Introduction to Early Financing for Web3 Startups

Author: Chainlink

Whether for Web2 or Web3 startups, fundraising is one of the most challenging and important hurdles. However, the difference in the Web3 ecosystem compared to Web2 is that entrepreneurs can adopt unprecedented decentralized methods to raise funds.

For Web3 companies in the early stages of entrepreneurship, the best approach is to first secure some seed funding like Web2 startups. However, in subsequent funding rounds, Web2 and Web3 startups will begin to diverge.

Early Stage Entrepreneurship

The "seed stage" typically refers to the first round of funding for a startup. However, some investors believe that the seed stage is more like a kind of "gradient" rather than a stage. Early-stage investor Parul Singh has provided the following "gradient classification" for the seed stage:

The early funding scale for current Web3 projects is continuously expanding, surpassing the scale of the seed stage gradient proposed by Singh in 2018.

According to an article from Forbes in 2021, the average funding amount for the seed stage in 2020 was $1.5 million, which grew to $3.3 million in 2021. Some Web3 companies even raised $3 million in the pre-seed round.

Despite the capital market's keen interest in the Web3 field, Web3 startups still face multiple challenges during the fundraising process, and their funding channels differ from traditional startups.

To understand these differences, a specific study of the early funding stages is necessary.

Pre-seed Funding Channels for Web3 Startups

In the pre-seed funding round, most founders are still at the stage of idea presentation and prototype development. Many view this stage as the "project initiation stage" rather than a true funding stage.

To smoothly cold-start their startups, entrepreneurs often need to utilize some special funding channels to obtain funds without giving up equity, such as applying for grants or loans. In addition, founders can also invest out of their own pockets, or if they are lucky, find an angel investor willing to provide early-stage funding.

However, most entrepreneurs initially cannot rely on their networks to secure funding. Therefore, startup grants are a key channel for obtaining non-repayable startup funds, which is particularly prevalent in the Web3 ecosystem.

Startup Grants from Traditional Institutions

Many traditional institutions from the public and private sectors are looking for opportunities to enter the Web3 field, providing startup grants to promising startups to stimulate innovation. Here are some examples:

• The European Commission's "Horizon Program" has distributed €180 million in rewards and grants under the "Horizon 2020" program.

• The "Santander Global Blockchain Challenge" initiated by Santander Bank offers startup grants to blockchain startups, with a total prize pool of €120,000.

• The UNICEF Venture Fund provides up to $100,000 in non-equity investments for startups that have the potential to benefit humanity.

Considerations

These grants typically require that the startup comes from a specific region or industry. Government grant incentive programs especially encourage the use of blockchain technology to create value for society.

Additionally, many traditional grant or subsidy programs require founders to bear a certain percentage of the costs. For example, these grants may subsidize 70% of the prototype development costs, while the founders or team need to cover the remaining 30%.

Startup Grants from the Web3 Industry

In the Web3 industry, some large companies also wish to incentivize startups to use their technology to expand their ecosystem. This is particularly true for companies developing ecosystems on Ethereum, Cardano, or Solana blockchains. However, these large companies or project teams' grants are often highly sought after, so entrepreneurs may also consider grant programs launched by emerging blockchain networks. Once a product concept is validated on one chain, it becomes easier to raise funds and expand to other chains.

Grant Programs Focused on Specific Blockchains:

• Ethereum's "Ecosystem Support Program"

• Polkadot's Web3 Foundation

• Avalanche's Multiverse Incentive Program

• NEAR Protocol's Grant Program

• Celo Foundation's Grant Program

• Harmony's Ecosystem Fund

• Cross-Chain Foundation's Grant Program

For a complete list of grant programs, please visit:

blockchaingrants.org

In addition, there are some Web3 organizations whose grant programs are not limited to a specific blockchain, such as blockchain infrastructure companies and cryptocurrency trading platforms.

Grant Programs Not Limited to a Specific Blockchain:

• The Chainlink Community Incentive Program provides grants to development teams, encouraging them to develop tools for the Chainlink ecosystem or integrate Chainlink technology.

• Filecoin has launched a developer grant program aimed at funding new products, businesses, and tools to enhance Filecoin's functionality.

• Kraken has introduced a developer grant program to support new projects in established blockchain ecosystems like Bitcoin and Ethereum.

• Coinbase has launched a developer grant program to support developers in building and maintaining the crypto ecosystem.

Considerations

These grant programs are often very competitive and fill up quickly. Therefore, it is essential to set up Google Alerts to be notified as soon as possible.

