Seed Funding

Key Takeaways

  • Seed funding or angel investing is the funding of business at the earliest stage in its life cycle.
  • Angel investors are usually individuals or groups investing their own money after ascertaining the potential of the start-up.

What is Seed Funding?

Seed Funding Meaning

Seed funding or angel investing is the funding of a business at the earliest stage in its life cycle, which is usually anytime during its formation at the idea stage, having just a plan, prototype, or in a trial phase, with no or negligible customers.

Angel investors are typically people or groups who contribute their own money after evaluating the startup’s potential. The investment is expected to yield returns in multiples but also carries the risk of being lost if the start-up goes belly-up.

Since start-ups are frequently in their infancy and therefore not eligible for debt financing, an angel investor or seed funder invests stock. The investment could take the form of a stake in place of cash or a right to purchase shares in a future equity-raising operation. 

The angel investor is frequently someone with extensive vertical knowledge of the start-up business and they have the required resources to evaluate the potential of the entrepreneur. Venture capital and private equity are other forms of non-public equity financing options for businesses.

Difference between Seed Funding and Angel Investing

The difference between Seed Funding and Angel Investing is blurred as these terms are used interchangeably.

However, Angel Investors are the very first investors in a startup. Angel Investors may be individuals or a syndicated group investing in early-stage startups. On the other hand, Seed Funding is the round just prior to Series Funding rounds. Therefore, the seed funding round is the stage when the company starts gaining the attention of the bigger players in the venture capital space.

Why is Seed Funding important?

Seed funding proves to be very useful for start-ups. Below mentioned are the advantages of seed funding.

  • It reduces the risk to founder in a new venture
  • It covers for funds insufficiency
  • It acts as a source of working capital
  • It expands a business relationship by bringing strategic partners
  • It provides means to scale up and it accelerates growth

Types of Seed Funding

  • Crowdfunding: In recent times, crowdfunding platforms have become a trendy destination for seed funding. These platforms are generally open, and anyone can back the idea, concept, or product.
  • Corporate Seed Funding: This is a very good source of seed funding as start-ups gain more visibility because of the big corporate investors. Large companies like Google, Intel, and Apple support start-ups regularly with seed funding. Such investments can prove to be very useful for new firms to build their brand.
  • Angel Investors: These are the investors who invest seed funds in a start-up in return for equity ownership or convertible debt.
  • Incubators: These investors, along with providing small seed funds, focus on helping the new ventures through training and often also provide office space. Many leading educational institutes, like IITs and IIMs, also provide such services. Generally, Incubators do not ask for equity holdings from start-ups.
  • Accelerators: These investors mainly focus on helping the new firms in scaling-up rather than supporting them in early-stage innovation. They also provide help through various training, mentoring, and giving networking opportunities. Unlike most incubators, accelerators usually take equity.
  • VC funding: Venture Capitalists are the high-end investors that invest in a new venture after looking into various parameters such as market conditions, founder vision, growth potential, etc.

How to raise Seed Funding?

To raise seed funds, it is imperative to have a creative business idea that can be commercialized. Along with the idea, the pitch made in front of the investor is equally essential. The firm seeking investment should be prepared with a well-documented business plan describing its target market segment, market potential, existing and potential competitors, and its financial projections for next few years.

Funding rounds for startups are designed in such a way that an investor obtains partial ownership in the startup. Therefore, the investor not only benefits from the profits of the startup during the short-term but also the valuations of the startup over the long-term.

The funding for a startup follows a typical chain of rounds. The distinct rounds of funding adhere to the valuations, maturity of operations, and growth prospects of the startup at different stages of its life.

Funding Stages
Source: Tavaga Research

Pre-Seed Funding is the first time a business is introduced to funds. The funds are generally contributed by the promoters, close relatives or acquaintances of the promoter. Pre-seed funding helps the business get on its feet. The funds are utilized toward incurring the initial costs of setting up the operations.

Seed Funding is the first official funding made available to a business.

Series Funding

  • Series A Funding: Given the low success ratio of startups growing into major corporations, only a few companies make it past the seed funding stage. However, for the companies that do reach the series funding stage, investors ask for more than just a business idea.

Investors demand a long-term strategy. Any company out of a seed funding stage showing promise in terms of monetizing its growing user base over the long-term attracts venture capitalists. Series A Funding is provided to companies to help them scale their product offerings. Series A funding is also the stage where established players in the venture capital space cater to the needs of the startup.

Therefore, angel investors who invest in the seed funding stage are less prominent in this round. Venture Capital firms call the shots. Typically, an anchor investor will express interest in a startup and lead other investors to invest.

  • Series B Funding: The startups making it to the Series B round have grown past their development stage. After making their products visible, the companies have to now meet the demand created. Funds raised during this round are used to increase market coverage and increasing the size of the personnel force.
  • Series C Funding: Companies at this stage of funding have already created a successful product, a consistent user base, and a history of growth. The funding round aids the startup to expand as fast as possible. High levels of growth may be introduced through inorganic growth such as an acquisition of a competitor to create synergies while eliminating competition. The companies at this stage have already proven their potential and exhibit considerably lower risk. Therefore, more institutions get involved at this stage such as private equities, investment banks, and hedge funds. Also, most companies after this stage aim for an Initial Public Offering (IPO). If the companies are unable to accomplish the goals set for the Series C Round, they may opt for a couple more Series Funding rounds. The valuations at this stage are not a shot in the dark as they are purely based on numbers instead of estimations.