If you’ve been following this series closely with your own startup, it’s very possible you already have a functional prototype and a business plan, but your initial money is almost gone and you’re ready to start raising some real money. There are several natural questions that come up at this point. Where can I find the money I need? Who do I need to hire in my company at this stage? And how much money should I raise?
In a previous article, I explained when to hire your first employee (and who to hire) as you start to think about getting help when you have a great idea and just aren’t sure what to do next. Let’s fast forward a bit, and assume you did things correctly to get to this stage.
You raised some initial money and maybe have a small team working on your prototype, which is hopefully working to some degree. Your business plan is taking shape, and you have a pretty decent understanding of the market you are pursuing. It’s time to get serious and raise some real seed money.
What is Seed Money?
Seed money, also referred to as seed capital or seed funding, is a private investment of capital in a startup in exchange for equity. Seed money is typically in the tens to hundreds of thousands of dollars range, not millions. This range exists because venture capital firms typically won’t invest less than $1 million, where that might represent the maximum you can expect from seed investors.
Venture capital funding has some key differences from seed funding, but one of the primary differentiating factors is the amount of money invested. While venture capital funding can range from $1 million on the low end, up to about $30 million on the high end, seed funding is typically far less and its purpose is to keep the business afloat until it can independently generate cash flow and acquire more significant funding.
Another key difference is that venture capital investments most often come from institutions while seed funding typically comes from individual investors, such as angel investors, crowdfunding and even friends and family.
What are Seed Investors?
Seed investors, also referred to as Angel Investors are individuals who are looking to invest in very early startups. There are usually groups of these investors in your area. You can also look for incubators or accelerators, which are groups that might also provide some office space and access to other experts.
Since Angel Investors will typically reject 75% (or more) of the investment proposals they receive, you want to have your act together before you approach them. Angel Investors not only have money, but they often have plenty of experience as well, so if you are able to acquire funding from an Angel Investor, you’ve instantly improved your chances of success. You better believe investors are going to do everything in their power to get a return on their investment, and they wouldn’t have made the investment in the first place if they didn’t think they could. Acquiring funding in this manner not only gives you some money to help you get to the next stage of growth, but it also lets you know that other more experienced people believe in your idea and that what you’ve built so far has the potential to be successful.
So, how much seed money should you try to raise at this stage? In a prior article, I talked about the “friends and family round,” which, of course, is money from friends and family members. Now, let’s try to define the term “seed round.”
What is a Seed Round?
A seed round is typically a very first and small round of startup financing that allows you to hire a few key people and get your project to a demonstrable stage with a prototype. In some cases, a small seed round can be used to get your business plan completely written.
If you have to have an income while developing your idea, seed capital can provide this. The friends and family round discussed earlier is usually in the tens-of-thousands of dollars range and is usually just enough to get you started. Seed capital, on the other hand, is typically enough to get you to a venture capital round but is rarely enough to get you all the way to market.
So, most often, a seed round will result in investments that are more than the friends and family round but less than a venture capital round. It can also be pretty expensive in terms of the equity you have to give up in order to get it, so don’t raise more than you think you need to get to a real funding round – and be very frugal in how you spend it.
How to Approach Investors for Seed Funding
If you have a functional prototype, you must also have a business plan of some sort – before approaching angel investors. Why? Because you must have some idea of who would want this product, how big the market is and how much money you need to get to the next stage. You don’t really have to be right about all this, and you probably aren’t, but you need to write down your assumptions about why you are doing this.
Related: How to Establish Product-Market Fit
Now is the Time to Hire Your First Marketing Employee
If you don‘t have a written business plan, think seriously about creating it or finding someone to help you write it, because without it your odds of raising seed money are pretty slim. Your efforts to raise seed funding at this stage almost require it. Cover your bases and make sure you have a professional and thorough business plan before you approach investors. If you are an engineer, as I was, and your small team is comprised of engineers, and you are lacking the business or marketing experience to put this together, get help.
This leads me to my first recommendation:
Find and hire a great marketing person who knows the market you are pursuing.
How Much Should You Pay a Great Marketing Person?
What you pay a great marketing person certainly depends on market conditions, but pay what you need to pay to get the right person. This can be very tough at this stage.
You are raising your first seed round of capital, so you don’t yet have a lot of money to pay salaries. It’s the same with the engineering lead, although it’s possible that you or one of your seasoned developers can take this role. The equity component of this compensation package is a bigger question.
