Even revolutionary ideas need a little help to get rolling. When an entrepreneur has a new business vision, they usually need to raise money for development, marketing, and talent management. Unless the startup founders are high rollers with years of experience, they will look to venture capital and angel investors who will guide them through the first round of funding, known as the seed stage.
There are a few guidelines that founders should listen to carefully in order to raise seed capital and grow their startup. First and foremost, leaders should be prepared before meeting with prospective investors, and have a list of references who will back the idea. Founders should get creative with funding, always willing to put themselves out there beyond a comfortable limit.
- Seed capital is the initial investment into a business provided by venture capitalists or angel investors to help it grow.
- Many investors that provide seed capital are involved in the business in more than just a financial way.
- When seeking seed capital, a business must be prepared with a solid business plan, avenues for growth, and cost and revenue projections.
- Networking is an important part of obtaining seed capital, and mentorship programs such as incubator firms help as well.
- Crowdfunding is an increasingly popular and quicker route in obtaining seed capital.
What Is Seed Capital?
Seed capital rounds differ from proceeding rounds quite significantly. More than a few players are involved, as multiple funds invest an average of $200,000 to $700,000 each. In addition, there are usually a few individual angel investors who invest more than just financially in the company.
Angel investors usually get to know the founders and have an interest in the business that transcends the necessary belief in a high return on investment (ROI). Some distinguished angel investors include serial entrepreneurs and former CEOs who have a track record of bringing businesses public. The seed stage “plants the seed” for a startup to thrive, in order to launch business operations and show revenue data for the next rounds of funding.
Above All, Be Prepared
Business leaders need to have specified projections and hard numbers ready on demand for venture capitalists before diving head-first into the seed capital round. A compelling business plan will include a strength, weaknesses, opportunities, and threats analysis (SWOT). Founders need to have a thorough understanding of how venture capitalists make investment decisions.
Venture capitalists will need to know exactly how much funding a business will need and specific plans for allocating investment resources. A detailed cost projection will need to be explained and defended. In order to uphold credibility and shield oneself from entering an unfair deal, founders should have a strong idea of how much of the business they are willing to give up. They should also have a clear concept of the interests and goals of the investors, and an understanding of the capital structure of proposed funding.
Seed capital is a form of equity financing, where the business owners give up a percentage of ownership in exchange for capital. It stands in contrast to debt financing.
Many upside provisions are confusing and if not understood can prevent founders from realizing future profits. Everything should be based on hard numbers that give best-case and worst-case ROI scenarios to founders. The numbers will ultimately drive negotiations for the VC's percentage stock ownership.
Business founders should put together a list of supporters prior to meeting with venture capitalists. Founders should identify references and make sure that they are on board, understand the business idea, and know what to say when questioned by investors.
Gather Committed Investors
Winning over investors is the focus of seed capital rounds, which is easier if businesses have established themselves prior to seed fundraising. Human psychology has shown time and time again that if someone else already went through the decision process, another will be more comfortable in making the same decision. No one wants to be the first one to take a risk, even risk-loving venture capitalists.
Founders should solidify investor commitments. This way, when prospective investors make contact, the committed angels can confirm their decision to invest X amount in the startup.
Founders may strategically shoot for relatively small commitments, around $20,000 to $50,000. They should also consider giving reasonable provisions on these promises, such as minimum amounts and other stipulations. This will make early investors more willing to negotiate, given the downside protection.
Put Yourself Out There
If a founder doesn’t have mentors and angel investors as contacts, they cannot be afraid to get out there and go to the VC community directly. Networking is the most essential tool and skill that an entrepreneur needs, ahead of business acumen.
For example, Gagan Biyani, the co-founder of Udemy, a platform for online courses, has written extensively about the challenges and errors made when his company was initially trying to raise seed money, including being rejected by dozens of potential investors.
Startup mentorship programs and incubator firms are open for applications. Y Combinator and TechStars are two well-known programs that churn out a mass of successful startups. Many programs choose applications that receive on-premise coaching and a small investment to get the businesses off the ground, in turn for a percentage of equity ownership.
Incubator firms and accelerator firms are very similar businesses that help startups grow, but have some differences that are important to consider when deciding which to join.
Ways to Plant Seeds
In the technology age, it's easier than ever to reach angels, who enjoy using social media channels and interacting with enthusiastic entrepreneurs. Many lesser-known VC firms focus on local entrepreneurship funding, in counties and communities outside big startup hubs like San Francisco and New York.
Additionally, founders may consider the newly popularized crowdfunding method for raising seed capital. Kickstarter.com and many other crowdfunding sites now act as a platform to match investors and startups. The Jumpstart Our Business Startups Act, or JOBS Act of 2012, lifted restrictions on investing in early-stage companies so that the common person could have the opportunity to invest. Companies that aim to raise less than $1 million in total capital can do business with aspiring investors.
Find a Responsible Driver
The presence of a lead investor is essential in seed stage rounds. In general, relatively more firms and investors are involved in seed capital funding than in other rounds. However, few actually take the reins in “leading” the round.
Leading the round means taking a risk by providing a large amount of capital in relation to other key players. VC firms that lead have the responsibility for due diligence and setting the terms for future rounds. They, therefore, limit their involvement as lead investors.
For founders, it is vital to find a lead early on and secure other investments with strategic value add propositions later on. Leads must be completely enthusiastic about the long-term growth potential in order to take on this important role. Founders must make sure to space out exciting news and keep the momentum going throughout this courtship.
Don’t Give Up
Again, it is important to keep the entrepreneurial spirit and stay optimistic without wearing away credibility with a naive sense of idealism. Business projections should include the "best worst-case scenario." Staying transparent coincides with a clear pledge by the founders that they believe in the business and will sacrifice for it.
Usually, in seed rounds, the business does not have a track record to fall back on, and therefore VC firms and angels rely on faith in the management team more than ever. Keeping in mind all of these tips will help a company gain traction and succeed in later rounds of funding that are essential for developing and scaling the business.
What's a Venture Capitalist?
A venture capitalist is a type of investor that provides funding to new or newly expanding companies in exchange for an equity stake. The venture capitalist typically jumps in at the point that the company is looking to commercialize or otherwise expand its concept.
What Is an Angel Investor?
An angel investor is a wealthy individual who helps startups with funding in the early stages, typically using their own money. While angel investors usually represent individuals, the entity that doles out the actual funds might be a limited liability company (LLC), a business, a trust, an investment fund, or other type of financial vehicle.
Are Angel Investors and Venture Capitalists the Same?
While both invest in companies in the early stages, angel investors tend to use their own money, while venture capitalists invest money pooled from a group of investors that is then placed in a managed fund.
The Bottom Line
Seed stage capital funding allows business leaders to hit the ground running with their new ideas. The seed stage differs from other stages in the sense that many more key players are involved, including angel investors interested in aspects of the business other than ROI.
Founders should prepare well before meeting investors, by hashing out hard numbers and lining up support that will back them up to questioning VC firms. If you're an entrepreneur, you should already be inclined to get creative with your strategy, and never be hesitant to exert extra effort and confidence.