Seed Capital

While some founders may be able to raise financing from venture capitalists without a complete business plan or finished product prototype because of their previous track record and existing relationships with those types of investors, the more likely scenario is that founder will need to find smaller amounts of cash from friends, relatives, “angel investors” and others to plant the seeds necessary to begin building their business and help the business survive to the point where the initial business plan is done and a first version of the proposed product is ready to show.  While the amount of “seed capital” that may be required may be quite small in relation to the money that will eventually be needed to fully develop the business model, finding sufficient funding from the right sources can be a frustrating experience, even for founders who have previously been successful in raising venture capital funding for prior companies.  Approaching friends and family can be uncomfortable for the founders and they need to be sure that they carefully explain the risks to persons who generally have little experience with this type of investment.  So-called “angel investors” often promise access to connections and advise based on their own successes; however, caution should be exercised when taking money from professional investors with whom the founders do not have a pre-existing relationship.  Venture capitalists set aside only a limited amount of funds for seed financing and “accelerators” and “incubators” often demand a generous percentage of founder’s shares while falling short on their promises of support.  Also not to be ignored is that raising seed capital will be the company’s first step into the world of securities law regulation and bringing new stakeholders into the company beside the founders.

It appears that all of the challenges mentioned above are becoming part of the “new normal” for founders who eventually hope to be supported by venture capitalists.  As noted, venture capitalists have backed off from providing the first money to support product development and most founders now expect that they will need to devote anywhere from six to eighteen months to developing relationships with venture capitalists that will be strong enough to create interest in leading or participating in a traditional “Series A round” of financing.  During that time the founders will need to demonstrate the viability of their business model and proposed product and they will need sufficient seed capital to get moving and maintain momentum.  This means that founders must be able to determine how much seed capital will be required, set a defensible pre-seed valuation for the company and prepare for the seed fundraising process.

In some cases, the founders are able to line up all or most of the desired capital fairly quickly; however, it is not uncommon for companies to go through multiple closings spread out over a number of months.  The later scenario is obviously nerve wracking for the founders, since the company will likely be tight on funds with little room for error and the founders will be more distracted by the need for additional capital raising.  Companies may have to “get by with less” and hope that there is enough to get to the next financing level.  Sometimes founders discover that it makes sense to raise more money than anticipated during the seed funding stage to address unanticipated problems or opportunities or allow investors with valuable connections and experience to get involved with the venture.

To learn more, download the chapter on “Seed Capital” prepared by the Sustainable Entrepreneurship Project.  Additional Project materials on finance are available here.

 

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