Starting a business from scratch is no easy feat. Several elements need to align for even the most brilliant idea to materialize into a reputable enterprise. As with any crop, a seed is not enough to yield a big plant. Water, light, and warmth are some of the factors that must be in plenty to support germination. The same holds for the world of business. For companies in the startup phase of the business lifecycle, everything hinges on the acquisition of seed capital. This is the initial funding they need to get off the ground.
Hence, seed capital is a major milestone — the first significant deal or transaction of your business. No matter how brilliant an idea is or how experienced the entrepreneurs behind it are, it is impossible to reap the rewards of a good business plan without sufficient funding. That is why about a third of all small businesses fail, owing to a lack of capital funds.
Yet, it doesn’t stop there. The startup phase is often marked by hard work and incremental results. It’s a time of thorough industry analysis, setting up a successful strategy, and defining the company’s vision, mission, goals, and values. Additionally, there are many pitfalls to look out for, and avoiding all of them without the necessary financial acumen, or a dedicated startup finance team to back you up, is almost impossible.
Money is the push that any startup or business needs to get off the blocks and grow. But understanding the different types of funding available at each stage, and what you can do with them is just as important as having the cash on hand in the first place.
Table of contents:
- What is Seed Capital?
- Seed Capital Examples
- Seed Capital vs. Venture Capital
- What’s Next?
What is Seed Capital?
Seed capital is the initial funding needed to get a startup on its feet. This capital usually goes into sponsoring research and development efforts or covering any costs required to set up a business. Aside from proof of concept and setup costs, seed funding may find other applications. These include financing business plans, market research, legal costs, patent costs, and office rent. Some funds may also go towards marketing, prototype development or early team payroll.
During the initial stages, an entrepreneur often faces the disadvantage of limited connections with the wider business world. Additionally, their startup is unknown to the customer base and investment firms.
It is only when a startup is established that it can attract investments from financial institutions or venture capitalists. Until then, seed funding remains the only option for raising the much-needed capital. In other words, the lack of established reputation, product, or service makes it extremely difficult to attract outside investment.
Examples of Seed Capital
Depending on how brilliant an idea is or the milestones a startup achieves in its earliest days, it might raise anywhere between $10,000 and $2 million in seed capital. Here are the usual sources of funding available to startups.
Family and Friends
Firstly, an entrepreneur may rely on family and friends to raise the initial capital they need to implement their idea. Surveys show that about 22% of new businesses acquire financing through such means.
Family and friends are likely to donate funds because of their strong belief in the business concept. In addition, the kind of relationship at play determines the amount of money a startup founder ends up raising.
In exchange for investments, an entrepreneur may decide to offer certain benefits such as gifts or equity in the business. Importantly, investment from a relative or friend should be documented clearly to avoid misunderstandings in the future.
Although family and friends are common options for securing seed capital, some entrepreneurs may have to rely on their own savings instead. Such funds are often only enough to cover some initial costs. They are seldom sufficient to support growth or evolution into the next stages of development. Self-funding is one of the best ways to get a business up and running without giving out any equity, which could become scarcer and more valuable in the future.
Angel investors are some of the biggest players in seed funding. They are typically high-net-worth individuals who invest in a startup’s early stages in exchange for equity. Equity holdings are the most sought-after form of securities as they can become more valuable once the startup’s valuation increases.
In addition to looking for a solid return, angel investors usually play an active role in management. This is because they want to make sure their investments multiply with an increase in the startup’s value.
Crowdfunding entails setting up an online campaign on reputable platforms to raise seed capital from the general public. With crowdfunding, startup founders may choose to give out potential future benefits in exchange for investments. Thus, in some crowdfunding operations, founders and entrepreneurs offer exclusive experiences or early versions of the product.
Seed Capital vs. Venture Capital
While seed and venture funding are both used to raise initial capital, they have key differences that cannot go unnoted. Seed capital is a popular fundraising structure for startups and small businesses that cannot attract high-tier investors.
In contrast, venture capital is a mode of fundraising, deployed by well-established businesses with proven revenue models. Such businesses usually attract interest from high-tier investors more easily.
Seed funding mostly results in equity or private benefits being issued to investors. Venture capital, on the other hand, often comes in return for preferred or common stock, debt securities, or equity shares. While seed funding can lead to a startup raising between $10,000 and $2 million, venture capital can rake upwards of $20 million.
Startups undergo many challenges in the initial stages, not limited to innovation or product development. For example, one of the most common pitfalls is financial mismanagement and a mishandling of cash burn rates.
Once seed capital triggers accelerated growth, propelling a startup to new heights with unique products and services, interest from institutional investors often follows suit. This would be the perfect time to pursue other financing options such as Series A funding to accelerate growth further.
While you may yet be far from the opportunity of being acquired in an M&A deal, many large-scale investors require some form of restructuring of the company to ensure optimal returns. As a result, the need for a thorough grasp of financial analysis best practices will only become more pressing as your business grows. Start gaining the skills you need to become a successful business leader with our Complete Finance Manager Course.
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