Seed Round Funding: An In-Depth Guide
Seed round funding is the first substantial step in startup funding.
Unless founders thoroughly know what goes on in the background, the multi-layered process of raising a seed round might appear overwhelming and complicated.
This article is a comprehensive guide to seed fundraising for business founders, outlining when to initiate the round, how it works, how much money should be raised, and much more.
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Table of Contents
What is seed round funding?
Seed capital is an early-stage investment in which investors provide startups in return for an equity stake in the business. The seed round funding is typically the second round of funding after the pre-seed round funding.
Seed funds are typically spent on product, recruitment, sales and marketing, and research and development.
As part of the seed round funding for startups, there should be a return value to the investors. This may take the form of an equity stake, a stake percentage, or in some circumstances, a share of future (later-stage) profits.
The amount of seed capital varies, depending on the startup’s needs, the industry, and other critical business aspects.
What is the purpose of seed funding?
Few startups succeed without obtaining outside capital.
Usually, startups face competition from established, lucrative businesses. Therefore, a startup would already be severely disadvantaged without funding because a rapid infusion of cash via seed round funding enables startups to take off and thrive.
A seed fund aids a startup’s scaling to the point where it can attract venture capital and offer investors a strong return. That is, seed round funding is more than simply financial support.
Moreover, it comes with a network of investors and advisers who offer guidance, mentoring, and resources that assist startups in growing and scaling.
When should you raise seed funding?
Deciding when to raise initial money for a startup may be challenging. Founders should seek seed investors when they think they have a solid enough team, market, product, or mix to create a business that merits seed round funding.
When it comes to seed round funding, timing is crucial. Too early could prevent the founder from determining the product’s commercial significance.
However, waiting much longer can lead to the startup facing severe competition from other players. Typically, seed investors are interested in cutting-edge products, consumer traction, the founders’ track record, and the business’s potential for rapid growth.
The seed round is the ideal opportunity to show that the product or service has the potential to gain some traction in the target market. Founders must demonstrate that their products satisfy consumer wants and that their customer adoption rate is rising. It would convince potential seed investors that the business is on the right track and that it will generate substantial returns on investment.
How much seed round funding do startups need?
Generally, it’s advised to raise enough money to either become profitable or to meet the next funding milestone quickly. It demands a thorough knowledge of the company’s operations and what is required to move to the next milestone. Typically, startups seek capital for 12 to 18 months.
Also, it is recommended to create several plans that show the various funding levels and possibilities for how much stock you want to contribute, profitability, etc. This would clarify how much capital is needed to maintain profitability as the business expands.
How much money to raise is determined by several factors. For example:
- The development possible with a certain amount of money
- Investor credibility
- Dilution of stakes
While fundraising, founders should anticipate giving up 20-25% of their stock.
Another way of viewing the optimal seed round funding amount is by calculating the startup’s monthly expenses .
In any case, founders must be able to justify the amount they are asking for with a plausible plan. This plan will prove the founders’ credibility to the investors and convince them of the potential for success.
Also, it is typically a good idea to develop multiple plans anticipating various fundraising totals and to clearly articulate the conviction that the startup will succeed, whether it raises the entire amount or a lesser amount.
How are startups valued during the seed round funding?
Startup valuation is the process of finding out how much a new business is worth. Estimating the startup’s valuation is crucial to decide how much equity the founder needs to give investors in exchange for funds.
Equity dilution depends on the startup’s valuation. Often, a low valuation results in excessive dilution, and vice versa. It should be emphasized that startup valuation considers the company’s potential for growth.
Here are a few factors that are crucial in the valuation process:
Is there market demand for the idea? Does it have the potential to scale and grow sufficiently? Creating products pertinent to the market’s scenario is essential for attracting early investors.
Does the startup have a respectable reputation in its field? Having and maintaining a positive reputation can work wonders with investors.
Is a sample available? Investors are always more intrigued by a physical product since they can actually see it in use.
4. Pre-valuation Revenues
Has the product begun to generate revenue? An excellent strategy to attract investors is to let them know that the product they invest in has already generated pre-sales bookings or revenues.
