If thinking about or in the process of raising a seed, there are some things you should know. In the article below we cover some of the most frequently asked questions about seed funding, so you are more prepared for your next raise. Some of the things covered include: what seed funding is, how it works, who raises it, what the requirements are, and who the top providers are–let’s dig in!
What is seed funding?
Seed funding is a form of startup funding that is used by early-stage companies to get off the ground, e.g. develop the product, and hire a team. Typically startups raise seed funding following a friends and family round, SAFE, or another initial round of funding. Seed funding is usually raised from venture capitalists, angel groups, and angel syndicates following the completion of an accelerator or incubator, but it may also be raised from individual angel investors or accredited investors.
How does seed funding work?
Seed funding works in much the same way as other forms of equity and venture capital funding: startups receive capital, or ‘seed money’ in exchange for equity (an ownership stake) in the company. Seed funding may also be structured as debt, in which case, the principal may need to be repaid. That said, the vast majority of seed funding comes from equity investors, because banks and other financial institutions may require collateral to secure the loan since the company does not have a history or track record of success.
Why do startups raise seed funding and what do they use it for?
Startups raise seed funding for a variety of reasons, primarily though, it's because the business would fail to get off the ground without it. Seed funding provides the capital needed for early-stage businesses to test out the viability of their product ideas, make strategic hires that will ultimately build and bring the product to market, and compete in highly commoditized or cash-intensive verticals, e.g. biotech or agritech. The ultimate goal of seed funding is to determine whether or not the company’s solutions can get to product-market fit.
When is the right time to raise seed funding?
While there is no “right time” to raise seed funding, generally speaking startups should attempt to raise when they have a compelling story and vision for what they want to build, when they have sufficient leading indicators that support their idea (such as beta customers, or initial first-party research), and when they can explain why they’re uniquely equipped to accomplish it. Also, founders should have a good understanding of the size of the market opportunity that they are pursuing, insights into who the target customer is, and a unique strategy for reaching said customer.
Ultimately though, raising seed funding boils down to finding investors who believe in and want to support you and your founding team. Investors know that the company will likely have to pivot more than once to achieve product-market fit, they want to make sure that you’re in it for the long haul and will guide the ship through it no matter what rough waters you face.
How much revenue does a startup need to generate to raise a seed round?
The amount of revenue a startup needs to generate to raise a seed round is highly dependent on the vertical they participate in. Biotech startups, for example, are not expected to generate a single dollar in revenue for many years and thus can raise a seed round simply off an idea and a team, whereas SaaS startups may be expected to generate hundreds of thousands of dollars in revenue before being able to raise a seed. In addition, the market conditions also can affect how much revenue a startup needs to generate to raise a seed round. In periods of economic expansion, revenue expectations are much lower than in periods of economic contraction.
How much capital should and do startups raise through seed funding?
Much like the question above, the amount of capital raised seed stage startups raise is highly dependent on their business model, selected industry, and current market conditions. Some startups may raise tens of millions in a seed round, while others may only raise a few hundred thousand—ultimately though, the amount of money you raise should be enough to get you to a minimally viable product so that you can test your idea or so that you have enough funding to get you to your next “fundable” milestone, which is typically 12 to 18 months following the seed.
For example, let’s say you’re building a SaaS company and need to hire four engineers to get your MVP to market. The average engineer in Silicon Valley costs approximately $20,000/month. So if you think it’ll take 6 months to build your initial product, you’ll need about $500k = $20 x 6 x 4. This can be scaled up or down depending on how complex your product is to build and how many additional teammates you’ll need to bring it to market. In 2022, according to Carta, the average seed round was $3.3M at a pre-money valuation of $17.6 million (Cooley).
How long does seed funding take to raise?
Similar to the questions above, the amount of time it takes to raise seed funding depends on several factors including the size of the round, the type of investors involved, and the current traction of the startup. Generally speaking, seed rounds take between 6 to 8 weeks, that said, you should plan for it to take 8 to 12 weeks.
