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What is Seed Funding and Why Do You Need It?

March 24, 2022

Every business starts with an entrepreneur and a great idea. But in order to bloom, they need money to grow. Not only do successful startups need capital to build a solid foundation, they must also have funds to cover everything from hiring staff to marketing. So how can businesses start building this well of cash?  

Seed funding is capital that comes from any source. Unlike loans, seed funding for startups generally doesn’t need to be returned. Here’s everything you need to know about seed money, types of seed fundraising, and how to go about raising a seed round.

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What is seed funding?

There are several misconceptions regarding raising money. So what is seed funding and how does it differ from other funding options?

Businesses that seek out this type of capital have already proven a market need for their product. They simply need the money to get that product to market and obtain a foothold in their industry.

One of the biggest distinguishers of seed funding is that seed investors are not providing loans. They expect a share in the future of the business. Entrepreneurs embarking on fundraising must be comfortable giving away part of their business.

Unless entrepreneurs already have savings, they need to look into a seed round, or their startups won’t stand a chance.

 

What is the difference between seed funding and pre-seed funding?

Too many people use these terms interchangeably, but they are not the same thing. While both types of investment function similarly, businesses embarking on a pre-seed funding round are at a different stage in their development.

Pre-seed funding is when entrepreneurs still need to prove a market need for their idea. Someone looking into seed capital is seeking to prove their product-market fit.

Not every entrepreneur will search for both types of funding. It all depends on their individual situation.

 

The importance of seed funding for startups

So, what is seed funding’s purpose? Startups, by their nature, are seeking to grow quickly. Without startup funding, almost all startups will fail. The amount of money required for an entrepreneur to break into a market typically overshadows anything family, friends or traditional financing options can provide.

High-growth companies must burn through capital to achieve profitability and long-term staying power. While there are some startups that have never taken outside investment, they are the exception, not the rule.

A quick cash injection allows startups to get off the ground and survive. Remember, a startup often competes with established, profitable companies with capital in reserve. Without that money, a startup is already beginning with a crippling disadvantage.

Seed fundraising is challenging and typically requires a lot of time and investment. The process is arduous, complex and involves a lot of setbacks. If you’re feeling discouraged, just remember that most (if not all) successful entrepreneurs have gone through the same thing and it’s part of starting a business.

Now that you know why you need seed funding, let’s begin your journey of securing a seed investment.

 

Types of seed funding

A seed investment can take many forms. Not every startup is suited to every type of seed fundraising option. It’s essential to explore every avenue to determine which one gives a new business the greatest chance of success.

There are 10 primary ways to obtain seed funding. Here’s a quick summary of all 10 types:

  1. Crowdfunding – More than 500 crowdfunding platforms exist. They remain popular because anyone can upload their project, and anyone in the world can invest in it.
  2. Corporate Seed Funds – Getting broad visibility requires powerful support. Corporations like Intel, Apple and Google invest in startups as a primary resource for profit, talent and intellectual property.
  3. Incubators – Incubators offer smaller amounts of seed money. They also provide office space and training courses. Incubators typically don’t take equity.
  4. Accelerators – These seed investors concentrate on helping startups scale rather than jumping in at square one. Services include networking, mentoring and providing workspaces.
  5. Angel Investors – These investors typically provide capital to startups at risk of failure. As individuals, they provide capital in exchange for equity or convertible debt.
  6. Bootstrapping – Entrepreneurs use their personal wealth to relieve financial pressure and avoid giving away equity or taking on debt.
  7. Debt Funding – Debt funding is a traditional form of seed investment. Although banks may provide debt funding, investors may issue loans instead of asking for equity.
  8. Convertible Securities – Convertible securities start out as loans and then change to shares or equity, based on how well the company performs.
  9. Venture Capitalist Funding – Venture capitalists are major marquee investors that use several metrics to determine whether to provide funding, such as growth potential and current market conditions. In return, venture capitalists take a portion of the company and participate in multiple investment rounds.
  10. Angel Networks – Investors come together to provide small amounts of capital as part of a group. Startups requiring smaller investments may turn to angel networks to help them grow.

