A Comprehensive Guide To Seed Funding For Entrepreneurs
Recent research found that funding into privately held Indian start-ups crossed USD 10 billion for the first time ever in Q3 last year. With the entrepreneurship spirit soaring high and startups mushrooming across the country (as many as 14 unicorns created in the first three months of 2022), it is natural for brands to look for funding opportunities to continue building amazing products. In this blog post, we tell you everything you need to know about seed funding for your business. Read along!
But before that, the following articles may be useful if you are looking for raising venture capital:
- What is venture capital and how does it work?
- Top 40 most active venture capital firms in India
- Venture capital vs. private equity
What is seed funding?
Seed funding is the funds raised by a new-business at the earliest stage in its life cycle. It is around the time when a business idea is born, a plan is being made, or an initial product has been created, with minimal to no customers. New startups need funding at this stage to capture the market, increase user base and establish their foothold in the industry. Seed funding is typically the second round of funding raised after the pre-seed funding round, which involves raising funds from friends and families. Here is a detailed blog covering pre-seed vs seed funding in detail.
The capital raised during seed funding is usually spent on research and development, sales and marketing activities, hiring, and product enhancements. Start-ups can further raise more rounds of funding after the seed round, such as Series A, series B, series C and more.
Why should you raise seed funding?
In the absence of enough cash influx, most startups die prematurely. High-growth businesses require constant cash influx to maintain their growth before becoming profitable. Unfortunately, the amount of finance needed is usually way beyond the ability of founders’ or their friends and family members. Historical data shows that very few startups achieve success without raising external funds (bootstrapping); as per the CB Insight survey running out of cash is the primary reason for startup failure.
Having enough capital ensures that you can work towards making your product better, acquiring new customers, and increasing sales.
When is the right time to raise seed funding?
We mentioned before that seed capital is the investment that happens in the initial stages of the company. Timing is of the essence when it comes to getting seed funds. If you are too early, you might not be able to ascertain the relevance of the product in the market. However, if you wait longer, you will end up facing heavy competition from other players. Usually, seed investors look for innovative products, consumer traction, founders track record and ability to rapidly scale the business. To understand when to raise seed funding, here are a few questions you should be asking yourself:
- Do you have a unique idea that stands out in the industry?
- Is there a demand for the product you are building in the market?
- Do you have data to showcase the adoption rate of the product?
- Do you have a business plan in hand?
- Is your solution scalable in the current market?
- Do you have a list of angel investors and venture capitalists?
If your answer to the above questions is a big YES, you are ready to raise seed funding for your business. However, if your answer is no, it is best to work on your product and strategy before thinking of raising seed capital to ensure a high chance of funding.
How much seed funding should you raise?
The answer to this would ideally be “As much as you would like.” However, taking a strategic path here is of utmost importance. While the goal is to raise as much money as you need to reach profitability, a practical approach would be to have a set time period in mind that you would like to be funded for, maybe until the next funding cycle. Startups usually tend to look for funding for 12 to 18 months. We also recommend drafting multiple plans that highlight the different amounts that could be raised and the various possibilities with respect to how much equity you want to give, profitability, etc. This would help you understand how much money you would need to raise to stay profitable while growing rapidly.
How are startups valued during the seed funding round?
Another prominent factor that plays an essential role in determining the amount of seed funding to raise is your firm’s valuation. Startup valuation can be described as the process of determining the value of a startup business. It is important to determine your startup’s valuation to decide how much equity you will have to give to your investors in exchange for funds. Equity dilution depends on how your company is valued – usually lower valuation leads to high dilution and vice versa.
You might think, “But, the value of a startup at the seed funding stage would be almost zero.” While we don’t negate that, it must be noted that startup valuation takes into consideration the growth potential of the business.
Here are a few factors that play a significant role during your valuation process:
- Traction: Does your idea have demand in the market? Is there a possibility for scalability and sufficient growth? Building products that are relevant to the current market scenario is key to attracting more investors.
- Reputation: Do you have a credible image in the industry? Are you well-known for your interest in entrepreneurship? Having and maintaining a positive image in your network can do wonders among the investors’ circle.
- Prototype: Do you have a sample ready? A tangible product ALWAYS manages to create more curiosity among investors as they can see the product in action.
- Pre-valuation revenue: Has your product started generating revenues? Knowing that the product they would be investing in has already had pre-sales bookings or revenues is a great way to bring in investors.
- Industry: Funding in certain industries is consistently higher than in others. If your firm belongs to a flourishing industry, getting that seed funding could be much easier. In India, the most-funded industries are FinTech, EdTech, FoodTech, and SaaS.
