A new business needs money to start. But how much funding you need depends on what the start-up company is going to do. Whether it is to help develop a prototype for a new product or build a new software program, entrepreneurs need capital to start their venture. Unless they are independently wealthy or have exceptional credit, they may have a hard time borrowing money from a bank to start their new company. As a result, start-up companies often look to alternative forms of funding, such as seed capital assistance and angel investors, for help.
The main differences between start-up funding from seed capital assistance and angel investors lie in who is investing and how much. Seed capital typically comes in smaller amounts of money that a start-up raises from people they know. Angel investors generally are experienced business owners and investors who have a high-net-worth and contribute more considerable sums of money.
Your capital needs will vary based on the type of business that you start. But how can you get seed capital assistance or funds from angel investors? Is this an excellent way to start your new company? Do you need to pay this back? In this article, we’ll break down the answers to these questions to give you more insight into seed capital assistance and angel investors.
What is Seed Capital?
Seed capital is money that start-up companies raise to pay for initial costs, such as developing a business plan and conducting market or product research.
Often referred to as seed money, the funds may also pay for operating expenses, such as rent and utilities, research and development, or business plans. To get seed capital, entrepreneurs will often turn to people they know, such as family and friends, to contribute money.
Why Should I Raise Seed Capital?
Seed capital helps a start-up move from a concept to some form of Minimum Viable Product. The idea is to give your concept, your business, enough substance, to interest the next level of investor (probably an Angel Investor). If you are building a start-up, your focus in the seed capital phase should create a business concept that will interest investors.
Do I Need to Pay Back Seed Capital?
When a start-up receives seed capital, it’s usually an investment in a company. It’s typically not a simple loan that you repay. Instead, the investor owns a percentage of the company.
Alternatives to this may be a convertible note or some sort of loan structure that converts to equity at a future time. You would do this to avoid having to value the company today.
You often could borrow money at this stage, but if you want future investors, then you want to avoid loans or deferred payment structures. New investors do not want their money to pay for what you have already done. They are investing in the future, not the past.
Imagine you approach angels to raise $500,000 and have $500,000 of debt or deferred compensation to repay. The investor will see that their money will make no difference to the future of your business; you will use their money to pay for where you are today (repay the debt), rather than grow. Convertible loans work because they convert to equity rather than act as loans that drain cash from the business.
The key is that that business isn’t using new financing to back the past. Instead, the start-up can reinvest that money into the business.
So, where do I find seed capital?
Most seed capital will come from your savings or friends and family. But another great source of seed capital is sweat equity. You may find suppliers or people you know who are willing to put some work into developing your business against the promise of future gains.
Pay people with equity: initially, your equity is worth nothing; it is only a promise. But if you can inspire a group of people to work for that promise, you can create equity that has real value. Avoid paying with debt or the promise to pay in the future. As I mentioned above, that will make your business more difficult to invest in.
What is an angel investor?
An angel investor is someone that has a high net worth and an entrepreneurial background.
They typically seek a higher return on the money they invest. Because they usually invest their own money in the venture, they are focused on helping the entrepreneur become successful. An angel investor may make a one-time investment or provide funding over time.
To be an angel investor, you generally need to be an “accredited investor” and have:
- A net worth of at least $1 million in assets (or)
- An income of at least $200,000 for an individual and $300,000 for a married couple for the past two years
- The financial ability to invest
Being an accredited investor does not automatically make you an angel investor.
But most angel investors are accredited. The reason for this is start-up companies who pitch non-accredited investors end up with onerous reporting requirements. If start-ups solicit non-accredited investors, this can create significant issues for the start-up.
Why should I turn to an angel investor?
Angel investors often invest considerable sums of money in a start-up. They invest in the future growth potential of a company. They also provide expertise, guidance, and support to the start-up.
Compared to a bank or other traditional forms of financing, angel investors tend to give funding on terms that work better for a start-up company.
Angel investors may be the right first place to go for seed capital. Often though, you will get a better deal from angel investors, and it will be much easier to raise money if you invest some seed capital first. Unless you personally know an angel investor who is willing to take a chance on you and provide some seed money, angel investors are unlikely to be your first step.
How are seed capital and angel investors alike?
There are many similarities between funding from seed capital and angel investors:
- Seed capital and angel investors serve a common purpose: to provide funding to start-up companies. Both forms of funding are essentially the same, but they vary in amount.
- Both tend to provide funding based on their relationship or knowledge of the entrepreneur. Business viability and future profits typically do not drive the decision for investment.
- Personal funds are commonly used for seed capital and by angel investors.
- Start-up companies do not pay back funds received from seed capital or angel investors. Instead, both get ownership in the company in exchange for their funds.
Since both types of funding happen in the early stage of a company, the money given by an angel investor may also be called seed capital.
What Funding Comes After Seed Capital and Angel Investors?
Seed capital and angel investor funding can help a start-up get through its introductory stage, where it transforms a concept into a business plan. However, once the business begins to grow, it may need additional funding from other sources:
- Venture capital – A viable business plan can attract funding from a venture capital firm. They pool money from multiple investors to fund start-up companies that exhibit high-growth potential, strong management, and a competitive advantage with their product or service. A venture capital firm usually invests between $1 million and $20 million in start-up companies.
- Private equity – Known as PE firms, they typically invest in companies that have moved beyond the start-up phase and generate revenues. A PE firm can invest millions or billions of dollars.
Conclusion – what is the difference between angel investing and seed capital?
Even though there are differences between seed capital and angel investors, both play a role in growing your company. Seed investors and angel investors are owners in your company who want you to succeed.
Since seed capital and angel investors often base their financing decision on their relationship or what they know about the owner, it can be an easier way to raise money. Plus, the expertise that an angel investor to a start-up can contribute to its future success.