A beginner’s guide for founders looking for smart and reliable ways to finance their start-ups.
With over 61,400 start-ups being recognized by the Department for Promotion of Industry and Internal Trade (DPIIT) over the past decade, India has emerged as the third largest start-up ecosystem in the world. While it symbolizes a robust growth of the Indian economy, the rising competition also makes raising capital a challenge for new start-ups.
However, most start-up ideas waiting to fructify go hand-in-hand with a predictable, stable source of cash flow that can help scale the business quickly while securing its longevity in a highly competitive market. And that is where seed funding or seed investment comes into the picture.
If you’re a start-up founder enamoured with this ‘buzzword’ but don’t exactly know what it means and how you can leverage it to scale your business idea, stick around. We will run you through the basics of seed funding, and whether it is a viable option, of the many other funding alternatives available for start-ups.
Let’s dive in!
Seed funding is essentially the first phase of official funding (often at a stage where there are very few customers) that a start-up raises for commencing a new business venture.
It is best illustrated by the example of a seed, which in this case is the start-up and the seed funding is the initial nurturing that is required for the start-up to grow and be able to revenue on its own.
However, a seed fund isn’t a loan and investors providing such funding are instead looking for a share in the future of the start-up. Unless the entrepreneurs have a considerable fund of their own, the seed fund plays a crucial role in enabling the start-up to grow competitively.
Pre-seed funding is basically the preliminary round of funding that happens prior to seed funding and is generally not counted as an official funding phase. At this stage, the start-up is only trying to get itself operational and is usually funded by friends, relatives, and the founders themselves.
In contrast, a series A funding happens after the seed stage, when the start-up has commenced its operations and is now aiming to develop a business model that can help it garner long-term economic sustainability and profitability. At the series A seed funding stage, investors focus on companies that have a strong strategy to back up their business idea and ensure the success of their vision.
There are several ways to get seed funding. Like most technicalities related to start-ups, this is a laborious process. There are multiple factors one has to take into account, some of which we’ve briefly outlined below:
One of the first steps to getting the required seed fund for your start-up is to understand why you need the seed fund (if at all) and if you do, when exactly you need it.
The ‘why’ is mostly a reflection of your personal vision for the company and how you wish to expand its horizons.
That said, you need to assess whether you tick off the three main factors needed in your pitch deck (to convince investors) and have evidence of the same:1. Product – Your product is at the heart of the matter when it comes to drawing investors’ attention. So, do you have a product that has already raked up some consumer interest and has growth potential? 2. Market – Every investor is here to make a profit, so if you are unable to show them the potential markets your product is planning to capture and the ways it is relevant to the target group’s needs, it is unlikely they will invest in your start-up. 3. Team – “Ideas don’t magically work. People make ideas work.”
Euphemism aside, investors rarely only invest in ambitious business ideas; they also take into account the team that will help execute the start-up’s vision. They want to feel confident and secure that they’re putting their money in safe hands.
Needless to say, you will have to persuade (and establish) that you do have the right set of people doing the job, and that your team is focused, driven, and amply skilled to do what is required to scale the company.
If you said yes to all the three criteria above, congratulations! You can approach seed investors without feeling rudderless in this hyper-competitive start-up world.4. Type of Funding
To make the right deal for your start-up, it is important to know the type of investors that you’d like on board. Be it Venture Capitalists, Angel Investors, friends and family, bootstrapping, or crowdfunding, each has its own risks and benefits. So, it is important to decide on the type of investors you need and to build your pitch accordingly.5. How Much Seed Funding Do You Need
To ensure that your start-up has an adequate amount of funds to function, it is important to understand exactly how much seed funding you need.
This is only possible if you have thoroughly calculated your fund requirements on a day-to- day basis and the period of operation such a seed fund needs to sustain. This will help you pitch the specific amount that your start-up needs.6. Walk in Prepared
Using a one-size-fits-all approach is unlikely to help you obtain the funds you need. The key is to strategize your pitch according to the type of investor you’re planning to approach.
To be adequately prepared for the process, make time for gathering information on your desired investor, and study where they’ve previously invested and why. Don’t over-complicate your pitch, however, ensure that every claim you make is backed up by solid facts and figures. Do exhibit your competency (in understated ways, of course) but keep the window open for learning what you can from potential investors.
There are a few basics you must include, no matter which type of investor you are approaching.
Some of these are – your company’s long-term vision, the problem it solves, the solutions you’ve created to tackle the said problem, your ideal consumer, and financial projections and overhead costs.7. Balanced negotiation
Finally, every investor will try to make the most out of the deal. So, the only way to get the best is to negotiate and drive home a hard bargain by getting the maximum funds in exchange for a minimum stake in the company.
Remember, investors have probably practised the art of negotiating longer than you have; so, be cautious and don’t grab the first offer you get. Take time to process where you can compromise and where you cannot (hello equity!) and then arrive at a bargain that will (hopefully) work for both you and the investor.
Essentially, there are three types of seed funding that you could opt for your start-up –
In Equity Funding, the seed investor generally provides the required funds in exchange for an equity share in the company. Generally, the equity share ranges from 20% to 25% in exchange for the initial seed capital.
While the seed investor holding such equity receives a dividend in proportion to his shares, the main target is to hold the shares until the company grows considerably and eventually sells them for a larger profit.
Convertible debt or convertible note usually occurs in companies that are often difficult to value. In such a scenario, the investor extends a normal loan with interest and a maturity date to the start-up.
However, it gets converted into equity when the start-up proceeds with equity funding. It is a safer alternative for the investor as the debt can also be called by the investors at maturity, if they choose to withdraw from financing the start-up and not to convert to equity.
While it is similar to convertible debt, it doesn’t include interest or maturity date. So, it is essentially a loan that is given in exchange for the right to purchase stock at a future date, often at a discounted rate.
Owing to the fact that it has no maturity date or accruing interest, this makes it one of the best plans to opt for start-ups. However, such a right to purchase equity is usually triggered automatically during future equity financing or the sale of the company.
While you may be tempted to go for large scale seed funding, it is important to understand the needs and vision of your business and ask for funds accordingly. Ideally, the target should be to raise enough capital to propel the business to profitability.
Similarly, the funds raised should be adequate to last till the next round of funding, which is usually 12 to 18 months away. Calculating the requirements on priority basis can go a long way in ensuring that you can raise the right amount of capital for your business.
However, it is also important to ensure that you give up as little equity as you can. While less than 10% equity should be the aim, it is unlikely for the founders to agree on such an amount.
Usually, you’d have to part with around 20% equity, but anything above 25% is clearly a bad deal. So, it is always advised to be specific about the equity that you are ready to part with, in order to strike a profitable deal.
While seed funding may seem to have several benefits, it also comes with its own set of drawbacks, such as -
Investors with high stakes may cause excessive interference in the day-to-day affairs of the company and eventually hamper the effective functioning of your company.
While seed capital may seem like a good source of financing, it is important to remember that it is essentially giving up a share of your company as well as the profits that may arise in the future.
Investors are only there with the sole motive of making profits and have no attachment to the company like you do. So, if your company fails to perform or reaches a saturation point, it is likely that the investors would withdraw their funds and leave you high and dry.
BridgeUp is a platform that provides comprehensive financing solutions for businesses looking to skip the traditional fundraising methods or bear the debt or dilution that they bring. With BridgeUp, you can scale your business fast, while still being grounded in the security that upfront capital offers.
Eager to know how our revenue-first financing model works and how we can help you? Call us on +91 -9819660287 or drop us a query on the contact form here.