Getting a business up and running is an expensive endeavor. But, starting a business that is aiming to grow rapidly requires a significant amount of capital. When entrepreneurs do not have enough personal capital to get their new business off the ground on their own, they have to raise money. This usually comes in the form of seed money.
Seed Funding in A Nutshell
Seed funding is a very early investment aimed at helping a new business set up for long-term growth. The seed funding stage is the first equity funding stage for startups. Seed funding is usually the first capital that a business raises. Investors who put capital in a business venture at this stage are hoping that the founders can navigate the business world and develop a profitable, high-growth business.
When given seed funding, entrepreneurs can then take the steps to start their business, including hiring staff, renting space, initiating sales and marketing campaigns, and product development. This is very capital intensive. High growth-oriented startups often burn through initial funds to sustain growth before making a profit.
Seeding funding for startups is considered very risky due to the high rate of failure of startups. Investors taking this risk will likely expect equity in exchange for their investment. Traditional financial institutions typically do not provide seed funding for companies at this stage of growth.
The good news is that there are plenty of investors who see the potential of these new companies and are willing to invest their money. However, this kind of fundraising is also difficult, discouraging, and complex. Properly understanding what seed funding is will help any entrepreneur raise the capital they need to take their business to the next level.
Why Should I Raise Seed Money?
The first question you may have is why do I need to raise a seed round? There are a number of reasons why raising a seed round is beneficial to your business.
There are a few of the benefits to raising a seed round:
- No risk to your own personal assets and financial risk. Raising seed money keeps your personal finances safe when starting a new business. Entrepreneurs have taken personal risks and even used their credit cards to finance their businesses.
- Investors provide strategic business advice to your company. Starting a business is incredibly difficult. Experienced investors can help guide you through the early stages of starting your business.
- Rapidly accelerate the growth of your new business. Investor capital can be used to invest in better products, services, and staff. Extra capital helps your business create products and services that standout from the competition.
- More time to fine-tune the business model and greater flexibility to react to market demand.
Even with all of these great benefits, there are some risks associated with raising seed money.
- Reduced equity in the new business. Entrepreneurs give up equity in their company in exchange for capital. This equity could be worth billions of dollars in the future.
- Loss of control of the company. Investors could potentially kick you out of the company that you founded. This is an inherent risk when raising capital from investors.
- Investors who may demand a premium due to the riskiness of investing in an early-stage company. Seed money is inherently risky. Investors will demand more from your business when they invest in you in the early stages of your business.
- Costs of regulatory compliance associated with seed funding. Keeping up with all of the regulatory requirements can be costly, which takes capital away from other parts of your business.
When Should I Raise a Seed Round?
Figuring out when to raise seed money is not a straightforward task. It may not be clear when you should go to investors for a seed round. Entrepreneurs may often hold out as long as possible to hold on to as much equity as possible. Some companies even avoid raising seed money altogether by bootstrapping.
For ambitious entrepreneurs who are looking to rapidly grow their business, bootstrapping will not cut it. The startups they founded need a large amount of capital in order to achieve their full potential. Company founders should plan to raise money only when they have figured out the opportunity in the market, their customer segment, and its rapid rate of growth.
Considerations For Entrepreneurs When Raising Seed Money
Questions to Ask Before Raising a Seed Round
- What is the valuation of the company? Estimating the value of your business is critical before going to raise capital. You need to know if raising a seed round is realistically possible.
- How important is it to retain control of the company? When raising capital there is always the potential that you will lose some control over your company. Investors will have more input into your company’s strategy and operations.
- Do you have a backup plan in place if the business scales slower than you expect it to? Entrepreneurs should ensure that they have plans in place in case the business fails or grows slower than expected.
- Are there other funding options, such as Small Business Administration loans? Raising money from investors is difficult. Finding alternative fundraising routes could be an effective way for some entrepreneurs to get the capital needed without giving away equity.
- Is the market and opportunity real and sufficiently large? Entrepreneurs need to show investors that the market they are targeting is big enough to offer a return on their investment.
Potential Action Items Before You Go To Investors
There are action items that you should take care of before raising a seed round. These steps will help ensure that you have your business ready for investors.
Incorporation, Company Filing, and Taxes
You should incorporate your business as an LLC (Limited Liability Company), an S-corporation, or C-corporation. You need to ensure that your business is properly registered and is filing taxes. Investors will check to see if your business has taken the right steps to grow.
The value of your business idea may rely heavily upon the fact that you can get a patent for your invention and technology. Getting a provisional patent shows investors that your business will be protected from intellectual theft. Your business is worth much more if you can secure a provisional patent.
Projected Balance Sheet
Investors will want to see financial projections of your business. This balance sheet should have your financial plan for the next 18 to 24 months and shows where you need money and why you need it. You should ensure that the balance sheet is accurate and realistic.