When asking, “What is a seed investor?” the answer is that it can take many forms. Ultimately, they all differ slightly, and entrepreneurs need to seek the arrangement that benefits them and their prospects.

 

When should you seek a seed investment?

Timing is everything in business, especially for startups. It applies to embarking upon a seed round in the same way as anything else.

Unfortunately, there is no correct time to begin seeking outside investment. It depends on the investor and the founder. What matters is that an investor writes a check when they see a compelling business proposition.

Some founders can win funding just from their previous reputation and story alone. Others need an engaging and promising idea. Still, some entrepreneurs need to prove that some customers have already bought into their products.

In most cases, a product alone is not enough. Founders must provide the product that fits the market and shows strong growth potential.

Ideally, you should seek funding only when you already have proven rapid growth. How rapid depends on the investor. This is why obtaining seed capital is such a challenging process.

 

How much seed money should you ask for?

The rule of thumb is you should always look to raise enough money to reach profitability. Startups that reach profitability never need to ask for outside capital again, preventing further loss of equity.

Unfortunately, many businesses find that a single seed round is insufficient. Companies building physical products, such as hardware, often need a follow-on round to keep them moving. These organizations would look to survive until their next milestone, usually 12-18 months into the future.

Several metrics go into deciding how much to raise, such as:

  • How much progress a specific amount can buy
  • Investor credibility
  • Dilution

Entrepreneurs should expect to give up anywhere from 20 percent to 25 percent in equity during fundraising. Try to avoid giving up any more.

Another way to view the optimal funding amount is to calculate how much money the startup will burn per month and how long the startup wants to survive during this initial funding round.

For example, if a software engineer costs $10,000 per month and a startup needs five to function, that’s $50,000 of capital burned every month on a skeleton staff. Startups searching for a year of funding would need $600,000 in initial funding.

These are only rough estimates, but they can be an excellent starting point for settling on a number to present.

 

How to raise a seed round

Figuring out how to raise a seed round is intimidating if you’ve never tried to seek outside investment before. If you are comfortable giving away a stake in your company and have reached a stage where you can prove the growth potential within your idea, you may be ready to start the process of raising seed capital.

Here’s a step-by-step guide for how to raise a seed round.

 

Step 1: Build your pitch deck

Your pitch deck is your primary tool for raising money. Seed investors expect to see pitch decks when evaluating investment opportunities.

The benefits of a pitch deck include attracting investor interest and converting that initial interest into action. The point of developing a pitch deck is to tell investors about your startup, its current position, and where you expect it to be.

It should tell investors about your product and the issues it addresses. Make sure your pitch deck tells the story of you and your business. Make it compelling and impress investors with your background and what brought you to this idea. Everyone is more likely to remember an interesting story than boring facts and figures. 

Pitch decks also include information about the market, your customers and the steps you must take to make your company grow.

The right length for a pitch deck is between 10 and 12 slides. Keep it simple, and try not to go over 15 slides. Stick to one concept per slide and make liberal use of charts and graphs.

Savvy entrepreneurs always have two pitch decks: One is designed to support an in-person presentation, and the other is intended to be sent as part of an email. You may even choose to provide a video presentation within the second deck to make your pitch more personable.

Also, you’ll want to take the time to dig into the financials. Not every seed investor will be drawn in by you as a founder. Some investors focus primarily on the numbers, so provide detailed projects not for just short-term growth but long-term potential.

Show investors where you expect your company to be 10 years from now. Plan for as many eventualities as possible, such as potential competitors and new future product lines.

Overall, a pitch deck should be all about the facts. A well-prepared pitch deck demonstrates you are a serious entrepreneur who has put some serious thought into a great business idea. For inspiration, check out these pitch deck examples

 

Step 2: Create your investor list

Reaching out to every investor in the land for seed funding is neither productive nor viable. You need information on your list of preferred investors. But how do you determine who is a good option with a higher chance of success?

