The concept of seed funding for startups has been around for years as entrepreneurs rely on external funding to kick off their ventures, if they haven’t raised pre-seed funding. ‘Seed funding’ is a very important stage in a startup’s lifecycle as it acts as the foundation for the beginning. The stronger the foundation, the further the company can go.
So, here’s everything there is to know about seed funding
What Is Seed Funding?
Seed funding is a very early investment which aims at helping a business grow and generate its own capital. Also referred to as seed money or seed capital, investors often get equity stake in exchange for the capital invested. The investors can themselves be the founders and use their savings as seed money for their new company — also known as bootstrapping.
Why Seed Funding Matters
It is a fact that starting a new business and lifting it up off the ground is a huge ask for most entrepreneurs and it only gets tougher with capital constraints. Seed funding helps get things started before the business earns any revenue and can cover everything from infrastructure costs, marketing and development costs as well as the cost of initial hiring.
Investment is the fuel of any business and seed funding is the first drop of this fuel. As seed money becomes much-needed cash reserve or working capital, not having it is one of the main reasons for failure.
Why is Seed Funding Important?
There are several other reasons why seed funding is important:
- Cover for insufficient funds
- Reduces founder risk in venture
- Brings strategic partners to the table
- Access to working capital
- Easier scaling up and growth acceleration
4 Types Of Seed Funding For Startups
On the path of seed funding, the first step is understanding the different type of investors or potential investors as there are multiple sources where one can aid from:
What is Startup Crowdfunding?
With more than 500 crowdfunding platforms currently active, this has become one of the most popular avenues of seed funding. Crowdfunding platforms are usually open and anybody in the world may end up backing the concept, idea or product.
What is Corporate seed fund?
This is a great source of seed funding as it comes with big visibility for the startup brand. Tech giants such as Apple, Google and Intel back startups regularly with seed money. Big companies often look at startups as a future source of profit, IP or talent, and that’s the primary motivation for investment here.
What are Startup Incubators?
Incubators generally provide small seed investments and offer services such as office space or management training. Most incubation programmes do not take equity from the startup, but do offer support beyond just funding.
What are Startup Accelerators?
Accelerators are more focused on supporting startups in scaling up their business rather than backing and nurturing early-stage innovation. Accelerators also back startups through small seed investments along with professional services, networking opportunities, mentoring and workspace. Unlike most incubators, most accelerators take equity as they are privately funded.
Who is Angel investor?
Angel investors are individuals that offer capital in place of ownership equity or convertible debt. They are called angel investors because they provide capital at times when the risk of a startup failing is fairly high, which is during the early stage.
What is Personal Savings
Founders may put in their personal wealth and savings as seed funding. Also known as bootstrapping, this brings extra financial pressure but there is no pressure on founders to return borrowed money.
What is Debt Funding
Debt mostly includes money taken from banks as loans, or borrowed from friends and family. Sometimes, venture capitalists or angel investors also issue loans instead of equity investments.
These are investments which start off as loans but change into equity or shares depending on the progress of the company, and when it reaches certain milestones such as sales or revenue targets.
What is VC Funding
Venture capitalists are marquee investors that provide funding based on a number of parameters such as growth potential, market conditions, founder vision, idea or simply execution. In return, they take some portion of equity or stake in the startup. VCs usually join multiple rounds of investment after seed stage, if the startup manages to reach those rounds.
What is Angel Fund or Angel Network?
Sometimes, investors come together to form angel networks or groups where they each invest small amounts in the idea or the company during the early stage financing round.
Laying The Groundwork For Startup Seed Round
To know when to raise money for a project, founders must first realise what it takes to get investors to sign deals for investments. Investors need to see potential in the idea or product or vision. Sometimes, just the reputation can enable a founder to get seed money but, in most cases, the investors would undertake thorough vetting of the entire business plan.
Nowadays, technology has enabled founders to rapidly build a software product or hardware device in a short period of time and get it out for the investors to judge for themselves. Once they get to know the product, the first thing that will be assessed is product-market fit. Without projected growth numbers, this is a crucial part in a startup’s early journey. It will be quite hard to convince outsiders to support the product if the market-fit is not great. So, have answers for questions about the following major points:
- What is the market opportunity?
- Who is the target audience or customer?
- How does the product solve an existing problem?
- What will be the adoption rate?
How To Raise Seed Funding for Startup?
