Few entrepreneurs can launch a successful startup without some financial backing. The initial capital raised by a company is typically called “seed” funding. It can be used to purchase equipment, rent offices, hire staff, and anything else a business needs to move from ideation to market launch.
Seed funding can come from a variety of sources, including friends and family, angel investors, incubators, accelerators, and crowdfunding, and each has its pros and cons. Read on for a closer look at what seed funding is, who provides it, and how to secure the capital you need to launch your new business.
Key Points
• Seed funding provides the first financial boost to develop a business idea, covering costs like product development, market research, and operational setup.
• Typical sources of seed funding include angel investors, venture capitalists, crowdfunding platforms, and personal networks (family and friends).
• In exchange for seed funding, investors usually receive equity, gaining partial ownership and potential future returns if the business succeeds.
• Seed funding is high-risk, as startups are unproven, but investors are drawn by the potential for high returns.
• In addition to seed funding, new businesses can apply for startup business loans to get the funds they need to start and grow their new venture.
What Is Seed Funding?
Seed funding is generally defined as the first official round of funding for a startup. This is the money that allows an entrepreneur to turn a great idea for a business into an actual business. It can be used to cover all of the expenses necessary to nourish a startup idea so it can grow and succeed.
Seed funding may come after pre-seed funding (which is not an official funding round, but can be used to develop a business idea), but before later rounds of startup funding, which include: Series A, Series B, Series C, and Series D/E.
How Does Seed Funding Work?
Seed funding can come from any source, but typically it is not a small business loan. To receive funds, business owners will generally give investors equity, or a share of ownership, in the company in exchange for the capital. As your startup grows, that equity will (hopefully) become more valuable, and investors can cash in when your business gets purchased or goes public.
Seed money can also come in the form of convertible debt. In this setup, the business owner typically repays the loan by converting it into shares at some future date when the company has sufficient valuation.
For some startups, a seed funding round is all that the founders need to successfully launch their company. However, many new businesses will engage in multiple rounds of funding.
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Sources of Seed Funding
Seed funding can come from a variety of different sources. Here are some options for startup funding you may want to consider.
Crowdfunding
Crowdfunding platforms (like Kickstarter, AngelList, and CircleUp) have become a popular way for startups to raise funds. One key advantage of crowdfunding for startups is that you typically don’t have to give up any ownership to investors in return for financing. Keep in mind, though, that it can take a significant amount of time and energy to launch a successful crowdfunding campaign. Also, some platforms are “all or nothing,” meaning funds only get processed if you reach your project’s fundraising goal.
Friends and Family
Obtaining seed capital from friends and family can often be the simplest and most convenient route to early funding, since these are the people that know you best. However, it also has the potential to strain these relationships.
If you go this route, it’s a good idea to put the terms of the deal in writing. If the money is a loan, you’ll want to set out the terms in a promissory note. If it’s an investment, it’s wise to lay out what is expected in terms of reaping profits, and also make it clear they may not recoup any of the money that they put in despite how hard you will work to make the business a success.
Incubators
Incubators are programs that offer coaching and assistance to startups, including feedback on product development and connections to influential people in the entrepreneurial community. Some also include seed funding, while others will assist you in raising funding from angel investors or venture capitalists.
Some incubators focus on specific industries, such as healthcare or artificial intelligence, and there is typically an application process for startups. If accepted, you may need to relocate for the incubation period. This period typically culminates with “demo day,” where the startup entrepreneurs present their pitch to investors.
Accelerators
Accelerators are similar to incubators except that, rather than helping a startup launch, they typically focus on helping already-established startups grow.
Accelerators typically offer selected companies a set funding amount in exchange for a certain percentage of equity. Many also offer mentorship opportunities, as well as access to funding via networking events, demo days, and pitch events. Some accelerators also offer workspaces and access to technology and services that can help expedite business growth.
Angel Investors
Angel investors are high-net-worth individuals who invest in early-stage startups in exchange for equity in the company or convertible debt (which allows the funds loaned to be converted into equity at a later date).
These investors differ from venture capitalists because they use their own money rather than investing other people’s money. Angel investors also tend to supply smaller amounts of capital than venture capitalists, which can make them well-suited to the seed funding round. Many have niche specialties that could align with your business’s industry or focus.
Is Seed Funding Necessary?
Unless an entrepreneur is independently wealthy or a business does not require much capital to get off the ground, seed funding is usually necessary.
While some entrepreneurs may try to “bootstrap” a startup and rely only on their personal savings, the amount of money needed to take a startup to profitability is usually well beyond the ability of founders to finance. Securing seed funding can also give your business a competitive edge in the marketplace by allowing you to bring on key staff and pay for marketing and publicity. Fortunately, there are many investors looking to provide funding to the right startup.
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How Much Might You Look to Raise in Seed Funding?
While seed funding amounts vary significantly, these rounds are known to generate anywhere from $10,000 to $2 million.
Ideally, you’ll want to raise as much money as you need to reach profitability. If you are able to do this, you may not need later rounds of funding and, if you do, they can be easier to get. At the same time, however, you don’t want to ask for too much, since this could scare investors away or require giving up more equity than you’d like.