What documents should you prepare to raise a seed round?
Seed funding is typically less formal and less intensive than other rounds. While investors will certainly conduct due diligence, it typically will be limited in both scope and scale. If you’re raising a seed, you’ll want to prepare a slide deck overviewing your vision, product, team, traction, market size, and financials (if you have any).
You may also wish to prepare financial projections, but given that you won’t have much history to base it on, don’t spend too much time on these. The final thing you should prepare is an executive summary that outlines your company and the investment opportunity. Regardless of which docs you prepare, they should contain:
- Logo / Tag Line
- Vision - e.g. why your company exists
- Problem - what you are trying to solve
- Target Customer - whose problem you are trying to solve
- Solution - your product & why it will solve the problem (s)
- Market - the size of the market you are targeting
- Landscape - trends, competitors, regulations
- Traction - # customers/users you have, revenue, previous fundraises…etc.
- Team - who, what, why
- GTM Plan - how you plan to reach your target customers
- Summary - the key takeaways for investors & the opportunity
What are the common sources of seed funding?
There are three general buckets of seed funding: debt, equity, and grants. Not every startup is suited to every type of seed fundraising option, that’s why you must understand the benefits and drawbacks of each, so you can pick the one that best fits your needs.
- Accelerator: fixed-term and cohort-based programs that include a wide range of benefits including educational sessions, access to legal, financial, go-to-market, engineering, and other resources, and discounted technology subscriptions (AWS, Google Ads, MailChimp…etc.).
- Angel groups: professional organizations made up of individual investors who work together to identify and evaluate investment opportunities. When said opportunity is identified, they pull from the pooled funds to write a single check to the business.
- Angel syndicates: are informal groups of accredited investors who can select to opt in or out of individual investment opportunities. Each opportunity requires investors to write a new check, with which they pool together to invest (similar to crowdfunding).
- Convertible notes: debt vehicles used by early-stage investors to invest in a startup that doesn’t have a valuation—it starts as debt and transforms into equity upon certain milestones being achieved.
- Corporate venture funds: these are funds that are invested in startups related to the industry of the sponsoring corporation. They provide capital in exchange for equity in the startup, typically to capture talent or intellectual property.
- Credit line: banks extend credit lines to startups who have tangible assets. In some instances, credit lines can be used for seed funding, but they are very expensive.
- Crowdfunding: there are three types of crowdfunding: donation-based, rewards-based, and equity crowdfunding. In a donation-based, individuals donate money in exchange for nothing. In a rewards-based, individuals contribute money in exchange for something, typically a physical product or service.
- Debt funding: any financial product that needs to be repaid over time, such as a bridge loan, bullet loan, or mezzanine financing.
- Incubator: provides mentorship, early funding, working space, and connections to help entrepreneurs grow their businesses and develop a minimum viable product.
- Microloan: a form of debt financing used to finance entrepreneurial projects in impoverished or developing regions. Microloans are also offered to small businesses by the SBA and can range from a few thousand dollars up to $50,000.
- Revenue based financing: a form of business funding in which a company secures capital by selling rights to their future projected revenue streams at a discount.
- SBA Loans: Small business association loans range from $500 to $5.5 million and can be used for most business purposes, including the purchase of long-term fixed assets and working capital.
How do you find a seed investor?
Finding seed investors that are right for your business, is similar to finding customers. You first want to define the things you are looking for: industry expertise, previous track record, investing philosophy, market outlook…etc. Then you want to narrow down the target list, based on what the investors are looking for. Some only invest in particular industries, some only invest in particular geographic areas and some only invest in founders with particular characteristics.
Once you’ve narrowed down your list to a reasonable set of target investors, then see if you have any mutual connections who might be willing to introduce you, as warm intros are almost always better than cold outreach. Then start working down the list. Ideally, you’ll build relationships with investors before you ask them for money.
How should you choose a seed investor?
