Unless you’re very lucky and have founded a business that’s a cash cow from day one, you’ll likely need capital to help it grow. Whether it’s to hire new employees, buy equipment or fund your marketing efforts, an injection of cash is essential. The first pot of funds raised by a business is known as ‘seed fundraising’.
Discover what’s involved in seed fundraising and what factors to consider when seeking outside investment in this FAQ guide.
Jump to:
- What is seed fundraising or seed funding?
- How does seed funding work?
- Valuing your company
- What’s the difference between seed funding and angel investing?
- What are the different types of seed fundraising available for start-ups?
- Different types of seed funding investor
- How much should I raise in my seed funding round?
- When is the best time to raise seed funding?
- How long does it take to get seed funding?
- What documents do I need?
- Are there any investor red flags that founders should look out for?
- How much equity should you give away?
- How much seed funding should you raise?
What is seed fundraising or seed funding?
You’ve successfully launched your startup using personal funds, which is an impressive achievement. However, to ensure long-term success and growth, it’s important to recognise that most new businesses face challenges within their first five years. To truly thrive, you’ll need more than just savings and contributions from friends and family, you’ll need additional resources to reach your full potential.
Seed fundraising is the process by which start-up businesses seek financing from outside investors or a bank. The money is known as seed capital and it’s sometimes called venture capital, or VC for short.
How does seed funding work?
If you’re looking to raise seed funding from an external investor, they’ll most likely want a share of your business in return for their money. They may not take shares immediately, as it can be tricky (and expensive) to organise a valuation of your business and the negotiations can be long-winded.
Instead, many investors look for convertible debt in the form of a convertible loan note (CLN) or an agreement for a future issue of shares in the form of either an advance subscription agreement (ASA) or a simple agreement for future equity (SAFE). You can find out how these work and the difference between each in our SAFE vs CLN FAQ guide.
In short, convertible debt is where the business loaned money. The loan note will mature after a certain period, after which you’ll need to repay the amount of the loan plus interest. Before this point, however, the convertible note will typically convert into shares at a favourable price when your company does an equity financing. You can negotiate the way this price is calculated, there may be a cap on the amount the investors will pay per share, or they may be offered a discount.
SAFEs and Asas work in a similar way to convertible debt, but there’s no maturity date, no interest to repay and no obligation to repay the money. Instead, in exchange for the investor’s funds, you agree to issue shares in the business in the future at an agreed discount or with a cap on the amount the investor will pay.
If you do decide to issue shares straight away to investors, rather than issue convertible notes or agree a SAFE or ASA, you’ll need to get your company valued so a share price can be worked out.
You’ll need to engage lawyers to agree the necessary documents, including revised articles of association and a shareholders’ agreement. The negotiations are likely to be complicated, as both the founders (you) and investors will need to bake in special rights and protections against things like share dilution.
Valuing your company
There’s no standard way to value a company, never mind a start-up. In reality, a commodity is worth what a buyer is willing to pay, and that defines the market value. When you’re talking fundraising, substitute buyers for potential investors. The more investors you can get interested in your business, the more you’re going to be able to ask for your shares. You need to find a balance between raising the cash you need and not giving away too much of your company at the start. That should be your goal.
What’s the difference between seed funding and angel investing?
In short, not a lot. Angel investors tend to provide seed funding to businesses, so angel investing is essentially a form of seed funding.
What are the different types of seed fundraising available for start-ups?
Many different types of investors provide seed funding from founders and friends and family to angel investors, early-stage venture capitalists and crowdfunders.
Different types of seed funding investor
Seed funding is traditionally met by angel investors, early-stage venture capitalists and crowdfunders and more rarely may involve private equity investors for funding on a larger scale and banks who may participate off the bank’s balance sheet through a specialist entity. We look below at the main types of early-stage investors and the benefits of each.
Angel Investors
Angel investors are high-net worth individuals investing their own money individually or sometimes as a syndicate with other angel investors in exchange for shares in a start-up company. Angel investors are normally the first to invest when the start-up is just getting off the ground.
They typically have a bigger appetite for risk and are more likely to take a bigger leap of faith in your start-up than other investors. Funding can be secured more quickly from angel investors as they won’t have as many hoops to jump through and so can make decisions more quickly. Angel investors will usually take on a more passive role and not want as much involvement with the business whereas other investors may want a seat on the board and be included in management decisions. Some angel investors will be experienced in investing in your industry and be able to bring sector knowledge and connections to your business.
Venture Capitalist Investors (VC investors)
Venture capitalists are professional investors who invest other people’s money in start-up businesses. They do this typically by way of a limited partnership corporate structure where the professionals are the general partners who have responsibility for managing the investments and the investors are the limited partners (such as pension funds) who do not take an active role in the operational side and have limited liability.
Early-stage venture capitalists will generally come to the table after angel investors have already made their investments in the business. They usually invest a greater amount than angel investors in return for a higher proportion of shares in the company and because of this will usually require a greater involvement and control in the management of the business.
The benefits of a VC investor are that they have greater access to funds than an angel investor and so are more likely to be able to participate in follow-on funding. They’re more likely to be experts in the industry than an angel investor and will tend to have a wider pool of business contacts which could help your business. Another benefit of both angel investing and VC investing is that there is no debt introduced to the business and therefore no demands for repayment or interest, unlike the traditional PE investing.
Crowdfunding
Investors who invest in equity-based crowdfunding will receive shares in exchange for cash. It is a way for your business to raise a large amount of money from a wide pool of investors typically via crowdfunding platforms.