There are a few steps founders need to follow in order to understand how to get seed funding for a startup. For the best investment in terms of amount and investor relations, founders and entrepreneurs need to research the investor market and find an investor that is active for the sector it works in.
Startups should also be ready with all the paperwork and bank details that will be needed for the transaction. One of the most important parts of impressing the potential investor is the pitch. It should be precise with all the necessary data that the investor would want to know. The pitch should include all projected data and justifications for those projections. If the numbers seem impressive and achievable to the investors, they will proceed to the negotiations.
How Startup Funding Works
Before exploring how a round of funding works, it’s necessary to identify the different participants. First, there are the individuals hoping to gain funding for their company. As the business becomes increasingly mature, it tends to advance through the funding rounds; it’s common for a company to begin with a seed round and continue with A, B and then C funding rounds.
On the other side are potential investors. While investors wish for businesses to succeed because they support entrepreneurship and believe in the aims and causes of those businesses, they also hope to gain something back from their investment. For this reason, nearly all investments made during one or another stage of developmental funding is arranged such that the investor or investing company retains partial ownership of the company. If the company grows and earns a profit, the investor will be rewarded commensurate with the investment made.
Before any round of funding begins, analysts undertake a valuation of the company in question. Valuations are derived from many different factors, including management, proven track record, market size and risk. One of the key distinctions between funding rounds has to do with the valuation of the business, as well as its maturity level and growth prospects. In turn, these factors impact the types of investors likely to get involved and the reasons why the company may be seeking new capital.
Pre-Seed Funding for Startup
The earliest stage of funding a new company comes so early in the process that it is not generally included among the rounds of funding at all. Known as ‘pre-seed’ funding, this stage typically refers to the period in which a company’s founders are first getting their operations off the ground. The most common ‘pre-seed’ funders are the founders themselves, as well as close friends, supporters and family. Depending upon the nature of the company and the initial costs set up with developing the business idea, this funding stage can happen very quickly or may take a long time. It’s also likely that investors at this stage are not making an investment in exchange for equity in the company. In most cases, the investors in a pre-seed funding situation are the company founders themselves.
Startup Seed Funding
Seed funding is the first official equity funding stage. It typically represents the first official money that a business venture or enterprise raises. Some companies never extend beyond seed funding into Series A rounds or beyond.
You can think of the ‘seed’ funding as part of an analogy for planting a tree. This early financial support is ideally the ‘seed’ which will help to grow the business. Given enough revenue and a successful business strategy, as well as the perseverance and dedication of investors, the company will hopefully eventually grow into a ‘tree.’ Seed funding helps a company to finance its first steps, including things like market research and product development. With seed funding, a company has assistance in determining what its final products will be and who its target demographic is. Seed funding is used to employ a founding team to complete these tasks.
There are many potential investors in a seed funding situation: founders, friends, family, incubators, venture capital companies and more. One of the most common types of investors participating in seed funding is a so-called ‘angel investor.’ Angel investors tend to appreciate riskier ventures (such as startups with little by way of a proven track record so far) and expect an equity stake in the company in exchange for their investment.
While seed funding rounds vary significantly in terms of the amount of capital they generate for a new company, it’s not uncommon for these rounds to produce anywhere from £10,000 up to £2 million for the startup in question. For some startups, a seed funding round is all that the founders feel is necessary in order to successfully get their company off the ground; these companies may never engage in a Series A round of funding. Most companies raising seed funding are valued at somewhere between £3 million and £6 million.
What is Series A Funding for Startups?
Once a business has developed a track record (an established user base, consistent revenue figures, or some other key performance indicator), that company may opt for Series A Funding in order to further optimise its user base and product offerings. Opportunities may be taken to scale the product across different markets. In this round, it’s important to have a plan for developing a business model that will generate long-term profit. Often, seed startups have great ideas that generate a substantial amount of enthusiastic users, but the company doesn’t know how it will monetise the business. Typically, Series A rounds raise approximately £2 million to £15 million, but this number has increased on average due to high tech industry valuations, or unicorns. The average Series A funding as of 2020 is £15.6 million.
In Series A funding, investors are not just looking for great ideas. Rather, they are looking for companies with great ideas as well as a strong strategy for turning that idea into a successful, money-making business. For this reason, it’s common for firms going through Series A funding rounds to be valued at up to £23 million. The investors involved in the Series A round come from more traditional venture capital firms.