Remember, while it might be exciting to value your startup highly, you will also have to meet high expectations from the investors. Hence, avoid over-optimization and settle for a valuation that lets you achieve your goal at a dilution you are comfortable with.
Concepts to understand before raising seed funding
Pre-seed funding vs. seed funding vs. angel investing
An angel round is typically a small round designed to get a new company off the ground. Investors in an angel round include individual angel investors, angel investor groups, friends, and family. A pre-seed funding round on the other hand is a pre-business seed round that either has no institutional investors or is a very low amount, often below $150k. The seed funding round sizes range between $10k–$2M, though larger funding has become common in recent years. It must be noted that the three are similar but not the same.
Dilution is the decrease in the equity ownership by the owners of a brand that occurs whenever new shares are issued. When it comes to seed funding, the majority of the investors agree to invest in a firm in exchange for equity. That means they will own a part of the brand for as long as the agreement exists.
For example, let us say you decide to raise $1 Million in seed funding in exchange for a 10% equity in your firm, the investor would now have 10% rights over your business. They will now have a say in every decision you make for the company, small or big. Therefore, it is vital to decide how much equity you are willing to part ways with. Ideally, 10-20% equity dilution during the seed round is the norm.
ProTip: Use the formula 1/(1-n) while evaluating the various seed funding options where n is the fraction of equity. In general, if you are giving away ‘n’ fraction of the company, the deal is good if it makes your company worth more than 1/(1-n).
ROI for the investors
The final question any investor would be asking themselves during seed fundraising is “What is in it for me?”. There are three ways in which this can be managed:
- Equity funding: Equity funding is the concept where the investor agrees to invest in your brand in exchange for percentage equity in your firm. They would receive dividends relative to their equity shares over time. In many cases, as the firm grows, investors sell off their shares to make more money.
- Convertible debt: Convertible debt is a loan an investor gives to a company that will have a principal amount, an interest rate (usually a minimum rate of 2% or so), and a maturity date. When the company does an equity financing this debt would be converted into equity shares.
- SAFE: SAFE stands for Simple Agreement for Future Equity. Unlike convertible debt, SAFE is a loan given in return for the right to purchase stock at a future date, usually at a discounted rate.
6 steps to get seed funding for your startup
Choose type of seed funding source you prefer
While there are multiple sources of seed funding, these are the top 8 sources startups go for:
Friends and family: This one is a no-brainer and also the most common source of funding for startups. Reaching out to friends and family members can be highly beneficial given the relationship one shares with them. They may also be willing to invest in your business on an interest-free basis. Every year, almost 35-40% of startup ventures receive capital from friends and family.
Crowdfunding: Very popular today, crowdfunding is the process of presenting your idea to a crowd on a crowdfunding platform and getting funds for your ideas. Per a recent report on Startups.com, more than 50 percent of crowdfunded campaigns are successful. There are typically four types of crowdfunding: Reward-based, donation-based, equity-based, and debt crowdfunding. Some of the popular crowdfunding platforms for startups in India are Kickstarter, Indiegogo, Fundable, Ketto, and Catapooolt.
Angel investors: Angel investors invest at times when the risk of a startup failing is fairly high, which is during the very early stage. Angel investors understand the world of startups. They know that they need to take a long-term view. As a result, angel funding is more flexible. Remember to work only with accredited investors who can add value to the company via high-quality mentoring and advice. Some of the most active angel investors in India are Rajan Anandan, Anupam Mittal, T.V. Mohandas Pai, Girish Mathrubootham, and Anand Chandrasekaran.
Micro-Venture capitalists: Marquee investors that provide funding based on parameters such as growth potential, market conditions, founder vision, idea, or simply execution. As an ROI, they take some part of equity or stake in the firm. These firms also almost always invest on behalf of a third-party limited partner where capital is pooled into a fund, making investments through partnerships to lessen risk and improve credibility. Some popular Micro-VCs in India are 100X.VC, Stellaris Venture Partners, YourNest Venture Capital, and Pi Ventures.
Corporate seed fund: A great way to gain visibility is to participate in corporate seed funds. Corporates today invest in the growth of a number of startups that align with their vision and values. Corporate giants like the TATA group are always on the lookout for fresh talent. In fact, Tata has invested in some of the most famous brands today, including PayTM, Zivame, Lenskart, and more.
Accelerators: Accelerators are the ones who are more focused on scaling up businesses rapidly. They take equity in return for mentorship, capital, and connections to investors and business partners. Accelerator programs accept startups cyclically in cohorts which means there are 45-90 slots every year. Some of the top accelerator networks in India are India Accelerator, and The Accelerator Network.