Obtaining startup funding can be much simpler if the business is in a thriving industry.
Steps to get seed round funding
Here is a step-by-step instruction for raising a seed round.
1. Type of seed round funding for startups
Although there are many sources to get seed round funding, these are the top 8 sources that startups look at:
(i) Family and Friends
Friends and family are one of the most frequent sources of seed round funding. Given their cordial bonds, reaching out to them can be very advantageous.
They might also be open to making interest-free investments in the business. In fact, 35-40% of new businesses obtain funding from friends and family.
Crowdfunding is showcasing an idea to an audience on a crowdfunding platform and receiving financing. It brings small sums of money from many people to finance a new business endeavor.
Depending on the nature of crowdsourcing, investors may donate money voluntarily or receive benefits such as equity in the startup that raised the money.
Accelerators are primarily concerned with quickly expanding firms. They accept shares in exchange for guidance, funding, and connections to financiers and business associates.
Startup accelerators offer early-stage businesses with a minimum viable product (MVP), as well as the resources and guidance required to accelerate growth that may otherwise take several years into a few months.
(iv) Debt Funding
In debt financing, an investor lends money to a startup, and the startup agrees to pay back the loan and interest later. In this scenario, the startup raises funds without transferring any ownership to the investor, and the only amounts that must be repaid are the principal and interest. Debentures, bank loans, and external commercial borrowings are a few popular methods of debt financing in India.
(v) Angel Investors
Angel investors invest when a startup is very early and has a high risk of failure. Angel investors are familiar with the startup world. They are aware that they must adopt a long-term perspective. Thus, angel investing is more flexible.
(vi) Micro-Venture Capitalists
They are prominent investors who invest in accordance with growth potential, market circumstances, founder vision, and execution. They accept a stake or portion of the company’s equity in return.
These companies make investments on behalf of a third-party limited partner when cash is collected into a fund, using partnerships to make investments to lower risk and boost credibility.
(vii) Corporate Seed Funding
The creation of corporate venture funds have gained popularity as huge organizations continue to look for innovation and new sources of income.
Companies typically collaborate with a reputable VC (or start a fund internally) and invest money across seed-stage businesses that align with the company’s growth strategy or philosophy.
A startup incubator is a cooperative initiative to aid emerging businesses’ success. By offering office space, seed money, mentoring, and training, incubators assist entrepreneurs in resolving issues often related to business management. A startup incubator’s only objective is to help business owners grow their businesses.
2. Preparing the necessary documents
Being well organized can avoid procedure delays. Before addressing investors, be sure to prepare the following documents:
(i) Business Plan
A well-thought-out plan outlining the goals and the plans to achieve those goals is an excellent way to win over investors.
Make sure to write in simple, jargon-free terminology. Do thorough market research to ensure that you have adequate knowledge to make an opening statement.
The executive summary is the foundation for the entire organization, so it should be treated with the utmost attention. While it is true that the primary goal is to create profits, don’t forget that you are establishing your brand to answer the audience’s concerns. Keep this in mind when drafting the plan.
(ii) Pitch Deck
The primary tool for seed round funding is the pitch deck. While assessing potential investment prospects, seed investors expect to see the pitch deck. An investor’s interest can be attracted and turned into action using a pitch deck. The purpose of creating a pitch deck is to inform investors about the startup, its current standing, and its expectations.
It should also inform potential investors about the product and the challenges it solves. It must have infographics, charts, and at least 10-12 slides to tell the startup’s story.
Additionally, founders must show potential investors that they have a simple, scalable method for bringing in new clients.
3. Creating a list of investors
Selecting the right partner is critical to the success of any startup.
To find investors, many founders make use of their existing networks. Others look for lists of active investors using incubators and accelerators.
Let’s look at the main factors founders must take into account while assessing potential investors to approach:
- Type of Investor: Choose which type of investor you want. Are you searching for purely financial support or someone who can be more involved in your startup?