By this stage, it’s also common for investors to take part in a somewhat more political process. It’s common for a few venture capital firms to lead the pack. In fact, a single investor may serve as an ‘anchor.’ Once a company has secured a first investor, it may find that it’s easier to attract additional investors as well. Angel investors also invest at this stage, but they tend to have much less influence in this funding round than they did in the seed funding stage.
It is increasingly common for companies to use equity crowdfunding in order to generate capital as part of a Series A funding round. Part of the reason for this is the reality that many companies, even those which have successfully generated seed funding, tend to fail to develop interest among investors as part of a Series A funding effort. Indeed, fewer than half of seed-funded companies will go on to raise Series A funds as well.
What is Series B Funding for Startups?
Series B rounds are all about taking businesses to the next level, past the development stage. Investors help startups get there by expanding market reach. Companies that have gone through seed and Series A funding rounds have already developed substantial user bases and have proven to investors that they are prepared for success on a larger scale. Series B funding is used to grow the company so that it can meet these levels of demand.
Building a winning product and growing a team requires quality talent acquisition. Bulking up on business development, sales, advertising, tech, support, and employees costs a firm a few pennies. The average estimated capital raised in a Series B round is £33 million. Companies undergoing a Series B funding round are well-established, and their valuations tend to reflect that; most Series B companies have valuations between around £30 million and £60 million, with an average of £58 million.
Series B appears similar to Series A in terms of the processes and key players. Series B is often led by many of the same characters as the earlier round, including a key anchor investor that helps to draw in other investors. The difference with Series B is the addition of a new wave of other venture capital firms that specialize in later-stage investing.
What is Series C Funding for Startup?
Businesses that make it to Series C funding sessions are already quite successful. These companies look for additional funding in order to help them develop new products, expand into new markets, or even to acquire other companies. In Series C rounds, investors inject capital into the meat of successful businesses, in an effort to receive more than double that amount back. Series C funding is focused on scaling the company, growing as quickly and as successfully as possible.
One possible way to scale a company could be to acquire another company. Imagine a hypothetical startup focused on creating vegetarian alternatives to meat products. If this company reaches a Series C funding round, it has likely already shown unprecedented success when it comes to selling its products in the United Kingdom, for example. The business has probably already reached targets. Through confidence in market research and business planning, investors reasonably believe that the business would do well elsewhere.
Perhaps this vegetarian startup has a competitor who currently possesses a large share of the market. The competitor also has a competitive advantage from which the startup could benefit. The culture appears to fit well as investors and founders both believe the merger would be a synergistic partnership. In this case, Series C funding could be used to buy another company.
As the operation gets less risky, more investors come to play. In Series C, groups such as hedge funds, investment banks, private equity firms, and large secondary market groups accompany the type of investors mentioned above. The reason for this is that the company has already proven itself to have a successful business model; these new investors come to the table expecting to invest significant sums of money into companies that are already thriving as a means of helping to secure their own position as business leaders.
Most commonly, a company will end its external equity funding with Series C. However, some companies can go on to Series D and even Series E rounds of funding as well. For the most part, though, companies gaining up to hundreds of millions of pounds in funding through Series C rounds are prepared to continue to develop on a global scale. Many of these companies utilize Series C funding to help boost their valuation in anticipation of an IPO. At this point, companies enjoy valuations in the area of £118 million most often, although some companies going through Series C funding may have valuations much higher. These valuations are also founded increasingly on hard data rather than on expectations for future success. Companies engaging in Series C funding should have established, strong customer bases, revenue streams, and proven histories of growth.
Companies that do continue with Series D funding tend to either do so because they are in search of a final push before an IPO or, alternatively, because they have not yet been able to achieve the goals they set out to accomplish during Series C funding.
How Much Startup Seed Amount To Raise?
To understand how much to raise, founders must first know what their business is worth. This is where ‘valuation’ comes into play. Valuation at the seed stage is a measure of growth potential and not the current value of the assets or IP. It is important to determine the valuation of the company before heading to investors as they always have that in mind when talking numbers. There are multiple ways in which this can be done:
Discounted Cash Flow Method:
This method takes into consideration the free cash flow that will be generated in the future after accounting for instabilities and inflations and then discounting them to calculate the current value.
Market Comparables Method:
This method takes valuation estimates with reference to other comparable companies and their market capitalisation.
Venture Capital Method:
This comes into consideration when the investor is planning to exit the company in generally 3 to 7 years. In this method, the expected exit price is taken into consideration and then the current post-money valuation is calculated.
