A Guide to Seed Fundraising
Equipment must be purchased, offices must be rented, and employees must be hired. More significantly, they must expand. To execute these tasks, companies will almost always need outside cash.
Seed money is a term used to describe a company’s first round of funding. This quick guide summarises everything startup founders need to know about raising the seed money they’ll need to get their business off the ground.
Why Do You Need to Raise Money?
The great majority of startups will fail if they do not receive startup funding. The amount of money required to bring a firm to profitability is typically far beyond the founders’ and their friends’ and family’s financial capabilities. A startup is a firm that is designed to grow quickly .
Prior to establishing profitability, high-growth organisations nearly always need to burn capital to maintain their growth. Only a few new businesses succeed.
A war chest not only allows companies to survive and develop, but it is nearly always a competitive advantage in all areas that matter, including employing key personnel, public relations, marketing, and sales.
As a result, most businesses will almost definitely seek funding. The good news is that many investors are looking for the appropriate startup to fund. Fundraising is brutal. Raising the funds is frequently a long, arduous, complex, and ego-deflating procedure. Nonetheless, it is a journey that practically all businesses and founders must travel, but when is the ideal moment to seek capital?
When Should You Raise Funds?
Investors write checks when they hear a great proposal and are convinced that the tea is good.
How Much to Raise?
In an ideal world, you’d raise as much money as you need to break even, and then you’d never have to raise money again. If you succeed, you’ll be able to not just raise money in the future, but you’ll also be able to exist without new funding if the funding situation becomes tight. However, other firms, such as those developing hardware, will require a follow-on round. Their goal should be to gather as much money as possible in order to reach their next “fundable” milestone, which is normally 12 to 18 months out.
When deciding how much to raise, you must consider a number of factors, including the amount of advancement that money will buy, investor credibility, and a return on investment. If you really can give up little enough as 10% of your firm in your seed round, that is fantastic; but most rounds will require up to 20% dilution, and you should attempt to avoid giving up more than 25%. In any case, the amount you’re requesting must be backed up by a credible plan. That strategy will provide you the credibility you need to persuade investors that their money will grow. It’s always a good idea to make many plans based on various amounts raised, and to thoroughly communicate your view that the firm will succeed whether you raise the full amount or a smaller amount. The difference will be in your ability to expand quickly.
Determining how many months of operation you want to fund is one method to look at the appropriate amount to raise in your first round. An engineer (the most popular early employee for Silicon Valley firms) costs around $15k per month on average. So, if you want to be funded for 18 months of operations with an average of five engineers, you’ll need roughly $1.35 million (15k x 5 x 18). What if you intend to hire for more positions as well? Don’t be concerned! This is merely an estimate, but it will enough for whichever blend you employ. And now you’ve got a fantastic response to the question, “How much are you raising?” Simply state that you will be raising for N months (usually a year).
The fundamental fundamentals of venture capital must be understood by startup founders. It would be good if everything was really straightforward and could be conveyed in one paragraph. Unfortunately, as with most legal issues, this is not an option. This is a fairly high-level description; however, it is worth your time to study more about the specifics and benefits and drawbacks of various types of financing, as well as the essential aspects of such arrangements that you should be aware of, such as preferences and option pools. The articles listed below are a good place to start.
Venture capital is normally done in “rounds,” which have names and are usually done in a specified order. The seed round is followed by a Series A, then a Series B, and finally a Series C.
A convertible debt loan is a loan made to a firm by an investor using a convertible note as collateral. A principal amount (the amount invested), an interest rate (typically a minimum of 2% or so), and a maturity date will all be included in that loan (when the principal and interest must be repaid). When the corporation performs an equity financing, this note is intended to convert to equity (thus the term “convertible”). A “Cap” or “Target Valuation” and/or a discount are generally included in these notes. The maximum effective valuation that the note’s owner will pay, regardless of the valuation of the round in which the note converts, is referred to as a cap. The cap has the consequence of making convertibles more difficult to come by. Investors in the equity round frequently pay a lower price per share than other investors.
A discount, on the other hand, is a percentage off the round valuation that establishes a lower effective valuation. These terms are viewed by investors as their seed “premium,” and both are adjustable. Although investors are typically prepared to extend the maturity dates on notes, convertible debt can be called at maturity and must be repaid with fundamental to the understanding.
Setting a per-share price and thus a valuation for your firm (usually, the cap on the safes or notes is regarded a company’s notional valuation, though notes and safes can also be uncapped) and then issuing and selling new shares of the company to investors is what an equity round entails. This is usually more difficult, expensive, and time consuming than a safe or convertible note, which explains its early round popularity. It’s also why, whenever you plan to issue equity, you should always hire a lawyer. When your company conducts a pricing round, you must be knowledgeable with numerous key components of an equity round, including equity incentive plans (option pools).
Investors: Angels & Venture Capitalists
The difference between an angel and a VC is that angels are amateurs and VCs are pros. VCs invest other people’s money and angels invest their own on their own terms. Although some angels are quite rigorous and act very much like the pros, for the most part they are much more like hobbyists. Their decision-making process is usually much faster–they can make the call all on their own–and there is almost always a much larger component of emotion that goes into that decision.