Debt funding: In debt funding, an investor lends money to a business, and the business promises to repay the debt with added interest in a stipulated time. In this case, the company raises capital without giving any ownership to the investor and only the principal amount and interest is required to be paid back. Some common ways of debt funding in India are through debentures, bank loans, or External Commercial Borrowings.
BONUS: Did you know, the Government of India also has started a seed funding program? Startup India Seed Fund Scheme (SISFS) aims to provide financial assistance to startups for proof of concept, product development, product trials, market entry and commercialization. We will cover more about this in our upcoming blog posts. Stay tuned!
Determine the amount of seed money you need
The next step in the process is to determine the amount of money you’d require. As mentioned above, you can determine this by answering some essential questions (refer to “How much seed funding should you raise?” above). However, above all this, don’t forget to ask yourself if you are willing to let go of a part of your equity in exchange for the funding. Building a financial projection plan will help you determine the amount you would need. The general rule of thumb would be to raise 12-18 months of cash, raising less than that would be too little. Longer than 18 months implies that you would be sitting over the cash that you have raised when your company was worth less. This is too much dilution at this stage, so stick to a 12-18 months time frame. Remember you can always raise more in upcoming funding rounds at a higher valuation.
Prepare necessary documents for seed investors
Always being prepared beforehand can help you avoid unnecessary delays in the process. Here is a list of documents you need to have ready before approaching investors:
Business plan: Having a clear understanding and a chalked-out plan of what you want to achieve and how you would be doing it is a great way to convince investors. Here’s how you can draft a business plan that works. Ensure you use clear, concise language free of jargon. Research the market to the roots so you have enough information to lead with. Drafting the executive summary should be treated with utmost importance as it stands as a base for your entire operations. Don’t forget to keep your target audience in mind while drafting the plan— While it is true that your main aim is to make profits, don’t overlook the fact that you are building your brand to solve your audience’s problems.
Pitch deck: Presentations are still in vogue. Put all your ideas in a minimalistic deck. While you can do this using the usual presentation creation tools (PPT or Google Slides), we recommend taking some extra effort and making presentations that speak for themselves. While you are at it, also prepare an elevator pitch that can often come in handy when meeting investors for a brief amount of time. These pitches are usually 30 seconds long and highlight the value proposition and business metrics. It should cover the basics of who, what, why, and how of your business. Remember to create decks that are simple, legible, and to the point.
If creating the deck seems like a daunting experience to you, here is a slide template we think investors would be interested in:
- Slide 1: Name of the business, logo, tagline
- Slide 2: Meet the team (founders)— Talk about what makes your team particularly well suited to the problem.
- Slide 3: Mission statement— Why does your company exist? What problem is it trying to solve?
- Slide 4: Value proposition— Why would customers buy your product?
- Slide 5: Market size— What is the demand for your proposed idea/product
- Slide 6: Competitor analysis— Who are your strongest competitors in the market?
- Slide 7: Why do we stand out— What are the key differentiators?
- Slide 8: Roadmap— What are your immediate steps and the outlook on the future? Don’t forget to add your business metrics.
- Slide 9: Funding amount— How much are you looking to raise through seed funding?
However, if you are looking for readymade templates to make your work easier, here are some amazing sites that offer premium templates:
Identify the list of potential investors
One of the most important parts of the process is identifying the potential investors. Having the right partner can make or break your business. Today, there are a plethora of investors, both small scale and big, who are very keen on investing in homegrown startups.
Reach out and meet your seed investors
Once you have your investor list and the pitch ready, the next big step is to reach out to the investors and let your pitch do the magic. You know who you want to approach, but where will you find these potential partners? One of the most common places where you can get in touch with an investor is LinkedIn. Linkedin is a great platform for identifying and networking with the top investors in the country. That brings us to the next place, networking events. Various networking events keep happening across the country, where top businessmen participate to grow their networks. Some of the most prominent funding meetups for startups and businesses in India are Investor Series @ Lounge 47, Investor events a@ BHive, Bootstrap at Breakfast, and events by the Indian Angel Network, Startup Growth Networking Meetup, India Fund Fest, etc.
Other than this, a guaranteed way to meet with investors is through mutual contacts. However, be sure you get the investment for your brilliant idea, and not because of any obligation.
Remember to research your potential investors: What industry are they interested in? Who are their other investees? Are they influential in the industry? What is their funding ability? Are they known to be easy to work with? The answer to these will prove beneficial in the next step.
