The Basics of Seed Funding

by Startacus Admin

For startups with an ambition to grow, there are few words which carry the level of intrigue that 'investment' does, and foremost in the mind of anyone starting their own business is seed funding.

Seed funding is now a commonplace term and refers to a number of different types of capital investment related to startups, small businesses, and other ventures. It is often also known as 'seed investment', 'seed capital', and sometimes 'seed money', but whichever of these titles it is given, it usually describes the same thing and has got nothing to do with seeds, or any other horticultural accoutrements. It is quite simply money which is invested into a venture (usually an early stage startup) with the intention of helping it grow to the point where it is capable of generating its own income and delivering a profit.

Seed funding is different from venture capital and other enterprise investment types because of the stage at which it is given, and the fact that the sums of money involved are (usually, but not always) much smaller than those invested in more mature startups.

In the business it is often called the first 'round' of funding, since it is sometimes used as a way to grow the enterprise into a more attractive prospect for future, more substantial funding rounds.

What is seed funding used for?

The particular needs of a business will usually dictate how seed funding is used, but since it is most often applied to businesses in their very early 'pre revenue' stage, certain areas commonly benefit from it. These can include things like;

• Research and development

• Initial startup costs; including equipment and materials

• Rent and utilities

• Salaries

• Anything else which is needed to grow the business to the point where it can sustain itself financially, or has grown in value to the extent that it will be more attractive to higher level investors

Where does seed funding come from?

There are a wide range of directions from which an enterprise's seed funding can come, including;

• Equity crowdfunding

• Reward crowdfunding

• Direct investment from founders and/or their families and friends

• Angel investors (affluent individuals who provide funding to startups)

• Government schemes such as enterprise grants and loans

Sometimes an early stage enterprise will receive seed funding by the process of bootstrapping, whereby the revenue generated by a successful business is used to help the creation and early growth of another; although this is a fairly uncommon route.

What does seed funding cost to secure?

What the founders of a business will have to part with in order to secure seed funding will vary depending on the particular route which they have chosen.

Equity crowdfunding, for example, will require them to hand over equity based on the valuation of their enterprise, whereas reward crowdfunding will usually remunerate investors with products or services provided by the business, once it is trading.

Early stage funding by an angel investor will normally require a certain level of equity to be handed over and, due to the very high risks involved in providing capital to a business which is not yet creating revenue, the percentage of the business which is expected is normally quite large.

Alternatively funding can be secured from angel investors in the form of something called a convertible debt; this is a rather complex funding agreement which you only really need to fully understand if you find yourself in that situation.

Basically, a convertible debt (or convertible bond) allows the investor to provide funding to your enterprise with the intention of converting their investment into an equity share at a later stage, usually when the business has grown in value, and their equity share will be larger in monetary terms than it would be at the point of investment. There are lots of caveats and provisos involved in this kind of funding, but it can be a useful tool, especially for an enterprise with a low valuation, and high growth potential.

If founders are able to provide seed funding themselves or with the help of loans from their family and friends, they will usually be able to retain all of their business equity.

Hopefully you have found this short piece on the basics of seed funding useful. Don't forget to check out all of the startup support available in our marvellous business toolkit.

 

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Published on: 26th January 2015