Unless you are an experienced entrepreneur or have access to personal capital, most startups require outside resources to start their business. Gaining financing from investors is often a crucial step in the development of a company’s product or service.
Raising seed capital is hard for most brand new businesses, whether that struggle with preparing ideas to present to investors, finding the right investors, or building investor confidence from previous ventures or expected returns from the new business plan. Raising seed capital also includes legal costs that add more complexity to funding your business.
Understanding that raising seed capital is difficult allows you to approach financing more realistically and emphasizes the importance of carefully evaluating your business’s growth opportunities. The more prepared and developed your business idea is (which requires more work), the better your prospects will be for attracting investors to your business.
What It Takes to Raise Seed Capital
Seed capital is the funding required to start a business or develop a product. It is often used in the initial stages of the firm to cover the necessary expenses for growth. As the name implies, the funding contributed by investors for an equity stake or other benefits is used to help the seed (or young company) grow and blossom (into a profitable business).
While many companies want to raise seed capital to fund their operation, their company needs to garner interest for investment.
This can be achieved a multitude of ways, including:
- Creating a detailed business plan and diligently preparing a pitch for investors
- Finding the right investors to serve as backers or partners in a project
- Showing opportunities for financial growth, returns, and results
The strategy you choose to procure seed capital will depend on several factors, including the current circumstances of your business, the monetary value required to jumpstart your idea, and your goals for the future of the firm. It is important that you thoroughly develop your idea to be in the best possible position for investor interest before attempting to raise seed capital.
Business Plan and Pitch Preparation
Above nearly all else, investors choose to fund businesses based on the expected return on investment. This means that startups should be able to provide established financial landscapes for their business, including a value for an initial investment with the intended use as well as how that investment will impact the growth of the overall business in the future.
To provide these details as well as the whole idea and its feasibility, creating a thorough business plan is necessary. While not all investors will need or want to see the plan in its entirety, it is important to be able to answer all questions that may be asked of you and the firm. It also serves as a guide for your future decision-making to align with your mission.
There are many ways to write a good business plan to manage and grow the business as well as build investor confidence in the growth potential to secure funding. Business plans are often written in traditional and more detailed styles, and there are lean business plans that quickly state the plan for simpler businesses.
To create a strong business plan, you will need to:
- Establish a clear business idea with objectives: Also known as an executive summary, this information establishes the idea and mission of the business and how the company will be successful. There should be important financial information included in this section when asking for seed capital (Source: Small Business Administration).
- Conduct a market analysis: This section of a business plan shows that you’ve done your homework. In researching the competitive landscape for your business and its growth potential, investors will see their opportunity for returns. It will also help to guide you in decision making based on what other companies are doing and reveal any limitations or issues you may have moving forward (Source: Entrepreneur).
- Describe your product or service: Beyond a summary, you will want to go into detail about your product or service to convince investors that your business is worth their investment. This section should include information about any relevant R&D, the value brought to customers, and an explanation of how your business cycle will work.
- Detail the financial ask: Asking investors for money will need to be backed by a detailed section on the amount needed and what it will be used for. This plan should cover the use of the invested funds over a specified time and discuss future financial needs if necessary.
- Include all financial data: Knowing your financial projections will be imperative in securing seed capital. For startups, doing the necessary calculations to project all cash flows will determine if the company will be successful. If the company is already established, you should provide financial statements, including income statements, cash flow statements, and balance sheets (Source: Business News Daily).
If you are interested in creating a lean business plan, the Business Model Canvas is a great place to start. It allows you to cover all areas of the business plan in an easily understandable and visual way. It is less detailed than a traditional business plan but gives necessary information to investors. To better your chances, having the additional information available upon request will show preparedness.
After developing the business plan, you will also want to make sure you can convey these ideas in a pitch (or presentation). These presentations do not go into great detail like a business plan, but they present the business to investors. Being knowledgeable of the details in the business plan is very important when questions are asked during a meeting.
Financial Results and Valuations
Being able to look at the financial aspects of the business in more detail and show already established financial returns or accurate projections for future earnings will allow for much more success with raising seed capital. As mentioned, investors are interested in investing in companies that will be profitable to see a return on their investment.
Accumulating and accurately projecting the financial data can be one of the most challenging parts of creating a business plan and therefore raising seed capital. This also plays into how much money you will ask investors for, which should reflect the value that the company will provide, both financial and otherwise.
The financial ask should be based on the valuation of the company, or how much it is worth. For startups and new businesses, this can be challenging with little to no financial history.
These are some of the valuation methods to use to show financial results or projected growth:
- Multiple of EBITDA: A traditional form of valuing a company is to take a multiple of the company’s earnings before interest, taxes, depreciation, and amortization (EBITDA). This method is easiest for established companies who already have financial statements to show (Source: Corporate Finance Institute).
- Discounted cash flow: This method is helpful for companies that have not established earnings because it is based on future cash flows. Using predicted returns on investment and discount rates, the cash flows are determined by looking at growth potential as well as market conditions (Source: Investopedia).
- Market multiples: Companies arrive at a valuation by comparing themselves to similar companies and the rate at which they were acquired. A base multiple is created based on the market, and the company is compared to that number.
- Cost-to-duplicate: This approach considers all the costs in developing the business, including the purchase of assets. This will help estimate the value of your company to determine its overall worth (Source: Mass Challenge). It does not consider future earnings or any value that cannot be physically calculated.
