Seed funding for startups: the ultimate guide
- What is seed funding?
- Advantages of seed funding
- Who invests in seed funding?
- When's the right time to raise?
- How much to raise?
- What equity to give
- How long does it take to raise seed funding?
- How do you raise seed funding?
- How much revenue do you need to raise a seed round?
- Financing options
- How to find an investor
- What documents do you need?
- How do you choose a seed investor?
- Dos and don'ts
As an entrepreneur or startup founder, the question of how to fund your business is never far away – especially in those early days.
Seed funding is a common step for startups and it might be the right next step for you. But the exact process of raising a seed round can feel intimidating and mysterious unless you know what happens behind the scenes.
This guide is here to demystify that process, help you decide whether you're ready to pursue seed funding, and gain confidence about what to expect from the experience.
What is seed funding?
Seed funding is the first official round of funding that startups raise before moving into subsequent rounds, known as series A, B, C, and so on. Investors provide your startup with capital in return for gaining a stake in your company.
Initial funding for a new business often comes from the founders’ savings, or from friends and family. In fact, 77% of small businesses rely on personal savings at the beginning.
But in most cases, money from your own bank account and those of friends and family can only go so far. Ambitious start-ups will soon need to seek out alternative sources of funding. Bank loans may be an option for some early-stage startups, but getting seed funding is usually a better choice.
What are the advantages of seed funding?
Of course, seed funding gives your startup a major financial boost but having investors behind you means that your business gains more than just cash.
For investors, there's significant risk when investing in an unproven startup. One of the major advantages of seed funding is that your investors will understand that risk and be willing to take it on. You'll also benefit from the expertise of your investors, which can help you grow and develop your startup in directions you might otherwise have overlooked. What's more, your investors typically have strong business networks that you'll be able to access and benefit from.
Another advantage is that seed funding is typically debt free and flexible, so you won't be burdened with loans or restrictive agreements.
Who invests in seed rounds and why?
Angel investors are one of the most common sources of seed funding for startups.
The typical angel investor is a high net worth individual who is motivated to pursue riskier investments. You might also find angel investors teaming up to invest as a group (these are known as angel networks).
Seed funding can be risky for investors, as your company hasn’t had much of a chance to prove itself in the market. That being said, there is opportunity in it too. Angel investors who do choose to focus on seed funding rounds can purchase a portion of a startup’s equity when valuation is at its lowest and so these investments can be very lucrative.
For example, in 2004, Peter Thiel invested $500,000 in Facebook, then sold his shares a few years later for $1 billion.
Venture capitalists (VCs) are another common type of investor who targets seed rounds. Here, the difference is that angels invest their own money, while VCs invest other people’s. Or, as Y Combinator points out, the main difference between angels and VCs is that angels are amateurs and VCs are pros. As a result, angels can make decisions more quickly, while VCs will typically need to go through several rounds of meetings before making the final decision.
When’s the right time to raise seed funding?
According to Y Combinator, to be successful in raising a seed round, “founders should raise money when they have figured out what the market opportunity is and who the customer is.”
Seed funding gives you a financial springboard to prove that your business concept can work. Finding companies with credibility and product-market fit is usually the main goal for investors at the seed stage. The seed round is the prime time to demonstrate that your product or service can achieve initial traction in your target market.
Getting clarity on those points is vital. You'll need to show that your product matches customer needs and that customers are already adopting it.
You should also have evidence that your customer adoption rate is increasing over time. That indicates a positive trajectory or a sign to potential seed investors that your company will generate significant returns on investment.
Start-ups can decide to raise the seed funding at various different stages. Investor community StartEngine recommends that companies aim to raise their seed round "when they have less than $3 million annual recurring revenue (ARR).”
The average amount of funding raised in a seed round is $2.2 million, but it can be as low as $100,000 or as high as $5 million.
The exact amount of funding to raise is up to you as the founder. But, in general, it's recommended that you aim to raise enough to either reach profitability and/or to bring you to your next funding milestone with ease.
Judging this accurately requires a detailed understanding of your business operations and exactly what is needed to get you to that next milestone.
But just because you can raise a certain amount of money at the seed round, doesn't always mean that you should.
Average seed round by industry – examples
The average seed round has grown dramatically over the past ten years. In fact, today’s seed rounds are almost comparable to Series A rounds from a decade ago. According to Finmark, most seed rounds today are around $1-$4 million.
In Europe, as of December 2021, healthtech and software firms raised the most in seed funding, with fintech doing especially well. Fintech had a larger average seed funding round size of €5 million, compared with €2.5 million for health and €2 million for software.
Globally, and in SaaS specifically, the average seed funding round was $2.1 million, according to the SaaS Funding Report in May 2021. However, at least 15 companies in this survey chose to withhold details of the amount raised, so the true average would have been even higher.
How much equity should you give a seed investor?
Remember the essential trade-off between the amount of funds that you raise and the amount of your company you hand over to the investors.
According to Y Combinator, the sweet spot is to “give up less than 10% of your company, while still proceeding to Series A”. However, this isn't always possible, and many funding rounds will mean giving up 20 or even up to 25%.
How long does seed funding take to raise?
