Steps to Seed funding
If you are a new entrepreneur, you need to understand what seed funding is, how the seed funding works, and how to get it.
In today’s business landscape, millions of startups globally are doing everything they can to become the next big thing. However, most of these companies fail to recognize the importance of company funding and raising the necessary seed funding for their business to grow.
It does not matter what type of company is starting up, every company would need funding from a third-party at some stage for growing into a successful company or into what they imagine they want to become. Outside funding is normally needed when the partners or the founder do not have the capital to invest in the company.
If you are a new entrepreneur, you need to understand what seed funding is, how the seed funding works, and how to get it. This article will share all you need to know about the initial funding rounds you may encounter in the business lifecycle.
Seed funding says everything about itself just from the name. When your startup is still in the initial stages, where you have no actual Minimum Viable Product (MVP), you need funding so that you can grow your idea into a successful business.
And if you don’t have the right amount of funding for your business idea in the beginning, the most realistic option is to reach out to investors who would invest in your idea. Seed funding is normally claimed by those startup owners who want to do market research, hire a larger team, and develop a prototype for building their business.
In the seed funding round, the money comes from angel investors, who are people that have the funds to invest in projects with high potential. Another option in this stage is the early stage venture capitalists, also known as VCs, who invest in the business idea if they find that they would possibly get good returns.
There isn’t any hard and fast rule about the right investor for the seed funding, as long as you are getting the amount you need and from the right person.
So, what’s the difference?
Angel investors remove money from their regular income and invest it in new business ideas. The amount they invest ranges from $10,000 to $100,000 normally. In the recent trend, you can also find many groups of angel investors who work in groups known as angel investor networks where a startup can raise amounts that reach to $1 million.
Conversely, VCs are mostly firms that fund startups with seed funding or later stages in a startup. The funding is frequently done with many investors and group of investors involved in a single round. And in the seed funding round, the smaller (early) VCs may take more risks than the more traditional VCs.
Let us now dive deeper into the idea of seed funding to understand more and choose the right investor for you.
Why Seed funding?
Seed funding is the initial funding that a business needs to establish itself in the market. It is possible for an entrepreneur to fund the business without the extra capital, but when you need to build and grow the company, funding is needed.
Seed funding, also called startup funding, pays the expenses for the hiring of necessary talent, marketing collateral, equipment, facilities, insurance, business licenses, and incorporation. This capital is used to manufacture the products that the business would sell, and market and distribution of these products and services.
Startups cannot just begin earning profits in a minute. It takes time, and without profits, the business cannot pay any of the expenses that the company brings on like equipment, rent, bills, salaries, and raw materials. Due to the lack of seed funding, many companies suffer and eventually close down. You may turn to a bank for a business loan, but this may also be burden for the company with the monthly interest payments on the loan.
In short, you are left with the seed funding, which can be an integral part of a company, without which the business may not be able to grow successfully. It would offer an effective and straightforward funding solution that would assist you in growing your new business and get it off the ground.
But at which point of the business do you need the seed funding?
When to actively go for seed funding
When your business idea is ready, you have done the research and things for product development, and you have decided to put it on the market, begin selling products and get your business off the ground.
This step involves investors who would pay you an amount for the initial market research and early product development in exchange for a preferred stock option, equity, or convertible notes. The amount in this stage is between $50,000 to $2 million normally.
Requirements for Seed Funding
Before you can obtain seed funding, it is important to have the following steps completed to ensure that you get it easily. Here are the things that you need before you go looking for seed funding:
- Create a legal business entity by incorporating it as an LLC, S-corporation, or C-corporation before you can do any task from your business. Moreover, you cannot get any kind of funding just with a business idea as you need to show that you have a business incorporated.
- Apply for a business registration and trademark registration for your brand name and logo for protecting the identity of your company. This is important as if your company grows, you would have many competitors, and you do not want people stealing your ideas.
- Create NDA Agreements for securing the technology and ideas that you are using while you pitch your idea in front of investors or firms.
- Apply for the provisional patent to protect the technology you have.
- Prepare for all the company filing and tax regulations as soon as you register your business, which also includes keeping a cap table and updating it for new transactions taking place in your business.
- Create a projected balance sheet for your business, which has the financial plan for the next 18 to 24 months, defining where you need money and why you need it. Ensure that it has the monthly actuals since investors normally look at this more.
- Design a Stunning Pitch for the investors and ensure that you nail the explanation of your idea and the whole market size. Add details and back up information for everything.
After you have done all these things, you can request for seed funding. Search for the VC firms or angel investors who can fund your company and contact them.