Moreover, the purpose of these grants is often to incentivize developers to participate in a specific technology ecosystem, so applicants must use a certain technology or focus on a specific application scenario, which may not align with the startup's actual situation.

Like other grants, the amounts of these grants are typically only sufficient to develop a product prototype, and after that, founders still need to immediately seek funding channels to support further product development.

Web3 Incubators, Accelerators, and Founder Communities

While startup incubators and accelerators may not necessarily provide funding channels, they can offer training, guidance, and workspace for early-stage startups.

Startup incubation programs aim to assist entrepreneurs from the very beginning, helping them learn the necessary business skills and prepare for subsequent funding rounds. For blockchain startups, subsequent funding rounds may not necessarily follow traditional funding methods, so it is crucial to choose an incubator focused on the Web3 field.

Web3 Incubators and Founder Communities:

• Startup with Chainlink Program is a Web3 startup program created by Chainlink Labs specifically for founders, connecting early blockchain projects with a global network of founders and providing the necessary guidance to successfully launch blockchain projects.

• The Klaytn Startup Incubation Program focuses on startups in the fields of DeFi, metaverse, GameFi, and creator economy.

• R3's Venture Development Program specifically provides funding for startups developing B2B solutions using distributed ledger technology, extending from pre-seed to Series A funding.

• dlab INCUBATE is an incubator initiated by SOSV and EMURGO (an investor in Cardano), providing pre-seed funding and rich resources to founders around the world to help them develop and test blockchain products and services.

• Orange DAO is a community created by Y Combinator alumni, specifically for funding early Web3 startups.

Web3 Accelerators:

• Alliance DAO is a Web3 accelerator and founder community.

• Outlier Ventures' Base Camp is an Open Metaverse startup accelerator.

• Tachyon is an accelerator for early blockchain and Web3 startups.

Traditional accelerators like Y Combinator, Techstars, and Antler are also currently investing in blockchain startups.

Platforms like incubator list and F6S, which cater to founders, have also published complete global startup program lists, some of which are specifically aimed at blockchain startups.

While incubators are not the primary funding channels, they are still very suitable for founders who lack entrepreneurial experience or do not know how to communicate with investors. They provide founders with the necessary guidance, teaching them how to write business plans and develop specific market entry strategies for the Web3 industry.

Web3 Crowdfunding

Crowdfunding has been popular for a long time, but due to the adoption of blockchain technology in Web3, its crowdfunding model is slightly different. For example, Juicebox is known as the "decentralized Kickstarter," based on publicly available smart contracts on Ethereum, and is currently a very popular crowdfunding platform. Juicebox aims to raise funds for DAO projects from the Web3 community. Kickstarter announced in December 2021 plans to launch a new Web3 platform to crowdfund innovative projects on the Celo blockchain. Gitcoin provides decentralized grants for new projects and startup teams focused on open-source development. Similar to Gitcoin, DoraHacks continuously releases funding, grants, bounties, and hackathon events, with the only difference being its greater focus on the Asian market.

While these funding channels can enhance project initiation, the amounts are insufficient to support long-term product development. Founders still need to continue raising more funds to carry out subsequent product development.

Seed Rounds and Subsequent Funding Rounds for Web3 Startups

At this stage, companies will sell equity to an institution or professional investor for funding, which may be a startup accelerator or angel investor, or it could be an early-stage venture capital firm.

Then, financial capital will be transformed into productive capital, generating net value through acquiring hardware, technology, and human resources. For Web3, human capital refers to hiring new employees or signing community contributors through developer programs.

Regardless of where the funds come from, all startups must meet some basic requirements before starting seed round funding. First, they must understand the criteria investors use to evaluate a startup's potential; second, founders must be clear about what type of investors they need. The second point is especially important for Web3 founders, as many investors may be very optimistic about the potential of Web3 startups but may not have the ability to provide guidance for their development.

Understanding Investor Expectations for Web3 Startups

Traditional venture capitalists review thousands of investment projects each year and establish a decision-making mechanism to quickly filter opportunities before formal evaluations. Generally, the screening criteria for Web3 startups are similar, but there are still some differences.

The following diagram illustrates the typical venture capital deal evaluation process, including how to search for opportunities and what criteria to use at each evaluation stage.

This decision-making mechanism filters out 83% of investment opportunities at the outset, with only 17% of projects moving on to the next stage.

Many of these are basic criteria that are equally applicable to Web3 companies. For example, the founder's previous entrepreneurial track record and product or go-to-market (GTM) strategy are evaluation criteria that are important for both Web2 and Web3 companies. However, the moat and deal structure for Web3 differ from those of Web2.

