Here’s the brutal truth about startup seed round funding:
There are WAY too many people or startups today that think“having a good idea” is enough.
They think to themselves, “ if I have a great idea, people will naturally invest in me”.
If only it were that easy…
If you’re serious about building a successful startup, you need to be more realistic about how you raise new funds.
Otherwise your brilliant idea will end up being just an idea.
Well, today I’m going to share everything you need to know about startup seed round that almost guarantees that you raise funds from funding institutes.
What is the Startup Seed Round?
First things first, I will share the definition of seed round funding so you can have a better understanding.
Among the many definitions about the seed round, I like the one Manu Kumar shared on K9 Ventures:
“Pre-Seed is the new Seed. (〜$500K used for building team and initial product / prototype)
Seed is the new Series A. (〜$2M used get for building product, establishing product-market fit and early revenue).”
According to Manu, these terms are constantly evolving. As technology improves and it gets easier progress with less money, the definition for each round shifts. He indicates this in his definition as what was known as the seed round, is now referred to as pre-seed.
Today, the new standard of the seed round is higher and accordingly, the Series A is also higher.
Having said that, the definition for the seed round is considered a small amount of money given to a startup to give the momentum it needs to produce its initial product.
At this point, startups normally have a business concept and will know if it has potential viability on the market.
So if you know that your market is there, what else do you need to know about seed round?
keep reading to learn more.
How does an early stage investor value a startup to invest in?
Well, there is this thing called startup seed valuation.
Startup up seed valuation can be determined by the market size of the industry, and the sector in which the startup plays. Investors need to see if there is enough demands and supply of money, and the level of determination of the entrepreneur looking for money.
Investors are taking risks, so you understand why they need to do this right!
Market size can be measured. In order to give you a better idea on how to measure market size, I listed some of the valuation methods that you may want to familiarize with.
There are more tools to measure market size but there is no need to go in-depth for the purpose of this article.
Although market size can be measured, the determination of an entrepreneur is not easy to quantify.
So how can investors measure how much entrepreneur is motivated?
To better understand this, you may want to consider why you as an entrepreneur want to seed round.
Here is why.
Why the seed round?
By now you should have a little understanding regarding why startups need seed round funding. Take a look at this image Steve Schlafman made for Business Insider. It explains why startups need to raise funding.
Let’s say that you are Mario from Nintendo video game and you just ran into a coin called funding. You instantly become bigger, and strong enough to compete with the tiny monsters, right?
Actually, there is more to it than just that.
Image Source: Steve Schlafman/Slideshare
Seed rounds tend to bring a large number of participants such as angel investors and institutional seed funds. Of course, it also depends on where you get funded from.
They will help you access a wide range of networks and resources that early stage startups need so that you can become green Mario like above.
Let’s face it.
As an early stage startup, you may not have many connections. If you do have connections, then leverage fully.
For the majority of entrepreneurs and founders, you have few resources to scale up. Therefore, the seed round funding will help develop a good startup into a great one.
When should you get seed round funding?
This question may seem obvious but it is important to understand these fundamentals about the seed round.
You should get seed round funding when you establish the direction and goals of your business. At this stage, the majority of startups are unformed in terms of direction.
Seed round funding should get funded when you wish to achieve these things:
With so many different options for investments, it is easy to be confused or unsure about which option to choose.
Read the following to learn more.
Types of Investments and Options
Venture Capitalists (VC) are just one option out of many where you can raise your funding. You just need to make sure you evaluate the pros and cons for each source before making your final decision.
Startup founders should understand the basic concepts behind various financing options.
Here is a summary of pros and cons of each types of financing.
Venture Capitalists versus Angel Investors
The easiest way to understand the difference between VCs and angels is that VCs are pros and angels are semi-pro.
Angels invest their own money whereas VCs invest other people’s money. Don’t get me wrong when I say angel investors are semi-pros – but most of the time, they invest as a hobby. Therefore, their decision making process is much faster.
On the other hand, VCs require more time, more meetings, and there are more people or partners involved. They also have TONS of deals going on a daily-basis but invest in very few.
Having said that, here are the pros and cons of raising funds from angel investors:
Pros of using angel investor to fund a startup
- Faster way to raise funding.
- Less complicated way to raise funding.
- An angel investor takes a risk.
- Money is not exchanged for an ownership stake in your startup.
- Precious knowledge for sustainable growth.
- Lower expectations in terms of rate of return or equity compared to VCs.
- Suitable for early stage startups that require just enough money to bootstrap initial growth.
Cons of using angel investor to fund a startup
- An angel investor might set the bar higher due to higher tolerance for their risks.
- Strings attached
- Less level of involvement compared to VCs. Therefore, you have less advise and guidance for your startup.
Here are the pros and cons of raising funds from VCs:
Pros of using VCs to fund a startup
- Suitable for larger amounts of funding.
- High level of involvement with the management.
- Valuable source of guidance and consultation to help your startup make better decisions.
- Financial support aside, VCs can provide you with assistance in many critical areas including legal,tax, etc..
- LOTS of cash & conncections.
