Every beautiful garden starts with a sufficient seed planted in the ground. This is where the term ‘seed funding’ gained its identity. This is where a new venture obtains its earliest funding to grow. Seed funding for startups is what is required for you to see those beautiful flowers in the garden. It is the early money to plant the initiative of something in the ground and hope that it flourishes in the future. Continue reading to know more about how seed funding for startups works and what they actually are.
What is Seed Funding?
Seed funding for startups refers to the initial capital used to establish a business. It can be obtained by the founders of the company themselves, family and friends, angel investors, startup incubators, and venture capitalists, particularly in exchange for a stake in the business.
Some startups raise pre-seed funding, but the majority go with seed funding. This capital is used for the upfront investment in business operations like market research, product development, recruitment, and marketing campaigns.
Pre-seed and seed fundraising rounds are likely to be less formal compared to other rounds. A seed round remains undetermined. This means that the business does not have a valuation yet, and investors get convertible securities instead of direct equity. Seed-stage funding rounds can range from tens of thousands to hundreds of thousands or even a million dollars.
What are the Different Types of Seed Funding for Startups?
There are four types of seed funding for startups-
Unpriced Rounds
Since startups in the seed stage are very new, it could be challenging for a business to determine the business valuation against which they can raise capital. Hence, in several cases, seed rounds are unpriced and investors invest in exchange for a type of security that is convertible into equity. The equity conversion is often influenced by an event such as a priced funding round like Series A.
Frankly speaking, unpriced funding rounds are quite simple, quick and less expensive for the businesses in comparison to conventional equity rounds. This is why they need less paperwork and legal costs.
SAFE Notes
Simple Agreement for Future Equity (SAFE) notes are considered equity on the balance sheet. They are legal agreements wherein an investor agrees to offer capital in exchange for the right to buy shares in future rounds.
SAFE has become a common tool in the seed funding stage, as it is comparatively simple and quick. Unlike convertible notes, the SAFE notes are used in unpriced rounds. It does not include interest rates or maturity dates.
SAFEs encompass valuation limits that set a maximum valuation at which the investment will convert. This safeguards the investors from over-dilution if the value of the business increases significantly. Another common advantage is a conversion discount that provides a discount on the price per share for the early investors in comparison to those who invest later.
Convertible Notes
The convertible notes are another factor used in unpriced rounds. It is debt that converts into equity afterwards due to an influential event. When it is issued, a convertible note is somewhat similar to a bond. The convertible notes include an interest rate and a maturity date by which the interest must be paid.
The note is convertible into equity upon the occurrence of an event, such as a future equity round of fundraising or a company acquisition. If an influential event has not occurred by the maturity date, both the entity and the investor can decide to extend it.
On the other hand, the business may have to pay out the principal, as well as interest, when the maturity date arrives.
Priced Rounds
Finally, the priced rounds function similarly to a standard equity fundraising round. The investors obtain direct equity in the business on the basis of particular startup valuation. This is not very common for seed-stage entities compared to SAFE notes. However, it is available to founders like serial entrepreneurs who have achieved success over the years.
When to Raise Seed Funding for Startups?
Prior to seeking investment from the potential investors, whether that is family or venture capitalists, it is important to have some basics to appeal to the investors:
Demonstrate Product
It is beneficial to have a basic example of the product or service to showcase its potential for growth in front of investors. A minimum feasible product is the basic version with sufficient features for the consumers to use and engage with. This may not be an overall prototype. There are some types of minimum viable products that do not need you to develop a product such as:
- A website that determines the product and its features
- An interpretative video
- A smoke test marketing campaign
- A single-feature MVP testing
The outcomes from these MVPs will help us receive feedback from customers and demonstrate demand to investors.
Financial Plan
A financial plan is important for securing investment, which shows your idea as a profitable business. In your pitch, you should include specific details that depict the story of your business. For example, you can include market research and the justification of why the offering is the good-fit. Define the revenue streams, annual sales, customer acquisition cost, website traffic and profit margin of your business. Discuss future plans in your pitch and finally justify the need for capital.
Compelling Narrative
Investors should understand the pain point that your product or service addresses. Hence, you should catch attention of the investors through compelling story that shows personal interest.
Identified Investors
Finally, if you are focusing on angel investors and venture capitalists for fundraising, then you should research the investor’s past investments to decide whether the business fits to their interests. You may have the best products or ideas in the world. However, if your investors are into technology, there will be no point.
However, some startups only raise venture capital. Hence, while finding investors for your startup funding, do not limit yourself. Consider other investors like friends and family, crowdfunding channels and other grants.
Also Read:
Wave of Entrepreneurial Support: Transforming Startup Financing
