Exploring Seed Funding
Seed funding is an investment made in a company in exchange for equity in that company. Seed capital is similar to venture capital with the main difference being the source. Venture capital generally comes from institutions and is generally much greater in amount than seed capital. Think of seed funding as getting a lot of smaller investments rather than one large investment. Seed funding is also very flexible and can be used for many things. So, it follows that a startup gets seed funding by selling small chunks of equity in the company to a hopefully high volume of individual investors.
When does seed funding take place?
Seed funding can be crucial at the early stages of a business because it can signal to venture capitalists that a business is ready to take on funding. Venture capitalists generally like to reduce their risk and a business that has already generated seed funding seems to be less of a risk. Further, venture capitalists do not like to invest in startups at such an early stage, so seed funding is generally used as the first round of funding. Thus, if a startup is successful at raising seed funding at an early stage, it will be more likely to receive larger amounts of venture capital down the road.
Where to find seed funding?
So, an entrepreneur will want to exhaust every resource when seeking seed funding. Seed funding can come from many different sources, so it is important for an entrepreneur to be creative when thinking of these potential sources. Friends and family are a very good resource, as are neighbors and local business owners, and AngelList. Remember, you are not asking one person for a huge sum of money so your goal should be to find as many sources as possible. You will get plenty of practice pitching your business idea at this stage, another reason why it is good to start with your friends and family.
Small business vs Startup company
There’s a distinction to be made between a small business and a startup company, and it lies in the scope of ambition. The distinction is important because they tend to require different amounts of capital to build.*
Startups, in the way that most use the term, are actually more like big companies that are early in their development. They tend to go after bigger markets and require more resources to get to sustainable profitability. As such, they can’t survive very long without getting large. Small businesses can operate at a small scale indefinitely, spitting out cash as they go. Some can even shut down for periods of time and restart later.
Both small businesses and startups can start with a very little capital. Small businesses can get off the ground with little investment, and continue to maintain their operations without adding more fuel to the fire. This is because small business aspirations tend to be more modest.
You may have heard some people refer to small businesses as “lifestyle businesses” in contrast to venture-backed companies that tech reporters love to write about. Some use the term “lifestyle business” in a derogatory way, but that’s shortsighted – they often deliver exceptional value to their customers, employees, and owners. Startups tend to require much more capital throughout their lifecycle in order to achieve their goals.
Capital can come from equity or debt investments, but it can also come from retained earnings or other creative places. What follows is a rough lay of the land rather than an exhaustive survey of all options:
Traditional Sources of Funding
- Your Own Money
- If you have the money, you can choose to invest it into your new venture directly. This isn’t an option for many first-time entrepreneurs, but it’s something worth considering very seriously. Taking money from other people means you become beholden to those other people.
- Friends & Family (& Fools)
- Entrepreneurs can get seed money from anyone who believes in them, which usually starts with friends and family who know them best. The money can come in the form of equity (sell shares in the business), or debt (borrow it, with the promise to pay back later). Regardless of how informal your relationship may be, it’s a good idea to be formal about fundraising and document terms clearly and professionally. Finally, make sure they fully understand all of the risks before you take a dime from them!
- Angel Investors
- Angels are individuals who have a high net worth and make investments in early business ventures. Some have a “spray and pray” philosophy where they’ll invest a little amount into many companies. Others have strict criteria and focus on a specific industry, business model, etc. You can meet them via referrals by applying to pitch angel groups.
- Professional Investors
- You’ve probably heard of Venture Capitalists. These are professional investors, who get paid to invest Other People’s Money into ventures that can potentially return multiple times (usually 10x minimum) the original investment. You should understand that VC funding is ridiculously rare – fewer than 1% of businesses raise capital this way. It’s also reserved for a narrow set of industries and business models and only applies to startups – not small businesses.
- Institutional Lenders
- Banks are in the business of lending money, regardless of how much it seems that they love to say no. Really, they just have a very low tolerance for risk and new ventures are inherently risky. It’s rare for a bank to fund any early-stage company on its merits. More likely, they’ll be willing to lend your business money only based on your credit, assets, and background – and they’ll require a personal guarantee. Compared to other sources of debt, banks will typically have the lowest interest rate.
- Believe it or not, your customers are often willing to fund you! More often this comes in the form of deposits or pre-payments. The best way to find out if a customer is willing is to simply ask them. In our awesome modern world, there are platforms that help facilitate this like Kickstarter and Indiegogo.
- Let me tell you about one of the best things about buying B2B – payment terms! This is also sometimes known as trade credit. If you buy on Net 30 terms, your vendor is essentially lending you money for 30 days. Negotiate for Net 60 terms, and you’ve doubled your timeline. If you can combine customer prepayments with vendor terms, you’ve discovered Negative Working Capital. This is how many eCommerce businesses (including mine) have been able to reduce the amount of capital they raise from equity and debt.
- Credit Cards
- Credit cards should be used with extreme caution, but they are definitely a tool in the entrepreneurial toolbox. If you must use a credit card, choose one with the highest amount of cash back.
- If a customer who owes you money but won’t pay for 30 – 90 days, Factoring companies can help shorten your cash conversion cycle. They can get you money today, but there’s a price to pay for it – sometimes as much as 7% of the amount financed.
Funding can be a painful task at times but if handled properly and wisely, it can be used in a beneficial manner!
You would not want your company in someone else’s hand when it actually starts making a profit, would you?