Unless you’re very lucky and have founded a business that’s a cash cow from the beginning, you’ll likely need capital to help it grow. Whether it’s to hire new employees, buy equipment or fund your marketing efforts, cash is king. The first pot of funds raised by a business is known as ‘seed capital’.
- What is seed fundraising?
- How does seed funding work?
- Valuing your company
- What’s the difference between seed funding and angel investing?
- How much should I raise?
- What are the different types of seed fundraising available for start-ups?
- 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?
You may have got this far by using personal funds to launch your start-up, but let’s face it: the vast majority of new businesses fail in the first five years. If you’re serious about success, you’re likely going to need more than cash from friends and family (‘bootstrap financing’) to grow.
Seed fundraising is the process by which start-up businesses seek financing from outside investors or a bank. The money’s known as seed capital. It’s also 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 longwinded.
Instead, many investors look for convertible debt or a simple agreement for future equity, known as SAFE. You can find out how these work in ore article: Simple Agreement for Future Equity (SAFE) vs convertible notes.
To summarise, convertible debt is where you’re loaned money. The loan note will mature after a certain period, after which you’ll need to repay the principal plus interest. However, the real purpose of a convertible note is that it gets converted 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’ll be offered a discount.
SAFE works in a similar way to convertible debt, but there’s no maturity date, and no obligation to repay the money. Instead, you agree to issue shares in the future at an agreed discount or with a cap on the amount the investor will pay.
If you do issue shares straight away to investors, rather than issue convertible notes or agree a SAFE, 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 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.
We know from TV shows about entrepreneurs that it’s important not to be too optimistic in your valuation, as this can backfire. 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 ultimate goal.
What’s the difference between seed funding and angel investing?
The principal difference between seed funding and angel investing is that angels tend to be private individuals who bring their own expertise as well as their own cash to the party.
Professional seed funders and VCs tend to operate as firms and invest other people’s money. For that reason, it can be more long-winded to deal with VCs, as they will need internal reviews and approvals to move forward with funding.
How much should I raise?
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 numerous factors, such as:
- How far you can take the business with the money raised
- How much of your company you’re willing to share 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.
What are the different types of seed fundraising available for start-ups?
Many different types of investor provide seed funding. This can include founders, friends and family, angel investors, VC firms, institutions or corporate seed funders, and crowdfunding.
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, 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 thus competitiveness between investors and 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 pitch deck. For more information on creating the perfect pitch see: How to create the prefect pitch for investors.
As a headline, make sure your pitch is attractive and engaging, with images and charts rather than long-winded 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 are your customers and how will you find them
- What is your market, and are there any trends
- Your key financials and current market traction
- The makeup 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 motivation from VCs and corporate seed funders. Do your homework.
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 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 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 growth of the business with an idea of how much funding is required to reach the next stage of its growth. This will allow the company to accurately set out how much money is required to reach the next stage.
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 progress.