It is almost impossible to start a business without capital, which is why seed round funding (also known simply as seed funding) exists as one of the main sources of finance for a new business. Seed funding raises seed capital--or the initial capital--needed to bring a startup out of the conceptual stage and turn it into a real business venture that can generate its own cash flow or establish itself well enough to qualify for other VC funding rounds.
When you are in the earliest stages of developing your business, it is easy to feel overwhelmed by cashflow problems. Often, it seems like a good idea to take any startup seed funding available from any source just to be able to continue to fund your startup and develop your idea, but the contracts you sign for seed capital can have a huge impact on your company's development and on your role as a founder. Instead, make sure you understand what you are agreeing to and the tradeoffs of accepting startup seed funding before you commit. Priori can connect you with a seasoned financing lawyer who can help you negotiate an advantageous deal as you seek startup seed funding.
What are Startup Seed Funding and Seed Rounds?
Generally speaking, startup seed funding is the earliest funding that you can get to start your business. Entrepreneurs use seed capital at the pre-revenue stage to develop an idea into a basic operational company. Investors typically view seed rounds as high-risk because the seed capital is given at such an early stage. For this reason, startup seed funding (aside from founders' personal contributions and loans or investments from family members and friends) generally comes from “angel investors” in exchange for an equity stake in the company or a convertible note. Recently, crowdfunding has grown in popularity as a source of seed capital.
What is the Purpose of a Seed Round?
A seed round, unlike later venture capital financing rounds, is not meant to scale a business. Instead, a seed round is intended to allow founders to establish the product they are building, gain familiarity with the relevant market, and gain an understanding of a product's user base. Traditionally, startups use seed capital for research and development and to cover initial operating expenses before the startup begins generating revenue. Founders can also use their company's success in acquiring seed funding to attract the attention of traditional venture capitalists and secure additional financing as the company matures. Ultimately, a seed round is intended to kickstart a startup as it continues to grow.
When Should a Startup Raise a Seed Round?
If you have a clear concept around which to base your startup but cannot create a prototype or establish a market due to a lack of funds, seed round funding may be a good option to pursue as you seek sources of financing for a new business. Without seed capital, it is almost impossible to start a viable business, so seed rounds are key to the success of most startups. That being said, you should be sure to scrutinize all seed funding offers with the help of an experienced financing lawyer who is familiar with the needs of startups, as the startup seed funding agreements you enter into early on will in many ways define the later successes or failures of your company.
Should I Worry About Seed Round Valuations And Convertible Notes?
The pre-money valuation of a company is incredibly important during a seed round, as it determines what percentage of ownership you will be giving away in exchange for seed capital. Unfortunately, since the true value of your company is often very unclear and the risk of failure is very high early on, it can be difficult to ascertain the pre-money valuation of your company. Therefore, convertible notes, sometimes also known as convertible debt, are often used in place of an exact valuation.
Convertible notes are a financing vehicle that allow startups to raise seed capital while delaying valuation until a later date—usually during a new round of funding. When the company is more mature, investors and founders both have a clearer idea of what a fair valuation would look like. Convertible notes are typically structured as loans, but they convert into equity upon maturation. Because investors take on the risk of an unspecified valuation when using convertible notes, they usually get special assurances, discounts, or warranties at this stage.
A Priori financing lawyer can help you determine whether convertible notes are the right option for your seed round and can also help you negotiate a favorable term sheet. Also, watch our webinar, "How to Raise Your First Million," to learn more about seed rounds.
The cost of raising seed round funding varies dramatically based on the number of investors, instruments of financing, and amount you are looking to raise. When you hire a lawyer in the Priori network, conducting a seed round to raise seed funding typically costs anywhere from $2,000-$15,000. In order to get a better sense of cost for your particular situation, put in a request to schedule a complimentary consultation and receive a free price quote from one of our lawyers.
What is the difference between a seed round and other sources of finance for a new business?
While both seed round funding and Series A and other early funding rounds are meant to help develop a new business that is not yet well-established or even necessarily profitable, seed round funding comes at the earliest stage of a startup's life. In addition, investors usually offer seed funding in smaller amounts, and seed capital may come from individuals rather than traditional venture capital funds. The biggest difference, however is that seed rounds are meant to kickstart a company that does not yet exist, and other sources of finance for a new business are geared more towards scaling an established startup.