In terms of funding, you should expect to go through 3 phases:

1. Friends, Family and Fools
2. Angel funding
3. VC funding

1. Friends, Family and Fools:

Initial funds that will help you get your project off the ground. Small amounts from people who trust you. This is the phase when you have to build the "sweat equity", to produce a prototype and to start getting some traction.

2. Angel funding:

Once you have a prototype, and the begining of a revenue flow, you can attract Angel money, to help you polish the product and really get the sales process going on some key markets.

Typically, Angels are involved with amount up to $1M, with an average probably around $750K.

Note that between these amounts and what VCs will cover, you also have something called the funding gap (the funding levels that are too high for Angels and too low for VCs), which is increasing. It seems that after the clean-up that has happened in the VC industry after the bubble, we have now the same amount of money invested through fewer VCs. As a result, an average VC deal is now closer to $7M (instead of $4M a few years ago). Something that is not going to make the life of entrepreneurs easy.

A few things to keep in mind:

2.1- Notes with discount are not a good idea above 20% of the amount you plan to raise in the coming round (notes typically are to bridge until you can get a real round of financing). The trap is that if you raise too much money that way, you may end up with a problem when the time comes to discuss valuation:

if you raised $500K with notes and then you want to raise $1M in a series A round. If the VC/Angels ask for 40% of your company for $1M, then you will also have to give away another 20% to the people with notes (assuming no discount, it will be more if you had a discount included with the note).

2.2- The other trap with notes, and with friend and family money in general is that you may be tempted to take money from non-accredited investors which will represent a risk for the company, and therefore will pollute your negotiations with future investors. The issue with non-accredited investors is that they could decide to sue if the company does not perform as they expected. And if they are not accredited, they can claim that they were not familiar with investing and they were mislead. Not a good thing.

A good read on the whole thing:

http://money.cnn.com/2006/02/28/magazines/business2/angelinvestor/

More info on the Angel Market:

http://wsbe.unh.edu/Centers_CVR/2006pressrelease.cfm

3. VC funding:

The classic VC investment. From what I have seen, the odds are that 1 in a 1000 start-ups are actually funded, and then out of 10 funded, only 3 will make it big, 4 are bringing back a reasonable return and 3 fail.

Note that in terms of investment, the behavior from Angels is similar to the one from VCs:

- they do not take risk, and will only invest in start-ups that feel safe to them: senior management team with proven track record, or a company that already has a product and some sales.

The way I see it, VC or Angel money is like steroids: it is usually given to people that are already very good, and it is just a way to make them run faster than their peers. But if you cannot run, don't expect that this will do you any good...

- the goal here is to digest the feedback as much as possible, because it is always useful when it comes from people who look at a lot of business plans, and have good understanding of what other start-ups in the same field are doing.

From a process prospective, VC or Angel investment involves a lot of dancing: you talk, and you get feedback, and then you talk again until you get to a level of maturity in the business and a level of trust between the two that works on both sides. This includes revenue from sales, strong management team, strong advisory board, strong partners. In this area, despite the stories advertise by the press of guys who get funds after talking for a couple of hours in a restaurant, based on a business plan drawn on the tablecloth, you should expect the process to last a long time (I would figure a good 3 to 6 months assuming you have all the good ingredients already).

On this specific subject, there is a good video you can watch: VC Funding 101 - thank you Aurelie

Once there is interest, you will have to come up with a term sheet, and negotiate all the little details that will make the deal a good one or a bad one for yourself. Lots of options in this area, this is a hard part.

And then you will get the money in phases, based on milestones and results imposed by the investors. Another difficult stage. This is where the original founder(s) make it or not, depending on how they can deliver. The goal at that point is to last as long as possible, to maximize the equity that you have in the business. And then leave gratiously when it is time :-)