Some of the benefits of crowdfunding include the easy access to capital compared to sourcing funds from bank loans or VC investors which will require more paperwork and approvals. Presenting a crowdfunding campaign allows you to reach a wide-ranging, public audience which not only offers you the chance to receive feedback and gauge interest in your proposition but also opens up the opportunity for widespread publicity through social media sharing and coverage.
For more information on the types of investors for your business and the questions you should be asking them, please see our article onFive key success questions to ask potential investors before your next funding round.
How much should I raise in my seed funding round?
When you’re embarking on your first financing, try to think long-term. The objective is to get enough funding so that your business becomes profitable. That way, you’ll find it much easier to raise money in the future as you’ve demonstrated that you’ll return profits to investors. Typically, you’ll be looking at raising enough to see you through the next twelve to eighteen months.
You need to bear in mind several factors, including:
- how far you can take the business with the money raised
- how much of your company you’re willing to give up at this stage (you should avoid giving up more than a quarter of your shares)
- how keen investors are in your pitch
Either way, investors will want to see a credible business plan, tied to measurable objectives and goals. For example, over the next eighteen months you need to purchase this item of equipment at £100k, invest £1m in marketing, and hire two new members of staff at £150k per annum.
Seed fundraising rounds typically range from £100k up to around £2m.
When is the best time to raise seed funding?
This is a tricky question to answer as a lot will depend on the type of business and industry you are raising funds for and the wider economic background. If you raise funds too early then you could be left sitting on piles of unused capital but if you leave it too late, then your business could be struggling and missing opportunities due to a lack of capital.
As a general guide, it might be worth considering whether you have the following in place before approaching investors:
- an active customer base which is generating sustained revenue for the business and a solid plan for attracting repeat custom
- a comprehensive and up-to-date business plan with enough detail for investors to be able to make their investment decision
- a minimum viable product (MVP) which can demonstrate to investors the product’s viability in the market.
How long does it take to get seed funding?
You’ll only be successful at raising funds when you can convince investors that you have a viable product with a good market fit. If you can demonstrate actual growth in sales, that’s a bonus.
The more evidence you have of actual growth and profitability, the faster you’ll be able to raise funds. We estimate the quickest you could achieve funding, assuming a great pitch, is four weeks, with the average length between pitch and funding being around six months.
Here are our top tips to speed up the fundraising process:
- devote most of your time to fundraising once the time is right and you’ve perfected your pitch
- get as many investors as possible interested ahead of time. That stimulates interest and as a result, competitiveness between investors and this will encourage them to move faster
- only go out to raise funds when you’re sure you’re ready. Once you tell investors you’re looking for funds, the clock starts ticking. To maintain momentum and investor interest, it’s crucial not to be in fundraising mode for too long.
What documents do I need?
The most important document you’ll need for a successful fundraising is a pitch deck. For more information on creating the perfect pitch see: How to create the perfect pitch for investors.
As a headline, make sure your pitch is attractive and engaging, with images and charts rather than lengthy narrative. There’s no magic formula, but here are some things you should include:
- your logo and vision
- the problem you’re solving for your customers
- who your customers are and how will you find them
- what is your market, and are there any trends
- your key financials and current market traction
- the make-up of your team
- how you’ll convert revenues to profits (and make them money)
- how much you’re raising and what you’ll use it for
- an executive summary
Before meeting with any investor, make sure you understand what makes them tick. Every investor is different, and as we’ve seen, angel investors have different motivations from venture capitalists.
Who you are is just as important as your numbers. Investors will want to know that you have what it takes to succeed and make them money. They’re not just investing in your product, they’re investing in you, as a person. Remember that, and just be yourself.
Are there any investor red flags that founders should look out for?
Founders will want to carry out some limited due diligence on the investors and identify who the investors are (and to ensure they are not competitors of the business) and require them to self-certify as high net worth individuals or sophisticated investors.
Care should also be taken when granting any preferential rights to investors to make sure they are proportionate to the level of equity they hold in the company. As the company continues to grow and it completes further investment rounds, the new investors are likely to look for rights that are similar or in addition to the rights afforded to the existing investors. Some investors require the right to be actively involved in the business of the company going forward (e.g. requiring a board seat) and if any such rights are agreed, founders should carefully consider if they are comfortable with the level of involvement requested.
How much equity should you give away?
We usually advise between 10-20%. Founders should be careful about the percentage of equity they give away in seed funding as they are likely to require future investments over time which will result in further dilution of their shares. They will want some comfort that at the time they choose to exit, they still hold a sufficient percentage of shares in the company so they are rewarded adequately on an exit. We encourage founders to create and maintain a cap table so they can keep track of the allocation of ownership through the stages of fundraising and growth. A cap table is a particularly useful tool for seed stage startups to help them document their financial obligations and potential risks in terms of dilution as the business grows.
How much seed funding should you raise?
Start-ups will want to raise enough investment to reach the next stage of the company’s growth. It is always useful for the company to have certain projections and milestones set out about the development of the business with an idea of how much funding is required to reach each stage. This will allow the company to accurately set out how much money is required at each milestone.
Ideally, company founders do not want to raise more than they actually require as they may find they are giving away too much equity at an early stage, especially as there is an expectation that the valuation of the company will increase over time. It can be helpful to break down the investment rounds to coincide with different milestones of the company’s growth as it is likely to be easier to raise investments with higher valuations as the company continues to succeed.
If you have any questions on the seed fundraising process or the legal documents which will need to be negotiated and entered into between you and your investors, then our team of funding experts are available to discuss with you further.