The answer to this question is really "it depends”.
That’s because there are a whole host of factors that impact the timeline of a successful seed round. As a general rule, it's best to assume it's going to take longer than you expect.
If you find a willing investor and there's a decent level of demand for your offering, then it could take 6 to 8 weeks to close the deal.
That’s when your documentation is in order, you’ve got your lawyers ready and everyone involved in the process is communicating on time.
If there are delays with any of those elements, then 12 weeks is a more realistic timeframe. Finding a suitable investor is typically the part that takes longest, depending on how many you have to approach and/or pitch.
Remember, you’ll have to manage the seed fundraising process while also managing day-to-day operations of your start-up. Don't underestimate how much time this can take.
No matter what stage you’re at in the fundraising process, it's essential to keep cultivating momentum and displaying confidence in front of your potential investors.
How do you raise seed funding?
The overall process of raising seed funding is best viewed from a systematic perspective. The folks at Visible liken the process of fundraising to the systems within your sales and marketing funnels.
Just as you move new leads through the different stages of your funnel, so can you move potential investors through the different stages of raising seed funding.
Start by gathering qualified potential investors, either from outreach, introductions, or inbound interest. Then filter them to make sure they fit your model of an ideal investor.
Next, make sure you stay fresh in their minds by keeping in regular communication. This is important even if you're not actively seeking funding at the moment. For example, you might email them a list of highlights from your investor update newsletter.
Developing and maintaining good relationships with potential investors is a major key to success in raising seed funding. What's more, once those investors decide to fund your startup, they’ll be good sources to approach when you're ready for subsequent rounds of funding.
How much revenue does a startup need to raise a seed round?
That depends on the investor. Most venture capital investors want startups to be monetized, which can be difficult in the early stages. Other kinds of investors may be convinced by your story, your idea, and your expertise.
At the seed stage, a startup may be anything from a pre-revenue state, to making as much as a few hundred thousand dollars annually.
Beyond revenue, the most important factor is proof that people like your product and want to use it. If you don't yet have revenue, you can still show that people value your product by means of social proof like feedback, social media mentions, and press coverage.
The goal is to show investors that there is an audience that’s willing to pay for your product, giving them confidence that your business is financially viable.
What are your financing options for seed fundraising?
Several financing options are available for seed rounds, but the details can be complex. In this section, we present a high-level overview of the various options, with links for where to read more.
We recommend that you read up in in depth about the different types of financing and make sure you’re familiar with the key terms of these deals.
Seed fundraising typically involves one of three financing options:
- Or grants.
Let’s take a look at them.
Option #1: Debt
Here, your startup borrows money from the investor, intending to convert the debt to equity in the future. It happens via an instrument called a convertible note. The loan includes a principal amount (i.e. the investment itself), the interest rate, and a maturity date when both the principal and interest must be paid back. It will also specify how the debt will be converted into equity.
Once your company does an equity financing round, the convertible note will be converted into equity. Financing via convertible debt can be useful for your company if you believe your equity will be worth more later down the line. For more on convertible debt, check out this detailed post from Fred Wilson.
Safes (simple agreements for future equity) are similar to convertible debt, but without the requirements for interest rate, maturity, and repayment. Typically with a safe, you'll be able to negotiate the terms of the amount, the cap, and the discount.
For detailed information on safes, check out this detailed primer from Y Combinator.
Option #2: Equity
When financing with equity, you’ll set a valuation for your company, with a per-share price, then issue new shares and sell them to investors. As Y Combinator points out, financing with equity is “more complicated, expensive, and time-consuming” when compared to safes or convertible notes. They strongly recommend that you stick to the latter two financing options when seeking seed funding. Later on, when you plan to issue equity, it's essential to hire a lawyer.
Option #3: Grants
In both the US and UK, governments often fund promising startups. This may sound enticing, but the disadvantages include cumbersome application processes, intense competition, and many conditions attached.
In the US, seed funding for startups is available via two federal government award programs: the Small Business Innovation Research (SBIR) program and the Small Business Technology Transfer (STTR) program.
In the UK, government funding opportunities include the following:
How do you find a seed investor?
At the early stages of your start-up’s life, you probably don't have many sales figures to prove the success of your idea.
That’s why the people most likely to invest will be those with confidence in you, who are fascinated by what you're working on, and willing to commit the funds.
Here are the types of investors most likely to provide seed funding.
The most common type of seed funders, angel investors are wealthy individuals who invest their own money in projects they believe in. The big advantage for you is that they can typically move quickly with their decision-making.
These programs not only train you in how to run a business, but also give you access to a community full of expertise, plus exposure to high-level venture capitalists for additional funding rounds. They can be a great choice for finding seed investors while gaining essential knowledge about business.
Accelerator programs (such as Y Combinator or Techstars) are another possibility, but they're usually aimed at helping companies scale up, rather than supporting early-stage innovation.
Venture capital groups specializing in pre-seed and seed funding
Venture capital (VC) funds have the ability to make large seed investments, but the decision-making process can be long and drawn out. To find one that may suit you, look at what different VCs have funded in the past, and build a list of those who have previously worked with start-ups similar to yours. It's important to create a tailored campaign for each specific investor, rather than taking a scattershot approach.