VCs will usually require more time, more meetings, and will have multiple partners involved in the final decision. And remember, VCs see LOTS of deals and invest in very few, so you will have to stand out from a crowd.
The ecosystem for seed (early) financing is far more complex now than it was even five years ago. There are many new VC firms, sometimes called “super-angels,” or “micro-VC’s”, which explicitly target brand new, very early-stage companies. There are also several traditional VCs that will invest in seed rounds. And there are a large number of independent angels who will invest anywhere from $25k to $100k or more in individual companies.
New fundraising options have also arisen.
How does one meet and encourage the interest of investors? If you are about to present at a demo day, you are going to meet lots of investors. There are few such opportunities to meet a concentrated and motivated group of seed investors. Besides a demo day, by far the best way to meet a venture capitalist or an angel is via a warm introduction. Angels will also often introduce interesting companies to their own networks. Otherwise, find someone in your network to make an introduction to an angel or VC. If you have no other options, do research on VCs and angels and send as many as you can a brief, but compelling summary of your business and opportunity (see Documents You Need below).
These crowdfunding sites can be used to launch a product, run a pre-sales campaign, or find venture funding. In exceptional cases, founders have used these sites as their dominant fundraising source, or as clear evidence of demand. They usually are used to fill in rounds that are largely complete or, at times, to reanimate a round that is having difficulty getting off the ground. The ecosystem around investing is changing rapidly, but when and how to use these new sources of funds will usually be determined by your success raising through more traditional means.
When planning to meet with investors, there are a few simple principles to follow. To begin, make sure you understand your target audience by conducting research into what they like to invest in and why. Second, focus your pitch on the most important points: why this is a terrific product (demos are virtually a must nowadays), why you are the best team to produce it, and why you should all dream about building the next big company together. Next, pay close attention to what the investor has to say. Your chances of closing a deal increase dramatically if you can persuade the investor to talk more than you. In a similar spirit, do everything you can to make contact with the investor. One of the key reasons to conduct res is for this reason.
If you are meeting investors at an investor day, remember that your goal is not to close. It is to get the next meeting. Investors will seldom choose to commit the first day they hear your pitch, regardless of how brilliant it is.
Who you are and how well you tell your story are most important when trying to convince investors to write that check. Investors are looking for compelling founders who have a believable dream and as much evidence as possible documenting the reality of that dream. Find a style that works for you, and then work as hard as necessary to get the pitch perfect. Pitching is difficult and often unnatural for founders, especially technical founders who are more comfortable in front of a screen than a crowd. But anyone will improve with practice, and there is no substitute for an extraordinary amount of practice. Incidentally, this is true whether you are preparing for a demo day or an investor meeting.
During your meeting, try to strike a balance between confidence and humility. Never cross over into arrogance, avoid defensiveness, but also don’t be a pushover. Be open to intelligent counterpoints, but stand up for what you believe and whether or not you persuade the investor just then, you’ll have made a good impression and will probably get another shot.
Lastly, make sure you don’t leave an investor meeting without an attempted close or at very minimum absolute clarity on next steps. Do not just walk out leaving things ambiguous.
Negotiating and Closing the Deal
A seed investment can usually be closed rapidly. As noted above, it is an advantage to use standard documents with consistent terms, such as YC’s safe. Negotiation, and often there is none at all, can then proceed on one or two variables, such as the valuation/cap and possibly a discount.
Transactions have momentum, and there is no better way to generate momentum for your offer than to present a compelling storey, be persistent, and do the legwork. Before you get that far, you may have to meet with dozens of investors. To get started, you just need to persuade 5 of them. Each following closing will become faster and easier once the initial money has been received 6.
You’re almost done when an investor says they’re in. This is where you should use a handshake protocol to quickly seal the deal 19. It’s almost certainly your fault if you don’t succeed in bargaining after this.
Documents You Need
Do not spend too much time developing diligence documents for a seed round. If an investor is asking for too much due diligence or financials, they are almost certainly someone to avoid. You will probably want an executive summary and a slide deck you can walk investors through and, potentially, leave behind so VCs can show to other partners.
The executive summary ought to be one or two pages in length (one is preferable) and should include the following information: vision, product, team (location, contact information), traction, market size, and minimum financials (revenue, if any, and fundraising prior and current).
Make sure the slide presentation is a cohesive leave-behind in general. Graphics, charts, and pictures are more effective than long paragraphs of text. Consider it a foundation for a more thorough version of your tale to be hung around. Although there is no set arrangement or order, the following sections are frequently included. Make a pitch that is tailored to you, your presentation style, and how you want to promote your firm.
The Co Innovate Venture Club connects startups with more than 20 of the world’s finest venture capital firms through a B2B methodology, investing in early-stage and growth-stage startups and small businesses. Startups in the Innovation & Acceleration Program have the chance to expand as a result of these venture capital firms’ review, validation, and support.