The Reason Why Seed Money Is The Most Basic Investment Technique

Key Takeaways Seed money is the money raised to start developing a business or new product idea. Seed capital is typically used to grow the business idea to a point where it can be pitched effectively to VC firms who have a lot of capital to invest. Seed money is distinct from venture capital in that the latter comes from institutional investors, is typically far larger amounts of money, and involves extreme difficulty in writing an investment agreement.

Referred to as seed money or seed equity, investors typically receive an equity share in return for investing the money. Funding is provided by private investors — typically in exchange for equity stakes in a start-up company, or a stake in product profits. The investors may invest in a founder, using their savings as seed capital in the new company — also known as bootstrapping.

Unlike VC financing, which comes from institutional or corporate investors, business angels invest their own money. Some VCs will frequently lean on a business angel or co-investor to get a deeper stake in their seed companies.

In addition to seed money, business angels provide human capital in the form of advice and guidance. Professional angel investors sometimes provide seed money, either via loans or in exchange for equity stakes in a business. It may also help to think of seed money as the cash invested into the business prior to that business raising its first round of venture funding.

The amount of seed funding you are able to raise will correlate directly with the progress your startup has made. Considerations when deciding how much seed money to raise are how much it takes you to get to this point, and, to a lesser degree, dilution, which is how much equity you are willing to give up in your company. The more traction your startup has, the more seed capital you can get, and the less equity you have to give up to get this funding.

As the founder, your startup is your baby, the equity will get watered down for each investment round starting with that initial seed money. If it is above this threshold, angel investors who are professionals usually will take seed equity, in which investors buy preferred shares, gain voting rights, and become co-owners in essence of the start-up.

When raising seed capital for startups just getting off the ground, it will depend more on growth potential than how valuable a companys assets or intellectual property are.

Without seed funding, your big idea risks staying stagnant, or worse, a better funded competitor could jump in and take advantage of the market. To investors, providing pre-seed funding is a far greater risk since this product might never even get to market. Most entrepreneurs in this situation have yet to bring the product to market, and they might have nothing more than a prototype, making it hard to persuade early-stage investors to put their hard-earned cash behind an idea that is not yet fully baked.

Hiring new employees, finding office space, and marketing yourself to these early customers are all reasons why you should seek out pre-seed funding for your company. The harsh truth is you are going to have to do more legwork to find investors who are willing to invest in your startup in the pre-seed stage, but the payoff is well worth it. Startups have to find investors who will get on board with the founders ideas and vision because a lot of money is involved.

Seed funding is used to finance early stages of a new business, potentially all the way up to launching a product. Seed funding is intended to support early operations of the business until it begins generating profits or is ready to seek additional investors. Seed funding is typically intended to position a company for later rounds of equity funding from venture capitalists, angel investors, and similar sources.

Seed investments are often made by friends and family of founders, individual investors of a high net worth nature (often called angels), or smaller funds focusing on seed-stage investments, sometimes in conjunction with incubators or accelerators (programs to assist newly-founded companies in their early stages). Investors invest seed money via various instruments, from direct investments of equity, through convertible stock, and then through convertible debt. The primary difference between seed money and other sources of capital is that it typically involves the investor taking a lot more of a passive stake.

Most seed funding also includes a majority of bank loans, though banks are usually hesitant to lend to unproven sources such as startups. Seed money helps the start-up grow, reaching the point at which it can attract VCs, and at which investors can make strong returns. When a business is willing to take on either seed funding or late-stage financing, they often get the capital injection they needed, which can dramatically increase a businessas valuation and market share.

Much seed capital that a company raises may come from sources near the founder, including family, friends, and other acquaintances. The amount of money that entrepreneurs need to raise in a seed round depends on the type of company and how complex it is — in other words, what their idea would cost to launch. Whether you are a new business or you have been operating for some time, seed funding can help your business perform a number of crucial functions: From hiring those engineers who are going to refine your product, or those marketers who are going to accelerate customer acquisition, to buying hardware, or getting your new product launched.