To get a ballpark of how much seed funding you will need, you can calculate your current monthly costs, estimate how many months it will take to get your business up and running, then multiply costs by months. Once you’ve arrived at a figure, it can be a good idea to add some wiggle room on top for unexpected costs, which will inevitably crop up.
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5 Tips for Raising Seed Funding
Here are some ways to increase your chances of securing seed funding.
1. Building a Pitch Deck
Ideally, your pitch deck should include an executive summary, an overview of your product, its market fit, and your strategy for getting it to market. In addition, you’ll want to use data to support your points, budget for each stage, and estimate how much you need in seed funding to reach your goals. It might be ambitious to expect to get to a certain production level with just seed funding, so your pitch deck might have to show subsequent funding rounds.
Recommended: Writing a Business Plan: Step-by-Step Guide
2. Finding Which Investors to Pitch
To come up with an investor list, you may want to first reach out to other entrepreneurs and business founders that you know and ask them if they can put you in touch with potential investors. You can also find potential investors through accelerators, incubators, prospecting platforms (such as Crunchbase), and online lists of angel investors and venture capital investors.
Before putting any investors on your list, you’ll want to check to make sure they have a track record of investing in startups in your industry and your location, can access the amount of funding you need, and have timelines that match your expectations for growth.
3. Pitching
Investors will typically require an in-person presentation before they will consider committing to your company. Once you secure that coveted pitch meeting, it’s a good idea to practice your pitch until you can confidently give it from memory.
When crafting your pitch, consider your audience and their investment strategy, and then try to tell them exactly what they will want to know, such as your costs and revenue projections. Also anticipate the questions they may ask and have answers at the ready. At the same time, do your best to show your winning personality.
4. Negotiating
You may not get the offer you want right off the bat from an interested investor, so be ready to negotiate. Decide how much equity you are willing to give up in exchange for capital in advance so you don’t make a bad decision in the heat of the moment. If it’s possible to only give up 10%, that can be ideal. However, seed rounds often involve giving up 20% of your business. If possible, try to avoid going over 25%. Also, be sure to get any deal they are offering you in writing,
5. Choosing the Right Investors
If you get offers from several investors, there are a few factors you may want to consider when deciding which one to go with. These include:
• How involved are they likely to be? Think about whether you want an investor who plays an active role or if you would prefer for them to stay in the background.
• What is their track record? Try to find out more about their past investments — have the businesses they’ve invested in been successful?
• Are they a good fit for your business? Consider what else, besides money, they can bring to the table. What industries do they specialize in? What expertise and advice can they offer?
Alternatives to Seed Funding
While seed funding can give the capital you need to launch your business, it comes with a tradeoff — equity in your business. If you’d prefer not to give up any ownership of your startup, there may be some other financing options, such as startup loans, that you can tap.
Small Business Loans
There are many different types of business loans. The Small Business Administration (SBA), for example, helps businesses in early stages of product development by backing up loans made by partner lenders. Maximum loan amounts range from $350,000 to $5 million.
You may also have other small business loan options. While banks typically only lend to businesses that have been established for two years or more, alternative online lenders tend to be more flexible. You may be able to get a business loan, such as a short-term loan, startup business lines of credit, invoice factoring, or equipment financing, from an alternative lender with only a short length of business history. However, you’ll likely receive smaller amounts and pay higher interest rates than more established businesses.
Small Business Grants
There are a variety of government, nonprofit, and private entities that offer small business grants. You may be able to qualify for a grant if your startup supports a specific government initiative, your ownership meets certain qualifications (such as women, veterans, or minorities), or you will be doing business in an underserved community. Unlike loans, grants do not need to be paid back. However, competition for this type of funding tends to be stiff.
Business Lines of Credit
If you’re looking for flexible, short-term financing, a business line of credit may be a viable option. Similar to a credit card, it allows you to withdraw funds as needed up to a predetermined amount and only pay interest on the money you withdraw. Once you repay the funds you’ve borrowed, you can continue to draw on the line.
While banks tend to have strict qualification criteria, some online lenders offer lines of credit to borrowers with one year or less in business. However, they may charge higher interest rates than banks and offer lower credit limits.
The Takeaway
Seed funding is the initial capital provided to a startup or early-stage company to develop its idea, product, or service. It helps cover initial costs like research, product development, and marketing. Seed funding often comes from angel investors, venture capitalists, or family and friends in exchange for equity.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
What is a good seed fund amount?
The ideal seed round funding amount is exactly the amount you need to reach the next stage of your startup’s development. Amounts raised during this round can range anywhere from $10,000 to $2 million.
What should seed funding be used for?
Seed money is used to fund the earliest stages of a new business with the goal of taking the product to market. Some uses include research & development (R&D), product testing, hiring key staff, marketing, public relations, and sales.
Does seed funding have to be paid back eventually?
It depends. Angel investors recognize the risk involved, and if a business fails, they generally accept the loss. However, if the business succeeds, the angel investor will be entitled to their ownership stake or whatever terms were laid out for the seed funding. If you borrow from a lender, the lender will expect you to repay it, irrespective of whether the venture succeeds.
Photo credit: iStock/VioletaStoimenova
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