A VP-Marketing level individual who is not a founding partner and coming in after you have raised money can probably expect 2% to 3% equity. If your marketing person is not a VP-level candidate, but is taking career risks working with you full-time at this early stage, then 2% to 4% is fair and may allow you to pay them a bit less than market rates. Don’t go overboard on the equity though, you are going to need it later. These are guidelines, not rules and everyone you ask will have a different opinion.
What do Early Seed Investors Expect to See Before Investing in a Startup
The question at hand is really about what potential seed investors expect to see in a team before committing to investing. Everyone has different ideas about this.
Some experts believe that you should have a stellar executive team. Others believe that having a Board of Advisors made up of big names is required. There are probably cases where one or both of these are true, but from my experience, there are often more important factors that should be prioritized first.
I happen to believe that a demonstrable prototype, a well thought-out business plan and a small, hungry team are what early investors expect to see first. A Board of Advisors at this point has little value in raising money, and a stellar executive team, or even any executive team, is not really adding any value either.
A really good marketing person can put together a more formal business plan that contains the essentials you need to raise money from real Angel Investors. They can figure out the target market, market size and describe the customers you seek. They should also serve as a Program Manager, having long conversations with your engineering team about what’s possible and how long things might take to get to a shipping product.
Putting the numbers together may require outside help, but with that being said, it’s probably not worth the cost to actually hire a money person yet.
The investors I have dealt with over my career all seem to understand a few things at this stage. These understandings lead to three important things you must show investors when raising a seed round: A solid business plan, a functional prototype, and a committed team capable of success.
Why Having a Solid Business Plan is so Important to Investors
It’s your business plan that got you the audience with the potential investors; they are clearly interested in the space you are pursuing. But there are some things you should understand about how investors will view your business plan.
First, your business plan and numbers are probably wrong. Don’t take it personally, their opinion is based on experience. Second, it’s going to take a lot longer than you are estimating to get something to market.
What investors like to see, and the reason they are even talking to you, is that your product idea and the market you are pursuing are appealing to them. What they really want to see is a team that can adjust and adapt to the ever-changing market variables and engineering challenges ahead with fire in their eyes and get into the market they are interested in with a compelling product.
If all you have is an idea and a small team, it is still possible to raise money, but the amount of equity you will be giving up is commensurate with the risk the investors are going to take.
Why Having a Functional Prototype is so Important to Investors
Angel investors know there is huge risk at this point of investment, but even they have their limits. This is why having a functional prototype is important and why considering more friendly money (discussed in a prior article) might be best right now.
If your potential investors can see some reality and not just arm-waving, some risk is mitigated in their eyes. Money is very expensive at this stage in regard to the amount of equity you will give up for it.
Investors will need to see that the team is committed to doing what it takes to get to the next stage. They want full-time passionate people who can all articulate the concept and clearly believe in it. Full-time people. Please do not go out and try to raise money with a team that will join full-time when it makes sense or whatever justification they might have for not already being fully committed. While it isn’t impossible to do, it’s just less likely.
Why Team Commitment is so Important to Investors
If you have working code and a business plan, investors are going to be much more focused on the team. They will want to know that you and your team can succeed.
At this point, you should have someone on your team who can go deep on the market and address issues like defining the correct feature set for the product, finding customers and accurately sizing the market. You should also have someone who is clear and articulate on the engineering issues, development risks, schedules and feature requirements. This is probably you.
Who You Don’t Need to Hire at this Stage of Growth (Yet)
I don’t think you need a sales person at this point; for instance, I have seen cases where sales people get into sales mode in investor presentations and take the whole conversation off the tracks.
Your team at this point does not need to be made up of VP-level people; managing and leadership are very different skills than specific competence in markets or technology.
Your team should be small enough to not need heavy-weight leadership, if you are raising a seed round of capital. You also probably want a numbers person who can walk through the financial picture in the business plan, although my personal belief is that having credible numbers, forecasts and a deep understanding of the market you are looking at are enough at this stage.
Stay the Course: Focus on Metrics Important to Investors
Again, Angel Investors will likely assume your numbers are probably wrong, but it’s also likely those numbers aren’t what’s important to them. Instead, it’s your assumptions about the market and metrics that are important to them. Your marketing person and your personal understanding of the space can create very realistic views of the available market and potential customers. If you need help putting spreadsheets together, you can hire a CFO type on a contract basis to do this.
Now that you’re armed with the knowledge to go about raising seed money, next up, I explain the process for raising angel money: How to Pitch to Investors and Raise Angel Money.
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