If you plant the smallest seed and give it necessary attention and care, it can grow to be a massive tree that lives thousands of years. Seed capital is the same thing.
Seed capital is the first money invested in a startup. You should use it to set the conditions for growth and success. Seed capital defines the early stages of a business and positions you as the leader of a startup with growth potential.
This is often a small amount of money. The goal is to establish the firm’s idea, develop a business plan, and put yourself in the best possible position to secure funding from investors. Think of seed capital as the funding needed to get the company off the ground and sprouting.
What seed capital should pay for:
Companies that are in their infancy stages use initial funding to develop their ideas fully and pay for initial expenses. The type of business you aim to create and the investors you aim to attract will largely determine the uses of this seed capital.
If you are developing a software business and want to attract sophisticated software investors, you will want to invest in showing that you have the capacity to develop software. This may be coding, but it may also be a development plan combined with a marketing plan. Your investor in this case may care more about the market for your product or data and less about the coding itself.
On the other hand, a more marketing-focused investor may want to know that your software product is fully coded and that you are beginning to see adoption.
Seed capital should pay for developing your business plan
I know exactly how boring writing a business plan sounds. But planning is crucial to executing your business effectively and efficiently.
A plan accomplishes a couple of things.
First, a written plan helps you focus. It is easy to get bogged down in the enormity of what you are trying to do. A plan provides the context and ensures that the actions you take today will come together to create your vision.
Along the same lines, it helps to align your team. When you write things down you can have people work on different areas of the project and refer to the plan to see how it all fits together.
And finally, it shows investors that you can deliver. Investors are very concerned about execution risk, and creating a business plan is one way to show that you have what it takes to do what you say you will do. And, if you can show that you consistently do what you set out to do, by showing how you work to your plan, this will help inspire your investors.
Now, what a business plan is, is more complicated. I don’t mean that you should sit down and write a long document that sits on a shelf somewhere to gather dust.
Your business plan should be a living document that changes as you grow. It will define what you plan to do with the money that you raise where you intend to sell your product or service and why people should buy it.
The business plan mistake that we see consistently at the Westchester Angels is to talk in vague terms about what you intend to do and what the future looks like for your company.
If:
- your marketing plan is to get 1% of a large market, you haven’t done your planning.
- your development plan is to build an app, you haven’t done your planning.
- the money you raise will go to “growing your company” you haven’t done your planning.
So, define these.
To effectively scale a business you must create a business machine. The machine defines how to attract prospects, convert them to clients/customers, deliver some sort of transformation, and complete the deal. Be able to explain this. Invest in understanding it. This is. your plan.
Seed capital should pay for research and development (R&D)
This is probably the most obvious answer. Yes, you can spend seed capital on research and development. Research and development are essential to creating your product and helping you stay ahead of the competition.
Often research and development mean creating your prototype.
The problem with research and development that it is a never-ending exercise that can soak up all of your capital very quickly. Focus on creating a minimum viable product. We have seen many entrepreneurs at the Westchester Angels that have tried to create a perfect product. They end up spending hundreds of thousands of dollars before they get any feedback from the market or investors.
Building to completion then trying to sell a product is a terrible idea. Instead, minimize your initial R&D efforts and focus on the minimum that will get you to the next stage.
Operating Expenses
There are a number of operating expenses that will crop up when you start your business. These range from rent and insurance to equipment and supplies to ERP Implementation Services and payroll. These are all viable uses for seed capital.
At the same time, you will want to keep these expenses as low as possible. Many famous businesses started in dorm rooms, garages, and less than perfect office space because these were cheap places to work. No investor is ever impressed by huge outlays of capital for office expenses or high priced anything.
The leaner and meaner you can stay in this phase the better off you will be.
How Do Companies Secure Seed Capital?
The first round of funding can have many sources, but most often, seed capital is financed by individual investors. These can include personal connections (i.e., your family, friends, and network), investment of personal money, angel investors, or incubators if you are having a difficult time securing funding.
This initial capital may come in the form of money and it may be advice, time, or expertise. Remember, your goal here is to create a business machine and define what you will build.
All of these can be excellent options for getting investors to give money to your newly formed business.
(Interested in how to become an Angel Investor? Click here.)
Some sources for seed capital:
- Personal connections: Garnering interest from family and friends is a common way to get seed capital for your business. These individuals may be easier to approach and more supportive of your ideas. Having friend and family investors can be helpful when you start raising money from people you don’t know.
- Personal investment: Your funding source may also be your personal finances to get the business running. If you have the funding, this can be a great way to maintain full control over the business without owing money or equity. On the other hand, it is risky to put a large percentage of your savings on the line if you need larger sums.
- Angel investors: You can turn to angel investors for funding. These investors often make great partners, especially if they are passionate about the business or have investing experience (Source; Entrepreneur). Often though Angel investors prefer to join a business after the seed capital phase. Your objective with seed capital is to make your business attractive enough that angels want to invest.
- Crowdfunding: Especially with the popularity of fundraising sites, you can get lots of people passionate about your project that you don’t know. This is a great way to see the demand and interest in your business before it even launches. You are using your seed capital for necessary costs and, at the same time, gaining an excellent customer base with this built-in marketing tool (Source: Forbes).
The type of investors you attract will also depend on the amount of money you need to raise in the seed capital phase.
These costs can be very minimal to quite expensive, depending on the business. When approaching investors, you should first look over exactly what is included in your expenses and come up with an estimate.
Consider whether your business is ready for investment and approach your investors with their needs in mind, so they can see where their dollars will be used and feel confident in your ability to manage funds.
It is also important to know the differences in seed capital and how they impact your business. The two most common funding options are loans and equity investments.
Both loans and equity investments each pose their advantages and disadvantages, which are:
- Loans: A loan is the borrowing of money to be paid back at a later date, with interest payments to provide investors with returns. For companies who do not want to give up equity, this is a great way to secure funding. It also means you can pay off an investor and not have the responsibility to share future earnings. At the same time, you will be paying additional interest on the initial investment (Source: Investopedia
- Equity investments: The buying and selling of equity within the company is a viable option for start-ups seeking to accrue funds. The company does not have to return the money to the investor, but they do give up a portion of their business profits in the future. Strategic partners may be worth the giving up of equity for some companies, while others may choose to maintain full control (Source: BlackRock).
Take Advantage of Seed Capital
To start a business and position yourself as an attractive investment for venture capitalists and larger investors down the line, getting seed capital is an important first step. It can take only a few thousand dollars to develop your business plan and pay the additional costs it will take for jumpstarting your company.
Analyzing the costs associated with your business and coming up with a number to bring to investors for seed capital shows you are organized and professional. It will help you to manage expectations for the planning of your business as well as hold you accountable for the costs you project.
Taking advantage of seed capital sources will help to initiate the process of building your business and incorporating partners that not only serve as funding but also as strategic influences to help your business grow and prosper.
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