The method chosen for valuing your business will depend on the available financial information and history of your particular business. Startups may find it challenging to use traditional methods when they do not have financial statements or any developed product. Using a cost-to-duplicate method may be best for firms that are in their early development stages, as most are looking for seed capital.
Finding The Right Investor(s)
Raising seed capital will require attracting investors that will not only provide you with the necessary funding but also provide intangible benefits that can be significantly more valuable. For startups with great business plans, securing funding is often the least of your concern. Finding an investor that can double as a strategic partner is just as important for many entrepreneurs.
When receiving seed funding, you will likely be giving up equity stock in your company. You are making investors part-owners in your business; therefore, you give them small portions of control. Many investors may want to be involved in business decisions to optimize their opportunities for growth and returns.
As the owner of your business, you must consider both your need to raise capital and the investor you take money from, as this decision can have major implications for the future of your business.
Choosing the right investor will be different for every startup, but these are some important factors to consider:
- The amount of seed capital needed: The type of investor you can attract will be impacted by the amount of money that is needed to fund the startup. Not only will the stage of development impact how much money you can ask for, but different investors have often had varying propensities to spend. Angel investors typically provide lower sums of funding but are easier to acquire than venture capital (Source: Eqvista).
- Strategic partnerships: The intangible benefits an investor can provide may be even more valuable than the money. If they are experienced in your particular industry or have impressive networks to tap in to, these can help to grow the business. In exchange for money, you may also be getting an important mentor to drive profitable business decisions.
- The investor’s history: You will want to do some research into the investor that is interested in your company. Looking at their past investments will help to determine if they will have the ability to pay, offer multiple rounds of funding, what their level of involvement will look like, and their overall reputation (Source: Forbes).
- Company fit and values: Especially when giving up an ownership stake in your business, you will want to make sure that the investor aligns with your vision for the business and values. This is especially true when giving up a larger stake in your company with a possibility that control can be shifted. A common fear for startups is the giving up of too much equity and losing control of their business. Finding an investor who is a good fit and who you get along with will help to avoid many issues throughout the relationship.
- Influence and other investors: Securing the right investor may lead to interest from other investors and influence relevant parties to take an interest in your business. While securing prominent investors that are well-respected can be a challenge, doing so can open many doors.
How Much Does It Cost To Raise a Seed Round?
Beyond the money you are asking investors for to fund the initial business costs, you also have to consider additional fees in raising rounds of seed funding. The cost to raise a seed round will depend on the amount of money being raised and the investors you are working with. The highest costs are the legal fees to solidify the paperwork and accounting costs.
The initial seed capital required to fund your business will likely garner attention from angel investors at lower amounts unless your company has already been identified as having high growth potential for venture capitalists. Legal fees associated with angel investing paperwork will likely be lower than that for venture capital (Source: VC-List).
There are three primary ways to structure seed capital to receive funding from investors, and they each have different costs associated with them:
- Priced equity rounds: This is the most traditional form of equity investing that exchanges investor money for preferred stock in the company based on a pre-determined firm evaluation. This is the costliest method because it requires much more paperwork and negotiating in the form of legal fees (Source: Tech Crunch). Typical costs for these rounds can be $10-$15 thousand when raising large amounts of money and considering any restructuring or cleanup required.
- Simple Agreement for Future Equity (SAFE): These seed rounds do not count as debt and have no interest payments or maturity dates. They are also inexpensive and allow funding to be raised quickly (Source: Carta). These costs should fall around $3 thousand, depending on law firms and the specific needs of the company.
- Convertible note: These seed rounds are issued as short-term debt and turn into equity after future rounds of financing in most cases. Many startups exchange seed capital for convertible notes because it requires less paperwork and, therefore, lower legal fees. Prices will vary, but you can expect to pay between $3-$5 thousand to raise this seed round (Source: Startups.com).
Many law firms will offer flat fees rather than hourly, which is often in the best interest of the startup and their limited access to finances. More funding can be spent on business development rather than paying legal fees and accounting costs. Businesses should factor these costs into their overall expenses while raising money for their business.
Steps to Raising Seed Capital
Many working parts go into raising seed capital, all requiring thorough preparation to approach investors and secure the funding. While it is difficult, there are certain steps you should follow to increase your opportunities for seed capital investment.
Here are some key steps and considerations in raising seed capital for your business:
- Identify your business prospects: The growth potential and data for your business will have a large impact on the type of investors you can attract. For smaller firms that are not fast-growing or expect significant scale (10x), you should look for angel investors rather than venture capital.
- Develop a business plan and pitch: With your business information, create a detailed plan for your business goals and their execution. This means you should know your stuff when prompted for more information. You should also have a presentation ready to bring to investors. You should practice your pitch before going into big meetings with important investors for the greatest execution.
- Find investors: Using your network and approaching angel investors, incubators, and other investment firms with your idea will help you to garner interest. Your network is the best way to get your foot in the door, as cold calling is largely unsuccessful (Source: RocketSpace). Leveraging your network through social media can also be very helpful. You must be strategic in approaching investors for your seed capital stage to help you build the company. Larger venture capital should be reserved for later rounds.
- Present and close the deal: Once you have gained interest, meet with investors, and present your idea. Make sure to be well-prepared and be confident in the value you are asking for. Work with investors to come to an agreement that will best serve the goals and mission of your startup.
While it can be hard for many startups to raise seed capital, diligently preparing all the necessary information about your company to present to investors will put you in the best position to get the funding you need. Using this information when approaching investors will help to build their confidence and improve your chances of funding your business.