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If you’re launching a new startup, one of the first stumbling blocks you need to overcome is how to fund the growth of your startup. Obtaining funds to start a business is extremely critical in the early phases. Even if they’ve answered the question, ‘what is seed money’, many new startups don’t know where to find it. Without it, your great idea threatens to stay stagnant or, worse, a competitor with better funding can swoop in and capitalize on the market.
Around 30% of start-ups fail from a lack of capital to grow the business for marketing, personnel acquisition, design, and development of the technology and business direction. Successful startups, however, know the power of early capital, and how to tap into it.
Definition
Seed money can be defined in many ways. When we define seed money or seek to give a seed capital definition, it simply means this – seed money is the first round of capital for a new business. For many new enterprises, seed money provides the capital and funds needed to establish and grow the brand. Common uses of seed money include product development, market research, hiring personnel, securing facilities or equipment, and initial launch and production. For an app startup specifically, common uses of seed money usually include developing the minimum viable product and initiating an early marketing strategy.
So how does it work? Seed capital is often given in exchange for equity ownership — that is exchanging capital in return for a stake in the company. Even when a new business presents a solid idea, unvalidated concepts are a substantial risk to investors. Equity stake, or part ownership in a company, lends incentive to investors to engage in risk and provides a method to earn a return on their investment. Effectively, in exchange for access to early funding, you are trading ownership of the company and a portion of your eventual returns. Likewise, if your business fails to produce a return, investors risk losing the capital that they invested in the business.
Capital for startups is a huge business, however, the traditional sources for seed capital are extremely competitive. While there are many investors seeking new startups to invest in, there are even more new startups seeking an investment partner.
Sources of Early Funding
While there are many ways a startup can raise early financing, the most common sources of seed capital come from three primary groups: friends and family, venture capitalists, and angel investors. There are distinct benefits and ramifications for partnering with each type of investor.
Asking for Seed Money from Friends and Family
Friends and family are a common source of early capital, but you should proceed with caution. You should really limit your list to close friends and family; there is no better way to ruin a relationship than a disagreement over money. Only approach those you would be comfortable discussing sensitive topics with. On the approach, be sure to be sincere and professional in your demeanor and request.
Keep in mind that if your friend and family are not experienced investors, they may solely be investing in you, because it’s you. They may not know anything about investing and make inexperienced financial decisions that other investors wouldn’t make. And they may only be investing for one reason – because you asked them to. Even if they are close to you, your integrity is on the line and you must remain accountable to your investors. It’s important to discuss with your potential investor the fact that your startup can potentially not work out. Your friend or family member could invest a lot of money and never see it again. Can your relationship survive that? Be honest with yourself, and your investor, or risk damaging the personal relationship.
However, friends and family can be great investors. Because they are intimately familiar with the entrepreneur’s character, they are more likely to take a risk on a pre-revenue concept than a bank or venture capital firm might be. Be enthusiastic, but most importantly, be committed to your business. Highlight your judgment, as personal knowledge of your character will be your greatest asset with this type of investor. Those who do invest are looking to get in on the ground floor of a successful business and see their investment take off.
Acquiring Seed Money from Venture Capitalists
Seed funding firms are another common route to early-stage capital. There are several really popular venture capitalists who invest in app startups such as LOWERCASE Capital, Homebrew Capital, First Round Collective, and others. To secure private equity seed funding from these investors is extremely competitive. Thousands of amazing startups submit their business plans and pitch decks to these venture capitalists (and others like them) each year, but very few succeed in securing funding. Raising funds from venture capitalists isn’t nearly as easy as it seems. They only take on new investments with impenetrable business strategy, an exceptional founding team, and well-developed and validated ideas.
In exchange for their funding, venture capitalists will require an unusually high equity stake when compared to other investor types. Furthermore, they will often require a polished business plan and a strong presentation with a top-notch pitch deck design. Entrepreneurs need to be prepared and persistent when seeking venture capital — investors will ask difficult questions and you will likely face several rejections before striking a deal. You should be sure to consult legal counsel before you begin relations with a seed money funding firm. Be aware of how much of seed funding equity you’re giving away in exchange for what seed funding amount. Never jump into a deal without knowing the terms.
Securing Seed Money from Angel Investors
The last source of seed money is from what is known as angel investors. An angel investor is a well-to-do individual, typically from high-end professions, such as doctors, lawyers, or entrepreneurs, who can invest their existing wealth into a new business. Though the size of the seed investment is typically less than what venture capitalists will commit to, the amount can still be quite sizable.
As a bonus, some private investors bring additional benefits outside of funding; they can offer mentorship and may even have resources that you can tap into. Often successful entrepreneurs themselves, they can offer advice and may even be able to leverage their existing industry relationships to help progress the business.
Is Your Startup Ready to be Funded?
First and foremost, seed funding a new startup is extremely risky for investors. Up to 90% of new start-ups fail and, even for the ones that don’t, it could take years to earn a return on investment. For that reason, before you approach even the first investor, it is important to know how to how to pitch investors properly and effectively. Walking into a meeting with just an idea and some enthusiasm is not going to be enough to install confidence in you or your business.
