The earliest stages of business creation can be confusing and seem like they’re full of Catch-22s. How do you raise money when you have no track record as a business owner? How do you demonstrate that you’re a good investment when you have no product? Where is the money supposed to come from?
Well, that’s where seed funding comes in.
What Is Seed Funding?
Like many buzzwords in the entrepreneurial investing world, seed funding is a term that may be used interchangeably with a few others and, depending on who you ask, comes either immediately after the angel investment phase, or concurrent with it.
So what is seed funding? Seed funding can be any amount of money, from any source, that helps move a business from the conceptual phase to the implementation phase. Seed funding is typically a small amount of money relative to the scope of the business proposal and often comes from personal sources like family and friends.
What differentiates seed funding from a loan — or even charity — is that you’re usually offering equity or a share of profits to the funder (which means your step-mom could be a shareholder. Proceed at your own risk). Additionally, seed money is used to prepare a business for future rounds of equity financing from venture capital and similar sources.
Note, however, that it is possible, if uncommon, for venture capitalists to offer money during the seed phase.
How Seed Funding Works
From the investor’s point of view, even if they are your best friend from high school, their goal is to get equity they can eventually liquidate.
In other words, it’s meant primarily for businesses that are looking to make an IPO or sell within a relatively short timeframe (figure somewhere around six years). Compared to future phases of venture financing, seed funding will typically be in lower amounts and from non-institutional financers. Your seed funders can literally be anyone. You’re also likely to have more of them than you will investors in future stages of financing. Raising seed money helps demonstrate to venture capital groups that you’re able to generate confidence in your idea.
The exact amounts you can raise will vary by business, with bigger, more complex ideas requiring larger amounts of seed money. More specifically, that means you are raising enough money to get you to your next funding milestone. Typically that will be a year to a year-and-a-half after implementing your idea.
Remember that you are selling pieces of your business. You’ll need to sell more of it in future phases of financing, so you are dealing with a finite resource. Ideally, you’ll want to sell as little of it as you can. According to YCombinator, you’re probably looking at selling around 20% of your company during the seed round. If you’ve more than 25% in the seed round, you may have issues in future rounds of financing. If you’ve managed to sell only 10%, you’re a business demigod and could probably have a fall-back career as a hostage negotiator if this entrepreneur thing doesn’t work out.
Seed Funding VS Series A Funding
Seed funding comes prior to Series A funding.
In fact, the point of seed funding is to keep you going long enough to be prepared for Series A funding.
Series A is the first phase in which venture capital starts to kick in, assuming things are going well. You’ll use your seed money, plus any angel investment, to build a prototype of your product or service and create a solid business plan to the investors you’ll be presenting to during Series A. In comparison to the seed phase, you won’t be petitioning family, friends, and neighbors so much as venture capital groups and investors with deep pockets.
During Series A, you’ll be raising money to expand your operations, hire personnel, and scale-up production with the goal of monetizing the product or service. The average successful Series A round in 2020 raised around $15.6 million.
Seed Funding VS Angel Investors
This one’s a little more confusing. That’s because angel investors can be a source of seed funding. They’re just not the only source of seed funding.
Angel investors are wealthy, accredited investors who offer cash infusions to startups, typically in exchange for equity. They’re differentiated from venture capitalists in that they tend to act as individuals rather than as a part of a group that pools its resources. They can also get involved during any phase of business development, whereas venture capital tends to happen in a more regimented series of fundings. Angel investors may also offer debt financing rather than equity financing, particularly if the amount of money being borrowed is low.
So technically angel investing can happen before, during, or after your seed funding phase.
How To Get Seed Funding
The answer is simple if frustrating: Anywhere you can. In fact, you — yourself and your business partners — may be a source of seed funding. Remember if you’re taking the route of equity financing, proving that you can get people to believe in your vision enough to give you money is an important part of showing venture capitalists that you mean business.
Your personal networks –friends, family, acquaintances, neighbors, even coworkers– are low-hanging fruit for seed funding, just remember to be honest with them about what you’re doing and what the risks are, or you’ll risk straining your personal relationships. As we touched on above, angel investors are also a potential source of seed funding. They can be elusive, but networks like AngelList can at least help you figure out where they are.
A more novel source of seed funding might be equity crowdfunding. This isn’t Kickstarter, where you’re essentially frontloading sales. Instead, you’re petitioning online masses for money in exchange for, you guessed it, equity in your business. These types of services are relatively new and are the subject of much debate and analysis in the investing world, but if you’re not lucky enough to live in an entrepreneurial hotspot, they may be a way to raise money remotely.
Learn About Other Financing Resources For Entrepreneurs
Seed funding is just one small part of equity financing and an even smaller part of startup financing in general. If you want to learn more, check out some of our other resources for entrepreneurs.
- 6 Financing Options For Up & Coming Entrepreneurs (Plus 4 Expert Funding Tips To Get You Started)
- SBA Loans For Startups: Types, Terms, & How To Apply
- How Much Money Do You Need To Start A Business?
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