This doesn’t always mean that a high valuation during the seed round is the best thing. For a high seed round valuation, the valuation for the next round will need to be even higher for investors to pay attention
Getting optimal seed funding would help startups reach growth stage sooner, but a lot of startups require follow-on rounds and need to have investment milestones in place. In such a case, reaching the next funding milestone becomes the goal of the company.
There are several factors and trade-offs that affect how much seed money startups should raise. Firstly, they need to think about credibility with the investors, the amount of progress they can make with that amount and the dilution of stake. To get investment, founders have to give something away. When it comes to trading off shares or equity, an ideal situation would be giving up 10% of the company for seed money. In most cases, up to 20% dilution may be required but anything more than that at the seed funding stage is considered a big no-no, and exceptional.
To ask for whatever amount seems right, startups need to have a believable plan that will tell investors that their money has the potential to grow. Whether they raise the full amount or some portion of it, founders need to believe that their startup will be successful.
When deciding what the right amount should be, calculate how many months they need funding for. This way, founders can get an estimate on the team growth and potential, and add cover for other possible factors. There can be a lot of variation in seed funding which is completely dependent on the founder and his vision for the company.
Making A Funding Deck
A seed funding deck or a pitch deck is a presentation that founders looking for seed funding showcase to their prospective investors with an aim to get capital for their startups. Therefore, one needs to impress the investors in order to get his/her company off the ground if seed funding is the way he/she has chosen.
Know the audience
When presenting a pitch, the people in the audience will have their own respective angles and goals. So, founders need to know what seed investors might be looking for. If the pitch reaches the right investor, he/she will want to jump on board and if the pitch pleases multiple investors.. Retain investor attention through interesting insights into the market, which will keep them engaged through the pitch.
The Startup deck is not a script
Any investor will be turned off as they look at an entrepreneur reading his idea off a piece of paper. Don’t just read out what the presentation already states. The pitch should come naturally and should have insights beyond what’s on screen. The design of the pitch and the delivery needs to be alluring, engaging and lively. Try to explain one idea per slide, and try to wrap up the pitch in as short a time as possible, without skipping over any important details. Always have plans and roadmaps ready for the pitch.
Don’t make it into a commercial
Startups often cross the line between pitch deck and a commercial. Focus on the idea and don’t sell it. Stick to numbers and projections and craft the startup’s story through its people in such a way that seed investors can relate to it organically. A startup’s idea is often automatically conveyed to investors in an interesting pitch, so it’s important to not hard-sell.
Start with the presentation core
Without beating around the bush, the pitch tells investors exactly what the vision is and what its implementations are. Starting a presentation like this is the best way to go about it. After the opening lines, go on to describe in enough detail what the company is, what are the metrics, the team, the expectations from investors and the trade-offs that the founder is willing to make.
A strong conclusion is as important as a strong intro. A confident end will stay with the investors even when they’re out of the room. Even though, towards the end of a pitch, an investor has already made up their mind whether to invest in the startup or not. But, a strong conclusion can change that opinion. The formula of “call to action followed by a bold sign off” works quite well when it comes to creating a pitch deck.
How To Choose A Right Investor for your Startup?
When looking for seed-stage money, startup founders need to make sure that they are not rigid in their expectations but adaptable. Seed funding varies from sector to sector and from investor to investor. Everyone expects investment from venture capitalists but that doesn’t mean ignoring or neglecting avenues such as fundraising through friends, family and angel investors.
As always the investor’s sector expertise, funding capacity, portfolio alignment or diversification — depending on the investor’s goals — and influence in the industry are key questions to answer when selecting an investor for the seed funding stage.
Sometimes, the amount of funding may be low, but the influence of the investor outweighs the amount — which can help in raising more funds through other investors or in growth prospects in the market. It’s all about finding the right fit and seeing the positive ripple effects of associating with the investors for the startup.
Finally, startups need to find investors that can get along with the idea and vision of the founders since there is a lot of money involved.
While it might be difficult to know someone’s intent right off the bat, startups and founders need to investigate in the right manner through discussions and meetings and diligence to know what investors have in mind, their goals, their method of working etc.
There are a lot of factors to keep in mind while starting a business and especially when looking for seed funding. It is one of the best ways to get new companies off the ground and hopefully on the right track. Seed funding for startups allows them to have a strong foundation without having to think about team salaries, office or retail space, product development costs and other hurdles in the early stage.