percentage ownership has changed, but nobody’s original shares disappeared.
Now You Have Capital to Grow
With the LKR 10 million investment, you rent a small office, hire developers and designers, improve your product and start marketing.
Finally, your product is ready.
Customers are coming in.
Revenue is growing.
Things are looking good.
But…
You run out of cash again.
This time, your business needs significantly more money to expand.
You want to hire more employees, invest in technology, enter new markets and scale your sales.
So you start looking for venture capital (VC).
VC investors are professional investors who manage funds and invest in businesses with significant growth potential.
And because your business now has a product, customers, revenue and a growing team, it is worth considerably more than it was when you started.
The Next Funding Round
Let’s say a VC agrees to invest LKR 100 million at a LKR 200 million post-money valuation.
Once again, the VC gets:
LKR 100M ÷ LKR 200M = 50%
Your company issues new shares to the VC, and everyone’s percentage ownership is diluted again.
You might be thinking:
“Wait… aren’t we giving away too much of the company?”
That’s exactly why valuation and ownership are so important when raising capital.
But there’s another interesting part.
Dilution Doesn’t Necessarily Mean Losing Money
Remember your angel investor?
They originally invested LKR 10 million for 50% of a company valued at LKR 20 million.
Now, after the VC investment, their ownership might have fallen to 25%.
At first, 50% → 25% sounds terrible.
But look at the value.
If the company is now valued at LKR 200 million, their 25% stake is worth:
25% × LKR 200 million = LKR 50 million
Their original LKR 10 million investment is now worth LKR 50 million on paper.
Your uncle’s 10% stake would now be worth LKR 20 million, compared with his original LKR 1 million investment.
And your 20% stake would be worth LKR 40 million.
Of course, these are paper values. Nobody has actually received that money yet.
The investors are betting that the company will continue to grow.
What Happens Next?
You might continue raising capital through further funding rounds — Series A, Series B, Series C and beyond.
Each round can provide the capital needed to grow the company, but each new investment can also dilute existing shareholders.
Eventually, after several years of hard work…
You make it. 🚀
Your business has grown into a successful company.
It has a strong customer base, significant revenue and a valuable brand.
Now your early investors finally have an opportunity to turn their investment into actual cash.
There are several possible paths.
The company could be acquired by another company.
Or, if the business becomes large enough, it could potentially go public through an IPO (Initial Public Offering).
In Sri Lanka, that could mean listing shares on the Colombo Stock Exchange (CSE).
After an IPO, shares become available to public investors, who can buy and sell them through the stock market.
Your uncle, your angel investor and other early investors may then have an opportunity to sell some or all of their shares and realise their gains.
So, What’s the Big Picture?
This is a very simplified example, but the basic journey looks something like this:
Idea → Family/Friends → Angel Investors → Venture Capital → Growth → Exit or IPO
Of course, real-world fundraising is much more complicated.
There are shareholder agreements, term sheets, preference shares, convertible instruments, due diligence, voting rights, liquidation preferences, employee share options and many other factors to consider.
But the basic principle is simple:
Investors provide capital.
The business uses that capital to grow.
In exchange, investors receive a share of the company.
And as the company becomes more valuable, those shares can potentially become much more valuable too.
That’s the basic idea behind startup funding, valuation and dilution.
Thanks for reading!