Many entrepreneurs leverage their existing business networks to track down investors. Others use incubators and accelerators to seek out lists of active investors.

Let’s examine the primary considerations you must consider when evaluating potential investors to approach:

  • Investor Type – Decide on the type of investor you want. Are you looking for pure capital or someone who can play a more active role in your startup?
  • Experience – How long has an investor been working with startups? What is their track record of success? It’s also worth digging deeper into their successful investments to determine the time frame.
  • Funding – Not every investor is equipped to throw in millions. Using your funding plan, narrow down your list of investors based on the capital amounts they’re able to provide.
  • Expertise – Does an investor have any potential expertise or connections you can take advantage of? When bringing in an investor, it’s worth looking beyond funding.
  • Fit – Is this investor a good fit for your business? How an investor interacts with you and the company can inform whether you will enjoy a successful working relationship.

Targeting and approaching the right investor is crucial to getting the funding you need. Too many entrepreneurs make the mistake of concentrating entirely on the money alone.

Score your list like you would a sales funnel. Rank different investors in order of priority and work your way down the list.

 

Step 3: Meet with interested investors

Most investor relationships begin by sending them your pitch deck. Keep it friendly but formal and get to the point. Any investors who are interested in knowing more will get in touch. If investors don’t reply to your outreach, don’t be discouraged. Simply move on to the next one.

Now, on to the hard part: meeting face-to-face. In-person presentations with investors can be intimidating. This is a skill you will refine over a period naturally.

Follow these rules to increase your chances of a successful meeting:

  1. Know your audience. Understand what this investor likes to invest in and the reasons why. Tailor your pitch accordingly. For example, some investors prioritize the founder themselves, whereas others prefer to work off the hard numbers.
  2. Simplify your presentation. Your pitch should be short and sweet. Focus on the primary details. You don’t want to bore your investor.
  3. Take the time to listen. Build up mutual trust by showing that you’re interested in what they have to say. Even if you never reach a deal for capital, you can learn by listening to feedback from an experienced investor.
  4. Balance your presentation. Between the dream of going big and changing the world with the facts and figures, it’s vital to demonstrate ambition without coming across as delusional.
  5. Be confident while demonstrating humility. There’s a fine line between showing off your charisma and coming across as arrogant.

One of the best things you can do is practice your pitch several times at home before meeting with investors. Over time, you will find what works and what doesn’t. For most, the first presentation is shaky. Don’t let a disastrous pitch derail your attempts at meeting with other investors, just make sure you learn from it and move on. 

 

Step 4: Negotiate the deal

An agreement to invest is not the end of the line. Plenty of investment offers fall through during the negotiations. As a founder, you instantly start at a disadvantage because the investor has much more experience than you at negotiating these deals.

Never jump at the first offer you get. Whether it’s a loan, equity, or something else, you need to take the time to think and come up with a counteroffer. For this reason, it’s recommended that you never negotiate in real-time.

Always consider what your company could be worth and whether it is a fair deal. An investor asking for 25 percent of your company may be OK when your startup is young, but what about going forward?

A company that explodes and becomes worth $10 million potentially leaves you with a lost $2.5 million. Consider the future value and whether those terms will be acceptable to you five years, 10 years, 20 years down the line.

You also need to take into account any added extras. For example, if an investor has agreed to give their time and expertise to the business, what does that mean? Get anything offered in writing and be specific.

 

Find your next investor with Crunchbase

Understanding seed funding and how to get it can help take your startup from an idea to a global organization capable of changing the world. With fundraising, preparedness is crucial. From building your pitch deck to analyzing the market and making financial projections, it’s important to know how to find investors for a startup.

That said, even with the most preparation in the world, you’ll likely experience setbacks.  The good news is, prospecting tools like Crunchbase can help you find and connect with the right investors.