Essential Advantages of Raising Seed Funding
Still not entirely sure why you need seed funding when you can use money from your pocket and begin working? Well, the following points would give you a much better idea of why it is vital:
- More flexibility to adapt and shift course, as per the market demand.
- Helps in company funds and the need for more capital for future rounds.
- More time to join with effective business partners.
- More liberty to tune your business model.
Now that you are clear about the seed funding, there are other things attached to this like the Series A, B, C and so on. But these rounds of fundraising are not the same as the seed funding. If the seed funding round means that you are planting a tree to root your business for having a strong foundation, the Series A means that you are helping the tree grow branches.
Lets understand the next rounds better.
In the Series A funding round, revenue growth is the primary factor. Basically, when a startup reaches this point, it is expected to have growth and clear evidence of a product that is fit for the market and that translates to revenue. Moreover, the business should now have the right source for getting many new customers and creating a huge database of existing customers. The company should also have an increasing ARPA (Average Revenue per Account).
In the Series A round, the sales and marketing are an important factor, mostly for increasing the revenue of the business. Up to this point where the seed funding was working, the growth was driven by a single channel. And for the company to grow more, the sales and marketing processes need to be developed, and innovation has to take place. Other than this, it is vital to identify new channels and make good relationships with the ideal customer.
Venture Capitalists are the ones that invest in this round mostly, while there are a few angel investors as well who invest in this round after the seed funding in the company. After the VCs are involved, we know that the amount raised has increased, and this also means that the share values of the company have increased too.
The range of the amount funded here is usually from $10 to 15 million, where the company normally has a valuation of at least $5 million by now.
Now comes the Series B. You might be wondering why this round is needed, as the company is already earning enough revenue.
Well, the previous rounds did everything and was fueled by the relatively experimental signs of improvement. These experimental signs were from the promising idea which was gathered from the leading indicators of product use in the market and its demand. This lead to the early signs of the revenue growth of the business.
Moving on to the Series B, investors usually search for the next growth stage, which means that they want to take everything that the company has made, learned, achieved, and use the same idea to make it work on a bigger scale. In short, the Series B investment is for allowing a startup to begin with any expensive hires that are needed, which can be across marketing and customer success, strategic accounts, and even business development.
This round of funding, unlike the seed funding, is the round where the capital is used to expand into the various market areas. The company would try multiple income streams, and in new situations, also buy-out companies that give a competitive advantage. The amount of funding in this series ranges from $25 million to $30 million for those companies that have a valuation of $30–60 million. Moreover, this stage is funded by the late-stage VCs or the super VCs.
The Series C rounds, unlike the seed funding rounds, funds are raised for fueling the large-scale expansion. This may include entering into new markets, like opening your business or shops in outside countries, or it can also be for powering the purchases of other companies.
However, this does not mean that the funding rounds of a company stop after the Series C. There isn’t any specific limit to the number of rounds of investment a company can have. A few companies can go up to raising investment from Series D, E and even beyond this.
Not many startups reach to the point where they need a Series D, but for those that do, they need a significant amount of variation in the amounts that they are raising. This is determined by seeing all the rounds and the investments made in each case, where each case is a different story.
By now, the company has reached a place where investing would be low risk, which is why investors openly invest for these company that approach them. These type of businesses mostly bring in big checkbooks to the financial meetings where they generate a larger round size. It was just in February 2016 where a company raised about $793.5 million in the Series C round, which was the largest amount in venture history.
But for raising money like this, the company has to have a good valuation that can prove to investors that they are investing in the right place. Unlike the seed funding, the amount that is normally raised in the Series C round is about $50 million. The investors in this stage are late-stage VCs, private equity firms, hedge funds, and even banks.
Post series funding
After the series stages, your company can choose to go public or stay as a large private company. In case your business decides to remain private, you would be able to raise the funding in the rounds like the Series D, E, and so on. And you now know that there is no limit to the number of funding rounds that your startup can go through, if there are investors who are willing to invest in your business.
The reasons for the endless funding rounds are not always the same for all the companies. It could range from merely needing the cash for achieving the fiscal target before the company goes public, or to recover from financial difficulty. But after some time, investors who have invested in your business would want to get the money back, and that is when you would have plans for the IPO for your company.
Later funding and IPOs
An IPO, or an initial public offering, is the first sale of the stock issued by the company to the public. Before an IPO, the company is taken as a private company that has a small number of shareholders, made up of the early investors of the seed funding and the professional investors for the successive funding rounds.
On the other hand, the public includes everyone from individuals to institutional investors who weren’t involved in any of the seed funding or other rounds of the company. These individuals may now be interested in purchasing the shares of the organization.