Creating an investor presentation is a key part of the seed fundraising process. This presentation will cover everything an investor wants to know about your business. You need to have an effective presentation that convinces potential investors to fund your startup.
Seek Legal Advice
The seed funding round is an incredibly complex process. You are probably not versed in certain legal topics, such as securities resolution or contract law. Legal issues could sink your business if you do not take the proper precautions. You should work with an experienced lawyer who understands this space to avoid any pitfalls.
Now that you have everything you need to start pitching investors, one looming question remains.
How Much Capital Do I Need?
Attempting to estimate how much capital is a task that many entrepreneurs struggle with when they are ready to raise money. This hugely complex problem has countless variables that need to be considered. Some of the variables that need to be considered are dilution of equity/ownership, rate of business expansion, and new staff hiring. Most funding rounds will require 10% to 20% dilution of ownership shares. Most experts recommend that you try to avoid more than 25% dilution.
Entrepreneurs often underestimate the amount of capital needed to start and sustain their business until the next funding round. After all, entrepreneurs do not want to give up more equity than they need to and it is extremely difficult to accurately forecast how much capital will be needed. The best-case scenario would be to raise enough capital to enable your company to make it to the next funding milestone.
Entrepreneurs should work closely with their team to develop an accurate forecast that gives investors an idea of how much capital is needed. If you accurately estimate how much capital you need, not only will future fundraising be easier, but you may be able to survive without new funding if the funding environment gets tight.
Regardless, the amount of seed funding that you are asking for must be tied to a realistic and believable plan. That plan will provide the credibility necessary to persuade investors that their money will have a chance to grow. However, it is difficult to predict the future in an ever-changing world. Entrepreneurs could consider developing multiple plans, assuming different amounts raised, to showcase inventors that they are ready for any scenario.
Now that you have a number in mind for the amount of capital that you need to raise, you need to decide who you are going to ask for their money.
Where You Can Get Seed Funding
There is a multitude of sources of seed funding available to entrepreneurs. Your business should carefully consider all sources of funding. Just because one source does not fund your business does not mean all hope is lost. Successful entrepreneurs are tenacious when it comes to raising money.
Family and Friends
Some of the biggest companies in the world have raised their seed money from relatives and friends. Entrepreneurs may find that raising money from this pool of investors is easier than other groups. This group of investors typically invest in their relationship with the founders, rather than the concept. Family and friends may offer their funding in the form of a loan, however, there are cases where they do take equity.
High-net-worth individuals invest in early-stage companies. These investors expect equity in return for their investment. Angel investors could potentially be family members or friends.
A venture capitalist (VC) can be a person or group of investors who invest in high-growth companies. VCs often provide a number of resources besides capital, such as hiring and networking, to the companies they invest in. In the past venture, capitalists would typically only invest in more established companies, but VCs are increasingly investing in seed rounds.
Incubators & Accelerators
Incubators are investors who along with providing small seed funds, also provide training and office space. Typically incubators do not ask for equity holdings from startups, they only charge startups on a fee basis. Accelerators generally focus on helping businesses scale up through training, mentoring, and networking opportunities. However, there are some early-stage business accelerators that also provide businesses with seed funding. Unlike incubators, accelerator programs take equity.
This form of seed funding has recently become popular for startups. It is relatively easy as compared to raising money from traditional investors. Crowdfunding sites provide platforms for startups to raise small amounts of money from a large number of people and give investors equity, debt interest, or rewards in return. Crowdfunding can be used to fill in gaps in seed funding rounds.
Raising money from corporate companies is an effective way to raise seed money. Large companies like Google, Intel, and Apple invest in startups regularly with seed funding. These corporations are eager to invest in startups that have talented team members. Some startups that have corporate-backed investments are eventually bought by large corporations. Entrepreneurs who are not well connected may have difficulty connecting with corporate investors.
Is Seed Funding Right For Me?
Seed funding plays a very crucial role in the future of many businesses. If you are considering raising a seed round, several factors must be taken into consideration including the amount of equity you are willing to give up, terms of payment, and the need for strict accountability. It is a personal and business decision when choosing to raise a seed round.
Startups generally do not begin earning profits immediately. When there is a lack of seed funding, many companies suffer and eventually close down. An alternative possibility is to apply to a bank for a business loan, but this may also be a burden for the company with high monthly interest payments.
Seed funding covers expenses for the hiring of necessary talent, marketing, equipment, facilities, insurance, business licenses, and incorporation. This capital is used to create the products and services that the business sells, as well as the marketing and distribution.
Overall, seed funding may be the best route for a business to be successful. It offers an effective and straightforward funding solution that enables the growth of your new business and gets it off the ground. Raising seed money is hard work, but it can be worth it in the long run if you play your cards right.
Interested in learning more about fundraising? Check out our guide “What is Series A Funding”
At Newchip we help entrepreneurs get funded. If you need further information about how to raise your Seed Round, feel free to apply here, one of our Venture Analysts will contact you soon.