There are several considerations you should take in before you begin to approach potential investors:
- Have a well-polished business plan: Even for businesses in the ideation stage, having a clear and thorough business plan is a signal of professionalism. It shows that you have thoroughly examined the ins and outs of your business. Most importantly, it will help you more clearly define your vision and goal. A top-notch business plan is complete with financial analysis, marketing strategy, and other important factors that investors will consider before striking a deal.
- Know how much seed money you need and why: Investors don’t just hand out checks. They want to know where their investment is going and how it will be used to progress the business. Part of your well-polished business plan is a strategy that explains what steps you will take to meet your business’ objectives. That means itemizing funding requirements, breaking down expenses, and projecting future revenue. The financial projections should also project when they can expect a return on their investment.
- Calculate the value of your startup: For many businesses in the early phases, the initial startup valuation will yield disappointing results. But with the right experience, dedication, a validated proof of concept and signs of revenue you can significantly increase the value of your startup. A well-calculated company valuation will make investors consider your pitch more seriously.
- Be ready to share equity in your company: Almost by definition, seed funding usually requires founders to give up equity in the company in order to make the deal. In many cases, this also means giving up some of the power to make decisions. Investors may require a seat on the board to ensure that they are part of the decision-making process. The percentage of equity an investor owns in the business is equal to their power in the decision-making process. An investor with 20% equity will have ⅕ of the vote when decisions are made. Taking on capital means taking on a partner; you’ll need to be ready to share your vision, but also open to hearing and considering the opinion of others.
- Take into account the personality of the investor: Be sure your vision aligns with that of your investor. If they don’t, or if your investor’s personality is not a great match with yours or your entrepreneurial style, it can cause major challenges in the future. To be clear, you should diversify the perspectives of your advisors and founding team to maximize your overall vision; but too big a gap in vision can be problematic. With family and friends, this is particularly important. If you mishandle the business relationship, you could greatly jeopardize the personal relationship. Consider how your relationship may be affected if you do not deliver the hoped-for results.
- Seek legal counsel, follow SEC requirements: You can’t just start collecting funds from people and passing out equity. You must follow the SEC guidelines for raising capital, and ensure that you are properly approaching the seed funding process. Search for the guidelines that relate to your business and make sure that you are aligned with them as you accept funds from investors. Likewise, make sure that you understand the potential terms of a contract so you can be ready to negotiate.
- Exhaust other seed funding options: Most new businesses are created as side projects while founders are still working a ‘day job’. In the early stages, many founders fund their new businesses by using their own savings and financing. If you are not ready to seek seed capital from any of the aforementioned sources, consider exhausting these options first. This method is known as bootstrapping.
What is Bootstrapping?
Bootstrapping means growing your business without outside funding. Most startups operate under this strategy, at least initially, and may continue to bootstrap for years. Many successful businesses have been able to grow their startup on the business’ revenue alone; substantially increasing their valuation and potential whenever they are ready to raise funding.
How can I bootstrap my business without seed money?
Businesses require time and money, and if you want to succeed, you’ll need to feed it both. Luckily if you need to raise startup funds, there are many options you can tap into. As mentioned, you can work on the business as a ‘side hustle’ while holding down a day job; using part of your income to fund the business. Alternatively, you can rely on your own savings, credit, and company-generated revenue to continually fuel the progress of your startup.
Another great way to generate cash is to sell personal services. Draw on whatever marketable skills you have. You can consult or freelance, work as a virtual assistant, clean basements — or do whatever else is necessary to progress your idea forward.
Growing your founding team can also help increase resources. More dedicated founders expand your base of savings, credit, and marketable skills that can add more cash into the business’ account until revenue is generated. Bootstrapping is tedious work and it will require that you cut expenses down to the minimum and outsource as needed. Outsourcing allows you to get vital tasks done without the expense of hiring in-house.
Any expense that can be spared, in bootstrapping, should be spared. Some famous companies that made it big after initially bootstrapping include GoPro, Whole Foods, and Under Armour. With enough tenacity, you could potentially fund your app startup to several million users without taking any outside funding (or giving away any equity).
Bootstrapping vs seed money
There are several reasons you may want to avoid seed funding for your business in favor of bootstrapping. If your idea is not ready to present to investors, for example, bootstrapping is an excellent (and maybe the only) alternative.
Additionally, if you have faced constant rejection, you may have to bootstrap until you can better validate the concept. Sticking with the idea and growing the business, even when funding is not plentiful, is another excellent signal of dedication and professionalism. When you are ready to approach investors again, you may find that you are better prepared. As you can see, there is no right way to fund your startup. Likewise, there is no easy way. In general, seed money will come with a little sweat and blood and a lot of dedication. But, whether you decide to seek the aid of experienced investors or go at it alone, be ready to adapt and refine your idea.
The greatest companies are never born overnight, they are developed by the most dedicated – the ones who keep moving forward even when the odds are against them!
How Much Capital Can You Raise?
The amount of seed money you can raise will relate directly to how much progress you have made with your business. The more traction your startup has, the more seed money you will be able to secure and the less amount of equity you will need to give away for that capital.
Check out our infographic below to see how much seed funding some of the world’s top companies raised in their infancy!