For Web3, the Moat Emphasizes "Switching Costs" and "Network Effects"

The essence of Web3 is decentralization, so Web3 projects are usually open-source and maintained by a decentralized network of contributors. This means that any project can potentially fork or give rise to new projects. For instance, at the time of writing this article, Defi Llama lists 254 forked projects of Uniswap, which is an innovative protocol used by many decentralized exchanges (DEX). However, despite the many competitors on Ethereum, such as SushiSwap, Uniswap remains the decentralized exchange with the highest TVL (Total Value Locked). This clearly demonstrates that in the Web3 space, timing and community are more critical moats than the code itself. Therefore, venture capitalists prefer products that can build strong communities and launch unique features to enhance user stickiness and switching costs, preventing users from being lured away by subsequent forked projects.

The Deal Structure in Web3 Has Different Considerations Regarding Equity Dilution

For Web2 startups, the negotiation focus of the deal structure is how to divide the equity between current and future investors and the founding team. Once a startup enters Series A, B, or C funding, the equity of the founders and early investors will be diluted. Therefore, many venture capital agreements take this risk into account and set terms to avoid equity dilution.

However, for Web3 startups, private fundraising typically does not extend beyond Series A. Once a startup gains traction in its target market, it will adopt a decentralized fundraising mechanism rather than relying on private placements. While equity dilution remains a concern, many Web3 startups will only face this issue in the early stages of fundraising, rather than repeatedly encountering it in multiple rounds of private fundraising.

Web3 Founders Must Be Clear About What Type of Investors They Need

While some Web3 projects choose to fund entirely through the community, for most Web3 startups, a better option is to find a primary investor who can provide ongoing guidance amid market fluctuations. This is essentially a long-term relationship. Although Web3 projects tend to grow faster than Web2, this rapid growth is closely tied to the cycles of the entire crypto market, resulting in significant volatility.

Experienced investors tend to take a long-term view and do not pursue short-term returns. Therefore, the relationship between investors and founders is often likened to a marriage, where both parties need to be clear about their expectations. We have already discussed the expectations of investors, so let’s look at what expectations founders should have.

Find an Investor Who Understands Web3

In 2021, a large number of investors entered the Web3 field, many of whom are still in the exploratory phase. While they are very interested in Web3, they may lack the ability to provide sufficient guidance to the invested companies to help them scale their business and community.

However, most Web3 startups need more than just financial support from investors; they also expect to receive a range of additional value:

• Guidance on equity distribution

• Guidance on how to create open-source communities

• Access to a larger resource network

• Expertise in business and operations

Founders must conduct due diligence on the current investment portfolios of venture capital firms to understand whether these invested companies have received the necessary support from the venture capitalists. This is because founders and venture capitalists often have different expectations regarding the specific forms of support. Forward Partners published a report titled "More Than Money," which mentioned that 3 out of 5 founders feel they did not receive the support initially promised by venture capitalists.

The Rise of Decentralized Investment

DAOs (Decentralized Autonomous Organizations) are also a unique funding channel. Investor syndicates are not a new concept, and many traditional investor syndicates exist on platforms like AngelList. However, the appeal of DAOs for Web3 founders lies in their ability to decentralize funding without needing venture capital approval.

For example, investors can establish decentralized "investment clubs" on Syndicate DAO, collectively investing in projects through a pooled fund. Stacker Ventures is also a DAO that specifically invests in early-stage startups, aiming to "align the economic incentives of community investors with the founding team."

Web3 is Transforming the Funding Process, but Founders Still Need to Focus on Fundamentals

Web3 startups can raise funds through various forms, including securing seed funding, startup grants, and participating in incubation programs. The Web3 field has greatly innovated funding channels, creating decentralized crowdfunding mechanisms. While many believe these innovations will change how venture capital operates in the Web3 space, founders must remember one thing: regardless of the form of funding, projects must have certain fundamentals, which is no different from traditional venture capital. Fundamentals include robust technology, a clear business plan, a pragmatic product roadmap, and a reliable leadership team.

Despite this, many founders still lack the skills, networks, and operational expertise to attract seasoned investors. Therefore, early Web3 projects can join incubation programs or founder communities specifically targeting Web3 entrepreneurs and take a crucial step on their fundraising journey.

Apply for the Startup with Chainlink Program

The Startup with Chainlink Program provides world-class resources specifically for Web3 entrepreneurs and supports them on their entrepreneurial journey. The program aims to provide one-stop assistance for startups from initial project conception, proof of concept, system development to community incubation.

All Web3 teams currently developing unique products and services are welcome to apply. Please subscribe to the Chainlink newsletter for more information about resources for Web3 startups.