Crowdfunding platforms (such as Seedrs or Crowdcube) are growing in popularity, especially among new SaaS startups. In fact, 96% of SaaS companies securing equity via crowdfunding were in seed or venture stage at the time of raising, according to Beauhurst.
The crowdfunding concept is simple: you showcase your business to the public and anyone in the world can support it. To succeed with crowdfunding, you'll need a compelling idea and the ability to weave a resonant story around it.
Corporate seed funds
Large companies like Apple or Google regularly provide seed funding for start-ups. They’re motivated by the potential for new sources of income, intellectual property, or talent later down the line.
Family offices manage wealth and investment strategies on behalf of ultra-high net worth families, with the goal of maintaining and growing generational wealth. For entrepreneurs, family offices are becoming an interesting alternative to venture capital funding. In the past, family offices have typically focused on hedge funds, real estate, and bonds, but many are becoming more open to investing in start-ups.
What documents do you need?
Getting the right documentation for your seed funding round is critical, so it pays to know exactly what should be on the list.
Andrew Pankevicius of FundSquire recommends tailoring your document pack to fit the preferences of the type of investor you're presenting to.
If it's a venture capital firm, aim for a short and concise pack, while also making sure you have an online data room at the ready. If it's an incubator, you'll typically have to fill out a standard application process, then do a face-to-face pitch if the application is successful.
Family offices usually prefer hard copies of financial models that follow accounting standards, such as income statements and forecast balance sheets.
Below is a list of typical documents that could be found in a seed funding data room.
Having these documents already prepared is an important way to keep conversations with potential investors flowing smoothly.
For seed funding rounds, investor questions typically revolve around market sizing, go-to-market strategies, or high-level capital deployment strategies.
- Cap table and vesting schedule
- Terms of the raise
- High-level capital deployment strategy
- Market sizing and breakdown
- Product development roadmap
- Go-to-market strategies
- Target customer personas
- Financial forecast model
How do you choose a seed investor?
Just like defining your customer persona for your business, choosing a seed investor starts by defining what your ideal investor looks like.
Tips from startup experts on choosing and working with seed investors.
- Understand the investor’s investment thesis to figure out whether your value proposition falls within it. Do your research carefully to avoid wasting anyone’s time. There’s no point approaching investors who only target a certain sector if your company isn’t in that particular sector.
- If you’re targeting seed funding in the UK, be aware that many UK funds will only invest in UK-based companies because that allows them to access certain tax benefits. This is common, but not always obvious from their websites.
- Understand what type of investor you want to work with. Do you want someone who’s very hands-on, or who lets you do things your way? Be aware of investors implementing conditions that might be unacceptable to you.
– Nadia Sergejuk, Early Stage Investor, London
- Always pay for experienced lawyers and accountants. One difference between UK and US startup culture is that the UK is more ‘hack it / do it yourself’, while Americans usually hire the best lawyers. Working with good professionals will pay big dividends and will ensure you get the best outcome from whatever contract you sign.
- Treat all investors equally, otherwise you're going to create chaos. Be clear, honest and transparent from the beginning. Define your boundaries, roles and responsibilities, and make sure that you trust everyone you work with.
- Try to learn from others, get referrals and interview potential investors just as they’re interviewing you and finding out who you know and how you work.
- Most importantly, remember – a deal is never done until the money’s in the bank.
– Anna Downey, CEO & Founder, Buzzbar, London
Dos and don’ts for communicating with investors
Knowing how to talk to your potential investors is another vital factor in successfully securing seed funding. Here are some handy tips to help you get it right the first time.
What to do
- Develop a great, one-line elevator pitch. Encapsulating your company and mission in one sentence leaves a great impression – that’s why it’s an essential part of your fundraising toolkit. Don’t forget to practice your pitch!
- Tell a compelling story. You need to convince investors to fund your company before you have any revenue. Having a great story really helps.
- Focus on market need. Make sure you’re clear on WHY the market needs your product or service, providing robust evidence if possible.
- Know your competition. Be ready to explain to potential investors exactly how your product or service is better than the competition. Failing to do so can make them nervous.
- Explain why the investment matters to you. You’ll need to clearly articulate why your company needs funding right now. Whether it’s to hire more employees, buy new equipment, or acquire a competitor – be as specific as possible.
What NOT to do
- Don’t send generic cold emails. It's always more effective to get a warm introduction; but if you can't do that, at least make sure your first email to a potential investor is personalized.
- Don't try to play investors off one another. This is usually a bad idea, especially when you’re inexperienced at fundraising
- Don't come across as indecisive. Although it’s fine to admit that you don’t know something.
- Don’t be slow when following up or closing a deal. Investors tend to move fast and you doing the same is a sign of confidence.
Getting seed funding doesn’t necessarily mean having big revenue numbers. In those crucial early stages, knowing your product-market fit, understanding your customer, and wrapping it all up in a compelling story can be enough to convince the right investor that your startup can succeed.
Ready to get started? Check out this article from SaaS expert Todd Gardner on determining your total addressable market (TAM).