Seed Funding: How It Works

Seed Funding

Startups go through various stages as they develop their winning idea and gradually — or rapidly — build it into a thriving company. There are moments along the way in which infusions of capital can push business development to a new level.

These cash infusions are known in the business as rounds: the angel round, the seed round, the private equity round, the debt round. Somewhere in the middle between the early angel round and the late-stage private equity round are the workhorse round knowns as Series A, Series B, Series C, etc.

The seed round usually comes sandwiched between the angel round and the Series A. Seed money, as the name suggests, is funding designed to germinate an idea into a business at its beginning stages.

Seed Stage: Investment and Ownership

Seed Stage Investment and Ownership

Typical investment amounts at the seed stage are $10,000–$2,000,000. In recent years, larger seed rounds have popped up more often, but it’s still safe to say that seed funding is on the lower side in the context of equity capital.

Like all other equity funding, seed funding works on an ownership model wherein the investor offers the company money in exchange for an ownership stake in the business. This is one of the first steps along a road that many startups take—especially in tech—which leads to the founders and other stakeholders in the business owning less and less of it and giving up more and more control.

How much seed funding a company is likely to get—and what that means for ownership—is based on a startup’s valuation. Investors look at the startup valuation to estimate their ROI in the deal; for example, investors who give $25,000 to a startup that is valued at $1,000,000 will own 20% of the business ($1,250,000/$25,000=0.20). Startup valuations are based on various factors such as management approach, record of growth, market size and share, and level of risk.

Seed Funding Sources

Seed Funding Sources

Seed funding can come from all the usual sources of equity: angel investors, venture capital firms, banks, crowdfunding, friends and family. If zany Uncle Bob gives you $10,000 to boost your business in exchange for a promised return, that’s seed funding. It’s not unusual for startup founders to invest their own money into their business as seed funding — an arrangement that allows the founders to retain full ownership.

Venture capital investors aren’t as active in seed funding as they are in later funding stages. A particular characteristic of seed funding is that it’s designed to get a business off the ground, not to expand or intensify an already-running company. The latter is the task of Series A and Series B rounds of funding, which are dominated by venture capitalists. Meanwhile, seed rounds often draw from a wider range of investors.

Preparing for Series A Funding

Series A Funding

A key task of seed funding is to get a startup into a strong position to raise a Series A round, which is the stage at which a business can really start to grow its revenue and solidify its position in the market.

Before applying for Series A, startups will want to achieve product-market fit, create a demonstrable monetization model and an effective customer acquisition strategy, and be poised to scale. These are precisely the type of business development steps that seed funding is designed to help accomplish.

Getting a chunk of money early in the business-development process can make a massive difference in future success. The accompanying relinquishment of equity and control is not something to be undertaken lightly, however, so founders should think carefully when accepting equity funding, even when it’s just a seed.

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