Cons of using VCs to fund a startup
- Raising capital from a VC is harder than an angel investor.
- Longer decision making process.
- Less control depending on the size of their stakes.
Friends & Family
Getting funded from your friends and family is the easiest way to raise money.
If you choose to raise money from family, you could be playing a risky game.
At the end of the day, you will more than likely be using someone else’s money to run your startup. If you fail or have any disagreement with your family, they can get very emotional opposed to angel investors or VCs.
You need to make sure that you spell out everything clearly. You don’t want to mix business with your personal relationships.
Here are the pros and cons of raising funds from friends & family:
Pros of funding from friends & family
- Get genuine feedback for you ideas.
- Less stressful environment when presenting your business plan.
- They may offer a helping hand when you need one.
Cons of funding from friends & family
- Could create tension between your friends or family.
- High level of involvement, maybe even too much.
- It could damage your relationship.
- Relatively smaller amount of investment.
Despite the fact that bank financing is tricky, it is the most sought-out method. You want to educate yourself fully about interest rate and its process before start bank financing.
Here are the pros and cons of raising funds from a bank:
Pros of funding from bank
- Variety of range and payback options to fit your needs.
- Once you qualify, you will be funded relatively quick.
- No need to give up equity in the company. (Depends on your option)
Cons of funding from bank
- One word. DIFFICULT.
- The criteria is constantly changing.
- Whether you succeed or not, the founder must still pay back the loan.
- TONS of documentation required.
- You may need an expert to better negotiate payment terms.
This is one of the more modern ways of raising funds. The most popular crowdfunding websites are Kickstarter, FundersClub, and Wefunder.
Many founders have utilized these sites to launch a product, run a pre-sales campaign, or acquire venture funding.
The investors are most likely not involved with the day-to-day operations. As a startup, you will have great sense of freedom compared to the other types of funding. Of course, just like the other methods, there are also some downsides for crowdfunding.
Here are the pros and cons of crowdfunding:
Pros of crowdfunding
- Save time and money.
- No need to give up equity.
- May help establish a first customer base.
- Control over how to reward your investors.
- You can start small for smaller project.
Cons of crowdfunding
- Smaller funds
- Not suited for complex business or project.
- You cannot make lots of changes as you promised online.
Each of these funding methods will have different length.
Equity crowdfunding is the process where people crowd invest in an early stage startup in exchange for shares of the startup.
Here are the pros and cons of equity crowdfunding:
Pros of equity crowdfunding
- No interest payments.
- No liability.
- No monthly payments.
Cons of equity crowdfunding
- Giving up ownership.
- No control over the way you operate.
How long does it take to gain seed round funding?
This is totally dependent on the demand for your offering. Truthfully, there are no rules.
You can close in weeks if you have a competing offers.
One thing that can be said, in most cases it will take longer than you think. Interestingly, Gil Silberman argued that getting funding faster than four weeks is unlikely. But still there are cases where startups have cashed within a week.
If you are pitching to angel investors, you might want to plan for 3 months before finding an investor.
How often should I raise funding?
This is a crucial point that many entrepreneurs often think about.
How on earth can I raise funding and how much will I get?
Entrepreneurs should raise enough money so that they can focus their efforts on growing their business without needing to raise more funds for at least 12〜18 months.
A standard seed round takes a few months from the initial coffee meetings you have with your investors to actual money in your bank account.
The main idea is that startups should IDEALLY only raise funds every 1〜2 years so that the focus is solely on building and selling their product or service.
Here is a graph that shows the average time between funding rounds. According to the graph, it appears that 16 months is the average time based on the findings from Stephan Von Perger.
Source: AngelList and Crunchbase
How much should you raise in the seed round?
This will differ depending on the type of products and services your startup will offer. SaaS startups normally aim for $750K in their seed round whereas hardware startups go for around twice that amount.
$750K will allow you about 18 months of runway if you spend $35,000 a month; which is enough for four core team members to work for your company. This will allow you to still have a decent salary and extra capital in your bank account.
After having knowledge about how much you should get raised, you probably wonder (at least I did) how should you allocate seed round funds.
How to spend the seed round wisely
Founders should recruit their core team members wisely.
Here is the typical startup team composure that has proved well for many startups.
- Two developers to manage the code, ops and customer support.
- One product manager to do UX, web-design, product testing and customer support.
- One business head to do operational, sales and marketing, legal, fundraising, and customer support.
This is what a typical early stage startup workload looks like.
You’ll likely have to work at least four different kinds of jobs EACH. Employees of early stage startups, including the founder(s), have to do anything and everything.
Investing in these core team members is the smartest investment that a startup can spend money on.
No people equal no product which leads to no business. It’s that simple. No employees means no finished products, which also means no business.
What should you not spend your seed funding on?
You want to avoid as much unnecessary costs as possible. Every dollar should go into the product or service.
Needless to say, this product or service is made by people, you should spend 80% on payroll. Anything else is considered to be waste.
A fancy office space is unnecessary.
Having cool office furniture is unnecessary.
A co-working space is a great way to start.
