April 30th, 2019 | By: The Startups Team | Tags: Funding
The very first money that many enterprises raise — whether they go on to raise more money or not — is seed funding. (Some startups may raise pre-seed funding in order to get them to the point where they can raise a traditional seed round, but not every company does that.)
The name is pretty self explanatory: This is the seed that will (hopefully) grow the company. Seed capital is used to move past the first steps (product development, for example) and to start exploring what the next stages will be (like growth or a pivot).
Seed capital may be raised from family and friends, angel investors, incubators, and venture capital firms that focus on early-stage startups. Angel investors are perhaps the most common type of investor at this stage. This is also the endpoint for many startups. If they can’t gain traction before the money runs out (also known as running out of runway), then they’ll fold.
On the other hand, some startups decide that they’re not interested in raising more money — that the level they reach with seed money is good enough or that they’re able to grow more without more investment — and choose to stop raising funding rounds at this point.
Seed capital is usually between $500,000 and $2 million, but it may be more or less, depending on the company. The typical valuation for a company raising a seed round is between $3 million and $6 million.
Seed capital is usually raised from one of three groups:
Friends and family Friends and family are often the first private investors that startups and small businesses turn to. They’re a great resource for seed funding and startup money, as friends and family already have that base of trust and involvement that founders usually have to build from scratch with other private investors.
However, it can also be risky to combine business with personal relationships, especially when launching a risky startup. Remember: The vast majority of startups fail. So before you approach your loved ones, make sure you’re okay with taking the risk of losing their money. And when you do approach them, make sure it’s very clear that this is a real possibility.
Angel Investors Angel investors are wealthy individuals who invest in startups, usually at the early stages in exchange for equity or convertible debt. Sometimes angel investors pool their money with other angel investors, forming an investor pool.
The typical angel investor is someone who’s net worth is likely in excess of $1 million or who earns over $200,000 per year. Incidentally, those look a lot like the credentials of an accredited investor. Remember, though, that the angel investor is playing with their own money — not invested capital — so even though they may be a high net worth individual, they are still looking at money coming out of their personal bank account.
Accelerators Accelerators are mini startup factories hoping to churn out the next big thing. They usually ask for a portion of equity in exchange for funding to the tune of a few thousands dollars. Some also provide guidance in the form of mentorship and classes, marketing themselves as startup bootcamps.
Let’s start with a big “don’t.” DO NOT try to cold approach angel investors. Why? Because they’ll ignore you.
Angel investors are high net worth individuals who are 1. very busy with their own lives and businesses and 2. being bombarded with requests for funding all the time. As a result, they have to be able to efficiently filter out founders who are coming to them with ideas. The best way? Only take warm intros.
That means you’re going to have to work your network. Take the time to do you research and find someone you know who knows someone. That’s the only way to ensure you get a foot in the door with angel investors.
Not sure where to start? Founder Mike Belsito talks about how he leveraged his network to raise seed funding for his startup, eFuneral, in his book Startup Seed Funding for the Rest of Us: How to Raise $1 Million for Your Startup – Even Outside of Silicon Valley.
“For those of you who already have great mentors in your life, this is usually the best place to start,” Belsito writes. “Having a stable of helpful allies is critical as you go through this process. Once you begin to engage with this group, you should see their level of excitement over your concept grow. If you don’t, you may want to pause and understand why. After all, these are the people that have a personal interest in you and should genuinely want to help. If they don’t seem that excited about your business, probe to find out why. They could have critical feedback that you need to hear.”
Belsito also recommends utilizing online sites and networks when you’re raising seed capital. These include Crunchbase, AngelList, LinkedIn, and any local angel investor networks in your area.
Friends and family are a little easier to approach — they already know you and your idea, obviously — but there are potential pitfalls here too. Working with people you’re close with can be great, but it can also ruin relationships. Investors at the seed level need to be very involved with the process of getting your startup to Series A, so if they’re someone you don’t want to work with — or they’re someone who just doesn’t get it — they’re probably not the person to ask.
Also, as we mentioned above, there’s a very high probability that you’ll lose your investors’ money. Make sure your friends and family know the risk before they hand over their checkbooks.
As for accelerators, most have application instructions on their websites. Of course, a warm intro never hurt there either, but it’s not as essential as it is for angel investors or, if you go on to raise more funding, venture capital firms.
Once you’ve gotten a meeting with a potential seed capital investor, it’s time to convince them that you’re worth investing in.
Angels more than any other type of investors at the seed capital stage should be treated like potential partners in your business. Remember that you’re taking on a partner with a lot of institutional knowledge. That means they should be asking smart, interested in questions when you meet with them. If they aren’t? They’re probably not a good fit.
In a meeting with an angel investor, be ready to sit down with them and work through your draft plan. They’re not expecting a fully fleshed out business plan, but you should be able to show how you think you’re going to move forward.
“We don’t need a lengthy presumptive business plan, nor a SWAT analysis or ‘market research,’” angel investor George Kassabgi says. “What’s needed is a set of assumptions, over time, over the traversal of desirable ground. Your map is not about why the idea is worthwhile, it’s about how you will make it real.”
Kassabgi recommends that founders who are trying to raise seed capital with angel investors treat the meeting like a collaboration — a test run for what things will be like if the investor decides to take your startup on. Be ready for (hopefully constructive) criticism and don’t assume your draft pans are perfect. Also, be careful not to stay in “presentation mode” the whole time. Remember: This is a collaborative test run, not a pitch competition.
The follow up
And, of course, remember your manners once the meeting is over. Send a follow up email thanking the investor for taking the time to meet with you and outlining whatever steps you’ve agreed on for moving forward.
And then, Kassabgi says, “close the Seed round and stop focusing on capital.” Staying in fundraising mode means your energy is directed away from building your company, so once you have the money, get back to the job at hand: Growing your startup.
Don’t miss our guides to the full range of startup funding options, below.