Bringing on outside investors is similar to getting married—you want to make the right choice the first time, as you’ll be interacting with them for the next 5-10 years. Startups should look for potential investors who are aligned with their mission, vision, and values, and those whose time horizon aligns with the startups’ expectations. The next thing to understand is how hands-on the investor wants to be in your day-day operations.
Some investors want to be highly involved, while others want to be completely hands-off, make sure the investors you select align best with your working style. Lastly, ask for introductions to a few of their portfolio companies. Similar to a reference check, the goal of these conversations is to uncover any red flags that other founders have experienced with the VC or investor.
Some other basic tips:
- Be clear, honest, and transparent with your intentions from the beginning
- Define your boundaries, roles and responsibilities, and expectations upfront
- Not all investors are created equal, the term sheets should reflect that
Tips for negotiating seed funding?
As with most negotiations throughout the funding stages, the more information you have the better. When negotiating seed funding, make sure that you know your numbers and have comps readily available to compare. Also, if possible, seek legal counsel to walk you through the potential implications of the provisions included in a term sheet. If you are lucky enough to receive more than one term sheet, consider negotiating async rather than real-time, so you have time to thoroughly evaluate the offers.
Ultimately, while valuation is important, it shouldn’t be the most important thing you consider. For example, if presented with two offers one at a $90M pre-money valuation with minimal provisions and one at a $100M pre-money valuation that is plagued with many provisions such as pro-rata rights, redemption rights, anti-dilution protection, and more, you should consider going with the former offer.
Once you have signed the term sheet, make sure to get the investor’s signature and cash as soon as possible. It should take no longer than a few minutes to exchange signed documents online and execute a wire or send a check.
Compared: Seed Funding vs SAFEs?
Seed funding and SAFEs (Simple Agreement for Future Equity) are both forms of early-stage funding for startups. While SAFEs can be considered a form of seed funding, not all forms of seed funding can be considered a SAFE. Further, SAFEs are always dilutive, whereas seed funding can be dilutive or non-dilutive.
What are some basic seed funding guidelines to follow?
When raising seed funding, or any funding for that matter, there are some general guidelines to follow, we’ve included some of the basic ones below.
- Research – you should know everything you can about the investors, what their investment thesis is, what investments they made recently, what their biggest hits have been and what they have been talking about recently
- Prepare – you should know your pitch and numbers inside-out, forward, and backward
Be Authentic – be yourself, and share your story
- Storytell – convince investors by painting them a picture of why the problem is worth solving and why you are uniquely equipped to solve it
- Stay Organized – you should keep track of exactly who you reached out to (who you haven’t) and what their response was
- Close – at the end of your pitch, make a concise ask outlining exactly what you are looking for and when you are expecting a response by
- Follow up – thank investors for their time, and feedback on your idea/business
- Screw over investors - word spreads fast, and the last thing you want is a bad reputation.
- Demand investors sign an NDA - nothing screams first-time founder more than asking investors to sign an NDA before you’ll meet with them the first time
- Get emotional - at the end of the day it's just business, don’t let pushback or a “no” upset you or get you down
- Be dishonest, arrogant, and overly aggressive - see point #1 above for why you shouldn’t do that
- Be too talkative - you want to aim for a 50-50 split, it should be a conversation, not a lecture
- Exaggerate the opportunity - use reasonable numbers to demonstrate the market opportunity, e.g. don’t say that every person on earth is a target customer (unless it really is like Youtube or Facebook)
- Delay - once investors say “yes” get the docs signed and the transfer started asap.
Final thoughts on seed funding
If you’re in the process of raising seed funding, congratulations, you’re well on your way! Make sure that you raise enough money to last you 12-18 months (with a buffer), or until your product reaches the market or you reach your next funding milestone, and make sure that you target investors that align with your vision of the future and are willing to help you get there.
Once you’ve received term sheets remember to negotiate the details to get to the ideal outcome, and finally once the money is in the bank, make sure to thank your investors for believing in and supporting you. Remember that ultimately the investors you sign with, will be with you for the rest of your business’s life, so choose wisely.