An entrepreneurship conference, or any type of event such as this, is only worth spending money on if will lead in a sale or for marketing purposes.
Our CEO, Jason Ho, shared his insights about the common mistakes entrepreneurs make when seed round funding:
“One of the most common mistakes startup founders make is underestimating all of their costs. Costs in early-stage startups are typically combined with development resources, and office and human resources.”
He also stated, “before the seed round, startups must come up with a solid financial plan, included with your business plan, forecasting a two year plan and not just for the next 6 months. Typical reasons why a lot of startups fail is because they run out of cash.”
When you’re raising seed, it’s not about paying yourself a salary. It’s about making a product. Upon getting seed funding, many entrepreneurs treat themselves with personal check and not company’s check.
I may sound harsh but I don’t even think founders should pay themselves in the first year. Jason elaborates that founders should allocate 90% of seeds into development and the rest in marketing. However, marketing part is only when you have clear business model or plan to increase your user base.
There is a common joke in Silicon Valley that goes something like
“The more expenses you’ve got not for developer, the lower your startup valuation is.”
Jason believes that this joke actually makes sense.
As a founder, they should pay their people cash once the startup becomes a company. When you have a viable startup or business model means you already got a company.
Prepare for Startup Seed Round Funding
What do you actually need to get funding?
Well, I have great news!
Developing sophisticated documents for a seed round is not necessary.
You will most likely only need the following preparations:
- Executive summary
- Slide-deck, with hard-copy so investors can show it to other partners.
- Prototype (If possible)
In your executive summary, you should include your vision, product, team location and contact info, traction, market size, and financial revenue.
Your executive summary should preferably be one page. Don’t bother making pages and pages of documents that investors probably won’t bother reading.
The slide-deck should consist of appealing and concise graphics, charts, or screenshots. It should be more than just words.
The pitch is one of the most important items for preparing for seed round funding, so I will go further in-depth with this topic.
14 Pages you Should Include for your Killer-Pitch when you go for Seed Round Funding
The following information is from the original Airbnb pitch deck that can be used as a great example.
There are approximately 14 pages you can create to get the most out of your pitch-deck:
Page 1: Cover Slide
Page 2: Problem
Page 3: Solution
Page 4: Market Validation
Page 5: Market Size
Page 6: Product
Page 7: Business Model
Page 8: Market Adoption (This one can be excluded)
Page 9: Competition
Page 10: Competitive Advantages
Page 11: Team
Page 12: Press (This one can also be excluded)
Page 13: Users Testimonial
Page 14: Financial
Page 1: Simple Cover Slide with a Catchy Tagline
Image Source: Slidebean
The cover slide should consist of the logo, company name, and tagline.
Perhaps the most important part of this slide is the tagline.
Investors can get an idea of your business with this sentence alone.
Page 2: Problem Slide
I have to admit. Airbnb nailed it on this slide.
They pulled out every possible problem using just a single sentence.
Page 3: Solution Slide
Just like the other ones, this slide is visually compelling and easy to understand.
Similar to the previous slide, the solution slide should include why the customer should buy your service or product.
This is your core value proposition.
Page 4: Market Validation Slide
Airbnb pulled statistics from Couch-surfing and Craiglist to validate their market value.
Page 5: Market Size
This is your chance to explain the size of your opportunity.
It is important to verify this data using credible sources to backup your explanation.
Page 6: Product Slide
On this slide, summarize the core functionality of the product with a few words and images that will help investors understand what it is that you are actually trying to build.
Using a video is another approach you could utilize for this slide.
Page 7: Business Model Slide
Airbnb takes a 10% commission for each transaction made.
This is the company’s business model in a single sentence.
If your startup business model appears to be complex, try to summarize it as much as you can.
Page 9: Competition Slide
When you create the competition slide, you need to include two core differentiators for your product.
Oh, and always put your product on the top right corner.
Page 10: Competitive Advantages Slide
Make sure to answer key questions before they come up.
As you can see, Airbnb made bullet points with images about the core benefits. This is a technique you can also use to show investors how you can differentiate your business model from your competitors.
Page 12: Team Slide
Most startups seem to struggle when it comes to creating a team slide.
They don’t include enough information about each team member.
Only list relevant team members with their accomplishments, then include their academic titles.
Investors are the ones that are risking their money. They want to see if your executive team is experienced.
Page 13: User Testimonials Slide
In the case that you already have customers, it is critical that you include them in the pitch-deck as it helps validate your startup.
Page 14: Financial Slide
This is your punchline. This is essentially the whole reason you are pitching your business to the investors. The financial slide will show investors how much money you need, and why you need it.
- Seed round is to raise just enough funding to get the momentum for your product.
- Ideal amount of funding in seed round should be around 12 months 〜18 months.
- You should allocate a portion of your funding in human resources.
- Go for angel investors if you are looking for fast funding.
- Making a great pitch-deck requires one page executive summary and slides with compelling images.
Now You Try It
I hope you succeed in getting seed round funding for your startup!
Yes, it will take some hard work to raise the funding.
But after reading this article, you should feel confident that your hard work is going to pay off.
Ready to get funded?