Raising capital at the seed stage can present a few unique challenges. You’re not looking for large sums of capital, instead you need to attract investors who are willing to put their money in early-stage startups with the promise of high returns.
Investors will often ask how much cash your startup needs to survive and thrive. While this is an important question, it can be a difficult one to answer.
There are many different factors that go into raising capital, so there is no one right answer.
In this blog post we explore five points when deciding how much capital to raise at seed stage. These insights will help you determine what capital amount is appropriate for your business and its stage of development.
1. Decide why you’re raising money
Before you approach investors with a business plan and a request for funding, you need to be clear why you’re looking for money.
If you don’t know the answer to this, it will be impossible to find the right investors. Your overall business objective should be to build a profitable company that creates value for customers, employees, and society at large.
This is fundamentally different from investing solely to make money. It is important to have goals beyond just making money; something that radiates your passion, vision and even your frustration with life. It is important to be super-clear on these because they can be easily forgotten in your everyday responsibilities.
In addition, you should make it clear to yourself, and later to investors, why you are raising money now. Timing is everything and if you have clear reasons and calculations why you need the money now (and not 6 months later for example), you have a stronger case for fundraising.
If you aren’t clear about your business rationale and fundraising goals investors may not understand why you’re raising money. This can make it difficult to connect with and convince them of your business’s merits.
2. Understand the types of capital available
Once you are more clear about why you raise money now, it is time to decide which type of capital suits you best.
There are many different types of capital that you may be looking to raise. Investors may be interested in making an equity investment, a debt investment, a debt-like instrument, or an investment-based loan.
Each of these has their own set of advantages and disadvantages, so be sure to do your research and decide what type of capital is right for your business.
What type of capital you choose to raise will depend on your specific needs and the available options.
With equity investments, the investors own a percentage of the company. Depending on the agreement, shareholders may have voting rights, receive dividends, and/or incur debt if there is a liquidity event, such as an initial public offering.
With debt-like instruments, the investors receive a promise from the company to pay them a predefined amount of cash at a predetermined time. These are often used for small ticketed transactions, such as ticket sales for a concert or an in-person training course.
With loan investments, the investors receive a promise from the company to pay them a predetermined amount of money at a predetermined time, with interest.
In addition, venture debt and bridge loans are typically convertible to equity, allowing you to choose the type of equity you’d like to exchange for the cash. Venture debt is a long-term financing, while bridge loans are short-term.
Make sure to do your research into these possibilities before making any commitment.
3. Know the minimum you need to keep your business running
Before raising any capital, it’s important to know what you will need the money for. You may need the funds to keep the current team working, to pay employees while they wait for product development to finish, or to pay bills while you focus on growing the business.
It’s important to know what your business is worth through valuating your startuo. This includes factors such as your company’s revenue, the value of its product, the worth of its intellectual property, how many customers it has, how efficient it is, and how large its market share is.
In addition to conducting the valuation of your startup, It is crucial to know exactly (with some leeway or contingency budget) how much is the minimum amount that you should raise in order to keep your business active and making progress.
For that, you need to have a good understanding of your burn rate and runway because they pretty much show the amount of time you have to remain solvent given you continue in this path.
It’s important to keep in mind that raising capital is risky. There is always the chance that your business won’t be as profitable as expected and you’ll need to use the cash to pay your bills.
If you end up in this situation, you’ll want to be able to show how much cash you raised, how much cash you expected to raise, and how you’ll use the money to pay your bills.
If you’re not ready to use the funds to keep the company running, you may want to reconsider raising capital.
4. Prepare a prototype of your product
It’s important to have a prototype of your product. This will make it easier to get investors excited about investing in your company.
You can have a prototype made by a designer or engineer on your team, or hire one out to create it for you.
Depending on the stage of development of your product, you may be able to use data from your current product to create a prototype. The data basically comes from market or problem validations you have done so far for example through talking to your potential customers or early adopters.
If so, you’ll want to include key features from your product and why investors should care about them. You can take this a step further and ask (potential) customers’ opinions about the prototype and incorporate some feedback.
Showing the customer satisfaction with your prototype can be another sign of future success and may further convince investors to trust you so don’t underestimate it.
You can also prototype elements of your product that don’t directly affect investors’ value from customers. For example, you can prototype your product’s functionality, user experience, look and feel, and marketing strategy.
5. Be realistic about the returns you can offer
It is easy for entrepreneurs to overstate the returns that they will get from investors. The truth is that many startups don’t see profits or make any money at all when they first launch.
Startups are risky, and you do not know if your business will be successful. With that in mind, it makes sense to be realistic about the returns that you can offer to investors.
You should keep in mind that it is perfectly normal not to make any or much sales in the first couple of years of your business.
Of course this heavily depends on the type of business or industry. For example in the pharma industry, it is quite common not to have any revenue in the first 5-7 years of the business since it is very knowledge-oriented and depends on patent approval.
Unlike a venture capital firm that may invest in a portfolio of companies, an investor in your business will only be willing to give you money.
If they are expecting a high return, they are expecting that they will get that money back when you eventually sell your company or trade it for something else.
You should have a transparent and honest conversation with them to make sure you both are on the same page in terms of future expectations of the venture.
Bonus point: Be flexible in your fundraising timeline
The most important factor in fundraising is timing.
You need to find the right investors in the right place at the right time. This will take time, so you have to be flexible with your timeline even though you might be pressed with your runway.
You need to be willing to wait as long as it takes to get the right investors on-board. In order to stay solvent, you can think of reducing some costs and focusing on main things, such as prototyping and growth marketing, that really matter for seed fundraising.
Fundraising can take longer time than expected mainly because finding “smart money” and the due diligence process can be quite time-consuming. So you should always be prepared for this scenario.
If you’re raising money from friends and family, this may be easy to do. However, if you’re looking for investors, you’re going to have to be more aggressive. You should aim for a target raise that you can realistically hit.
Wrapping up
Raising capital at the seed stage presents a unique set of challenges.
You need to attract investors who are willing to put their money in early-stage startups with the promise of high returns. There are many different factors that go into deciding how much money to raise, and we hope our insights are helpful in navigating these.
It’s important to keep in mind that raising capital is risky, you don’t know if your business will be profitable, and you need to be realistic about the returns that investors are expecting.
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