In the context of startups, ‘seed funding’, ‘seed money’ or ‘seed capital’ are terms that are getting more and more familiar to the casual audience. 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. It 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 or seed stage funding is a very early investment which aims at helping a business grow and generating 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. It is an effective solution for startups and growing businesses as it provides the much-needed early monetary support.
It 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.
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
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:
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. Some examples of successful crowdfunding campaigns include the Oculus Rift which raised more than $2 Mn, Pebble wearables which raised more than $10 Mn, and Indian company Exploride, which raised more than $500K for its heads-up display for cars.
- Corporate seed funds:
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. GV is the investment arm of Alphabet (Google’s parent company), while Intel Capital is chipmaker Intel’s dedicated division for startup investments.
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. The Indian Angel Network Incubator, IIT-Bombay’s Society for Innovation and Entrepreneurship or SINE, Khosla Labs and state-backed incubators such as T-Hub and KSUM are are some of the most active incubators in India.
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. The popular accelerators include Y Combinator, Techstars and 500 Startups.
- Angel investors
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. In India, the top angel investors in H1 2019 are Sanjay Mehta with eight deals this year, followed by VC Karthic, Siddharth Ladsariya, Sharan Aggarwal and Sachin Tagra – each adding seven deals.
- 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.
- 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 to ventures in sectors where cashburn is high, but so is the traction.
- Convertible Securities
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.
- 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 managers to reach those rounds. For seed funding, Accel Ventures, Seedfund, Sequoia Surge, Axilor Ventures, SEAFund are some of the most venture capital firms in India.
- Angel Funds or Angel Networks
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. The major angel networks in the market currently are AngelList, Indian Angel Network, Lead Angels, as well as angel networks for each major startup hub in India.
Laying The Groundwork For 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?
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. This way, startups can raise seed money in India and overseas.
How Much 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 tradeoffs 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 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.
- Confident conclusion
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 The Right Investor
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.