Negotiate the final deal
No matter how experienced one is, a majority of us tend to get nervous when it comes to negotiation. We understand— this stage of the process can make or break the deal and directly affect your business. Here are some tips that we think would be useful in your negotiation process:
Always be prepared with the truth. You must be in a position to answer any questions that come your way. Knowing the ins and outs of your business plan and the market helps reassure the investors that you mean business. Emphasize how the deal will benefit them, and help them connect the dots on how you’re going to build a game-changing business. Even if all you have is a great idea, strongly believing in that idea can help you get the funding you need to turn it into a reality.
Be mindful of the way you converse. It is quite natural to want to sound friendly and easygoing when meeting up with investors. But remember, investors LOVE formidable founders who know what they want and how to get it. That doesn’t go to say you shouldn’t try to strike up a conversation outside of your business. The key is to have a perfect balance of humility and confidence that shows you know the game.
Be open to reasonable negotiations. If the investors come up with reasonable negotiations and you don’t want to commit immediately, you can always request them time to consult with your team and get back. However, be mindful not to take up a lot of time. Investors usually tend to have multiple startups wooing them, and you might end up losing them if you take up a lot of time.
Be ready to hear a ‘No’. It is highly important that you don’t take rejection to heart. Remember not to let your emotions take control there. Look at this as an opportunity to learn more about your business and work on your plan. How you react in such a situation is something that would affect your image in the networking circle a great deal. Always part on the best possible terms.
Seed funding best practices for your business
Since the chances of this being the first time you’re raising a fund is high, it is always advisable to follow tried and tested best practices for success. Here’s what we think are great tips to get started:
- Don’t stop with just one investor. While you might be tempted to pursue only one investor who seems to like your idea, it is always advised to have at least 3+ investors interested in your business. This way, you have a larger margin for negotiations. This also helps boost your business’ valuation.
- Take reign in the funding process. Quite often, founders end up being intimidated by the investors and are forced to act according to the latter’s timelines. Remember to take control of when the funding happens. Ideally, you shouldn’t be meeting your investors until 2-3 weeks before your demo day. This way, you can ensure that no investors have an upper hand even before the rest of the investors have had a chance to be a part of the deal.
- Always be prepared. This is where domain knowledge and product knowledge come in handy. You definitely shouldn’t be meeting potential investors without making sure you are 100% ready with your facts. Even if you are invited for a casual catch-up, remember that every meeting is a potential event to judge you and your business plan.
- Build a healthy and positive relationship. Remember, even if one investor rejects your plea today, they might be interested to invest in the future funding rounds based on how well your business has fared. Not only does it lay the basement for future relationships, but also helps boost your image in the investors’ circles. Knowing how to handle a situation is key to building strong professional relationships.
- Keep building your product. It is very easy to get lost in the funding process. However, don’t forget to take inputs from your potential investors and keep working on making your product better. The more people you meet and network with, the higher the chances for you to better your product and cater to the ever-booming market.
Challenges you could face while raising seed funding
While seed funding might be known as an easy-to-source investment, it does come with its own problems. Some of the most common yet prominent challenges you might face include:
- Finding the right source of investment: One bad decision in choosing the investor can lead to the downfall of your empire. Oftentimes, the investors have a huge say in the business decisions, and with the kind of network they have, it could affect your future funding too.
- Bad pitch: The success of all the pre-funding work you put in comes down to the pitch. If you aren’t able to convey all the important highlights to the investor through a unique pitch, you stand to lose investors who could have helped expedite your growth.
- Not knowing the basics: There’s more to funding than what you might learn from online resources. Not knowing enough can prove to be fatal to your business. Remember, the investors are highly experienced and would prefer someone who knows what they are doing.
- Giving away your equity: This would be a long-term challenge if you choose to get seed funding. More often than not, you will have to give away a part of your equity to your investors. Though they are mostly debt-free, giving away a part of your authority is a downside of seed funding. The investors will have a say in every decision you make, and sometimes, it could lead to internal issues.
If you are looking for a flexible, highly scalable, 100% digital process of raising funds that require no equity dilution or any guarantee, we recommend revenue-based financing. This founder-friendly approach lets founders raise funds without diluting equity or providing collateral, and the repayments happen as a percentage of monthly revenue. You can learn more about revenue-based financing here.
Being India’s largest revenue-based financier, Velocity provides founder-friendly revenue-based financing to growing DTC businesses. If you are a D2C brand looking for funding to manage your inventory and marketing needs, apply here, and get funded within 7 days.