Seed Capital Defined
Seed capital is the initial funding used to begin creating a business or a new product. Obtaining seed capital is the first of four funding stages required for a startup to become an established business.
[Important: A startup generally goes through four phases of investment: Seed capital, venture capital, mezzanine funding, and an initial public offering.
How Seed Capital Works
Seed capital can be a relatively modest sum of money and might come from the founder's personal assets, friends, or family. It generally covers only the first essentials such as a business plan and initial operating expenses.
The goal at this point is primarily to obtain more financing, and that means attracting the interest of venture capitalists or banks. Neither is inclined to invest large amounts of money in a new idea that exists only on paper unless it comes from a successful serial entrepreneur.
The Phases of Investment
A startup generally has to move through four distinct phases of investment before it is truly established: Seed capital, venture capital, mezzanine funding, and an initial public offering.
Seed capital and venture capital are often used as synonyms, and in reality, they tend to overlap.
Generally, seed capital is used to develop a business idea to the point that it can be presented effectively to venture capital firms that have large amounts of money to invest. If they like the idea, those firms generally get a stake in the new venture in return for investing in its development.
Venture capitalists provide the lion's share of the money needed to start a new business. It is a considerable investment, paying for product development, market research, and prototype production. Most startups at this stage have offices, a staff, and consultants, even though they may have no actual product.
So-called mezzanine financing is sometimes necessary to support a business into its introductory phase. This is usually available only to businesses with a track record, and even then at a high rate of interest.
The initial public offering is the stage when early investors get their payday, and a young business raises sufficient capital to keep growing and expanding.
The Role of the Angel Investor
Professional angel investors sometimes provide seed money either through a loan or in return for equity in the future company. They often enjoy a hands-on role in helping develop a company from scratch.
If the angel investor is contributing under $1 million, the money is usually in the form of a loan. For the entrepreneur, this can solve the problem of attracting sufficient seed money, given the reluctance of banking institutions and even venture capitalists to take on considerable risk.
When contributing more than $1 million, an angel investor typically prefers seed equity and becomes a co-owner of the startup and the holder of preferred stock with voting rights.
An Example of Seed Money
Alphabet, the parent company of Google, provided seed money to the Center for Resource Solutions in 2015 for a project to implement renewable energy certification programs in Asia. The goal of the San Francisco-based center is to help businesses buy power from clean sources.
The Center is a nonprofit, but Google has a business interest in the venture. It is already the world's largest non-utility purchaser of renewable energy but it wants to power its global data centers, and eventually its entire operations, with renewable energy.
- Seed capital is the money raised to begin developing an idea for a business or a new product.
- It generally covers only the costs of creating a proposal that can be taken to venture capitalists in order to obtain additional financing.