- Experience: How long has the investor been collaborating with startups? What is their record of achievement? To ascertain the time frame, it is necessary to delve further into their profitable investments.
- Financing: Not all investors can invest millions. Using a fundraising strategy, reduce the number of investors on the list according to the funding they can provide.
- Expertise: Does a potential investor have any connections or expertise you can use? It makes sense to look beyond funding when attracting investors.
- Fit: Does this investor fit well with the business? Whether the founder and the startup will have a productive working relationship depends on how an investor engages with the startup and the founder.
4. Meet with interested investors
Once you have your investor list ready, reach out to them and allow your pitch to work its magic. Investors that want more information should contact you. Also, don’t give up if investors don’t respond immediately.
Presentations to investors in person can be daunting. This is a skill that the founder will inevitably develop over time. To maximize the chances of a productive meeting, adhere to these guidelines:
- Know your target audience: Comprehend what investors like to invest in and why. Adjust the pitch as necessary. For instance, some investors prioritize the founder, but others want to base their decisions on precise financial data.
- Make the presentation simpler: The elevator pitch needs to be succinct. Pay attention to the essential elements and keep the investor interested.
- Spend some time listening: Founders can build trust by demonstrating their interest in what investors have to say. Even if founders cannot secure funding, they can still gain knowledge by paying attention to an experienced investor’s advice.
- Balance the presentation: It’s crucial to show ambition without sounding naive between wanting to go big and wanting to change the world with facts and data.
- Be confident yet humble: The line between exuding charisma and coming off as conceited is thin. Before meeting with investors, do practice the pitch a few times. You’ll learn what works and what doesn’t over time.
5. Negotiate the Deal
An investment agreement does not mark the conclusion of the process. Several investment proposals are rejected during the negotiations. Remember, the investor has more expertise in negotiating these deals than the founder.
Don’t accept the first offer you get. Take the time to consider the options and come up with a counteroffer, whether it be for a loan or for equity. The founder should avoid engaging in real-time negotiations because of this. Constantly think about the potential value of the business and whether the offer is reasonable.
For instance, when the startup is still in its early stages, it may be okay for an investor to request 25% of the company, but what about in the future? The founder might lose $2.5 million if the startup takes off and becomes worth $10 million. Consider the future value and whether such conditions are acceptable in 10 or 20 years.
Be willing to negotiate fairly. If the investors provide acceptable negotiations and the founder doesn’t want to commit right away, it is fair for the founder to ask the investor for some time to get back on it.
But be careful not to take up too much time. Investors usually have several businesses vying for their attention, so if a founder takes up a lot of time, she may risk losing the investors.
Expect to hear “No” at some point. Avoid taking rejection personally. Consider this a chance to improve the business plan and learn about the startup.
Some challenges founders could face during seed round funding
Although seed money is considered an easy-to-find investment, it has a few drawbacks. Some of the most typical challenges a founder could have include:
1. Choosing the right investor
One poor decision in selecting the investor can cause the startup’s downfall. The investors frequently influence business decisions, and depending on their network type, it may also impact the startup’s future funding.
2. Poor pitch
Founders can risk losing out on potential investors who could have accelerated the startups’ growth if they cannot convince them of all the critical points in their pitch.
3. Not understanding the fundamentals
A lack of knowledge might be detrimental to a startup. Remember that the investors have extensive expertise and would prefer a professional.
4. Giving up equity
Most of the time, the founder must distribute some of the equity to the investors.
This means the founder has to cede some of the control even though the founder is mostly debt-free.
It’s essential to be prepared while fundraising. Understand all components, including obtaining investors for a business, creating the pitch deck, evaluating the market, and making financial projections.
However, to that end, you can expect difficulties despite your best efforts at preparedness.
This is why trica equity, a technology platform exclusively for startups, offers a plethora of products, services, and resources for early-stage startups, including end-to-end equity management, cap table management, stock option management, valuation management, and so on.
You will be in a more practical position with trica equity’s valuable guidance and actionable insights to understand your startup’s capabilities better, make the appropriate connections, and understand the funding process thoroughly.
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