Until the stock of the company is offered to the public, no one from the public would be able to invest in it. Even though you can approach the private company owners for investing and purchasing their shares, they are not bound to sell anything to you unless the company goes public.
For a public company, they would have given at least a part of their shares to the public for them to be traded on a stock exchange. And this is when an IPO is known as “going public.”
The Series Funding of Facebook
Let us understand the seed funding and the series funding with the help of an example. Here we take the example of the very famous company, Facebook. The journey of Facebook has been incredible. Headed by Mark Zuckerberg, Facebook has raised funding many times even after their initial seed funding round. Let us see the journey of Facebook explained below in detail.
Seed Funding Round
It all started in February 2004 when Mark Zuckerberg, Dustin Moskovitz, Chris Hughes and Eduardo Saverin launched Facebook from their Harvard dorm room. And when it became a popular hit in Harvard, Mark decided to take this outside the University and make it a public website. But for this, he needed the initial seed funding.
The idea had come up during June 2004, after which Peter Thiel invested an amount of $500,000 into the social networking website in July 2004. This was the very first funding that Facebook got and it was the initial seed funding round.
Series A Round
After the seed funding came in the next round of funding, which was the Series A round and Facebook raised about $12.7 million from Accel Partners and Thiel in May 2005. At this moment, Facebook had about 5.5 million users at this time and had a valuation of about $87.5 million. It was then in September the same year when the name was shortened to Facebook, from The Facebook.
Series B Round
Further in April 2006, the investors Meritech, Greylock Partners, Thiel, and Accel invested about $27.5 million, making this the Series B round for fundraising in Facebook. The company reached to have about 12 million users by December 2016 and had a valuation of about $8 billion, as per Thiel then.
Series C Round
In October 2007, Microsoft had invested about $240 million in Facebook, where Microsoft had a 1.6% stake and this made Facebook reach a valuation of about $15 billion. At this point, Facebook had about 50 million users. It continued where the Hong Kong businessman Li Ka-Shing invested about $60 million in Facebook in November 2007.
Again in January 2008, the European Founders Fund invested about $15 million followed by another invested of about $60 million by Ka-Shing in March 2008 where he effectively doubled his stake to about $120 million. And if we calculate the total amount raised till this round by Facebook; it was close to $315 million.
Debt Financing Round
During May 2008, Facebook had raised a loan of $100 million from TriplePoint Capital, and Facebook grew to have about 200 million users by April 2009.
Series D Round
After the loan raising, Facebook wanted to grow more and reached the Series D round from the seed funding round, and raised about $200 million which was invested by Digital Sky Technologies (DST). The company at this point had a valuation of about $10 billion.
Later on, DST then bought back up to $100 million of Facebook employee shares in June 2009. In September the same year, Facebook had about 300 million active users.
Secondary and Private Equity Round
In June 2010, Elevation Partners invested another $120 million, which made a total investment of about $210 million made by them to Facebook and also marked the secondary market round in the funding cycle since the seed funding. In Jan 2011, Goldman Sachs invested about $450 million, and DST invested about $50 million in Facebook. This made the valuation of Facebook to be about $50 billion, which was a new high.
But that was not the end of it. Facebook decided to go public in February 2012. Facebook had set the price range of one share as $28 to $35 for its IPO and was offering about 180,000,000 shares of its Class A common stock. The shareholders that were selling offered about 157,415,352 shares of Class A common stock, for a total shares offered of about 337,415,352.
By 15th May 2012, Facebook had increased the IPO price range from $34 to $38 per share. And with this update, the total shares to be offered was 421,233,615.
At this time, things began to go downside for Facebook where some shareholders filed a lawsuit again Facebook claiming that critical data regarding the financial fortune of Facebook were “selectively disclosed” to the large banks ahead of the public offering. With bad things coming in the way of Facebook, the stock price began to fall where the lowest price recorded of about $17.70 on September 4th, 2012.
After this in 2013, the share price began to rise, and hasn’t stopped much since. The current share price peaked at around $200, after dropping to around $170 per share after the recent 2018 earnings report. In case a person bought the shares with the investment of $1,000 in May 2012, their investment had grown to $5,000 during the start of 2018.
Mark ensured that his choices were taken towards growing the business, and it did. Today Facebook stands with a company value of approximately $70 billion. This story helps us to understand that some risks need to be taken and along with the risks, work needs to be done. Without funding, a company would not be able to grow.
The future of your business depends on how you want the company to be, and how fast the company grows. With all this, you should get the right investors to fund your business and move ahead with seed funding and become a global success.
If you are clear with all about the types of funding and the seed funding, it is now vital to understand the various tips on funding that you must know before you decide to raise funding. The article would share all the details. Check it out here!