Startup investing comes in many different flavors. There are angel investors, several stages of venture capital, and then, hopefully, an initial public offering (IPO). But before all of that is the seed round.
Seed funding is the very first money you raise for your idea. You will use it to test out the idea and get a business going.
Overview: What is seed funding?
Seed funding is the first capital investment you raise for your startup company. When you raise seed money, the company is usually more of an idea than an actual business.
The seed investment is used to do things like build prototypes of your product, purchase equipment, or even travel to conferences to try to sell customers on the product.
What are seed investors?
Here are a few types of seed investors:
- You: Just like startup investing, startup founders come in many different flavors. If you are already wealthy from a long career or other businesses, you may want to fund your own company to resist giving up any equity. This is referred to as bootstrapping the company and is looked at with favor by venture capital funds.
- Friends and family: As painful as it might be, you probably need to start with friends and family. Even if that means asking your in-laws for money. Friends and family are most likely to buy into what you’re selling.
- Angel investors: Angel investors are wealthy individuals who often got wealthy running businesses of their own and invest in pre-revenue businesses.
- Venture capital: Venture capital (VC) funds likely won’t want to meet with you until you have some revenue. If you have started and exited successful businesses before, you may be able to get a meeting with contacts you already have at VC funds.
- Corporate venture capital: Corporate venture capitalists often focus on more established businesses, but if you have a connection to one, you may be able to pull off a seed investment.
Seed funding vs. early-stage funding: What’s the difference?
Seed funding is the raising of money to turn an idea into a business. You use seed funding to build models of your product, work with vendors, and start searching for talent.
Early-stage funding happens with venture capital funds once you’ve got the business going and have some history to draw on. Early-stage companies likely have some amount of revenue but probably still aren’t producing positive cash flow.
It’s possible that one of your seed investors will become a lead investor in your VC stages, but seed funding is generally separate from the stages of venture capital you will go through.
How seed funding works
If you’ve ever seen the TV show Shark Tank, you know what a seed funding pitch looks like. The Sharks are all angel investors (save for Mr. Wonderful, who is secretly representing a venture capital fund) and the people pitching an investment usually don’t have a very established business.
When you pitch a seed investor, you’ll get the opportunity to show your pitch deck and small business plan to attempt to convince the investors to take a chance on your business. Often, the investors will agree to an investment pending due diligence. Depending on the size of the investment, you may even get a term sheet.
Due diligence will include research on what patents you hold or which ones would be necessary, how accurate any financials you have are, your personal history, and more testing of the product.
How to pitch investors for seed funding
Use this guidance to prepare your pitch deck and business plan.
1. Have a good idea
The first step is to actually have a good idea. The investors who you’ll pitch to may have sat through hundreds of pitches just like yours, and if they’re successful, they have built up a healthy amount of cynicism to all ideas.
There’s a scene in The Office after Michael Scott leaves Dunder Mifflin to start his own company. He visits his nana’s investment club to pitch them on a seed investment. Nana immediately sees through the pitch and turns him down. Michael pitches his experience and tenacity as a salesman, and his nana simply says, “But how will you make money?”
As hilarious as it is to watch the scene, it is actually pretty accurate. If you come to a pitch believing that simply working hard is what will make your company successful, you will fail. You also need to have a unique idea.
2. Become an expert
Once you come up with a product, you need to become an expert on the industry. Read all the trade magazines. If you can afford it, go to trade shows. Research the current market size and opportunity. Learn about your competition. Have lunch with potential customers and vendors. If you want to go all out, get a job in a similar business.
If you come across an angel investor during your pitch who knows far more about the industry than you do, it will be a deathblow to the pitch.
3. Be realistic
You’ll need to have a good idea of what the addressable market size is and what your business valuation will be. It is best to be optimistic but realistic.
If you go into a meeting pitching a pet flossing machine and claim the addressable market is $50 billion per year because every pet owner in the world could potentially buy one machine per month, you’ll be laughed out of the room.
You have to walk a tightrope between being overly optimistic and still getting the investors excited about your business.
4. Have projections ready
Financial projections at this point are, in one sense, worthless. If you haven’t even earned revenue yet, it is impossible to predict what you will sell in the future or what your exact cost structure will be.
I once met with a potential entrepreneur who wanted to get startup funding to purchase a truck to be used for long hauling products from Utah to California. He had been trained on how to drive the long haul truck in the military and had a pretty good resume.
We ended up declining the loan. On his financial projections, he hadn’t accounted for gas, and if you included that as an expense, the business would no longer work financially.
It is worth it to take the time to build out good financial projections to get a better handle on the key business metrics for your industry. There are probably CPAs or even accounting students in your area who you can reach out to for assistance. Don’t pitch a trucking company that will only have a positive cash flow if it doesn’t have to pay for gas.
5. Be able to answer questions
After you pitch your business, you may have time for a barrage of questions from the investors. Usually, this is a good sign — they won’t bother with questions unless they are interested.
Rehearse answering hard questions. If you can’t be nimble and come up with smart answers (or smart ways to say that you don’t know) during a pitch, how will you be nimble enough to manage an evolving business?
We have a need, a need for seed
All businesses have to start somewhere, and for exciting startups, that’s usually with a seed round. If you can pull off the funding yourself, all the better. If not, you’ll need to spend time working on and rehearsing the best possible pitch to attract seed investment from whoever will do it.
View more information: https://www.fool.com/the-blueprint/seed-funding/