What Is Seed Capital?
Whether you’re planning to start a small business, invent a new product, or build a multi-million dollar corporation, your venture starts with an idea. Even if you’re a new entrepreneur, you probably know you can’t build your dream business simply on an idea.
Every business idea requires some capital to get started. Raising funds for a startup is one of the most important tasks entrepreneurs face. The money you need to start your business venture is called “seed capital” and there are several ways to raise these funds.
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Seed Capital Definition
Seed capital is the money you need to raise to start a business. You can make this money on your own by working on side gigs or by convincing investors to invest in your idea. It’s also called seed money, venture capital, venture money, or seed funding.
Most seed capital funding comes from the entrepreneurs’ personal assets or their friends and family members. In some cases, entrepreneurs can convince investors to provide funding or a bank to offer financing options.
However, unless you’re a proven entrepreneur who has several different businesses under your belt, investors may be wary of your new venture. The seed capital stage is risky for investors since your business structure and plans haven’t been proven yet.
Seed Capital Examples
Depending on the type of business you plan to start, you may need a little or a lot of seed capital. If you’re starting a business straight out of college, you probably don’t have a savings account that can cover the startup costs you’re likely to encounter as you begin to create your business.
To raise the funds you need for these costs, you’ll have to keep an open mind about the sources you turn to and how you get them interested in your venture. To raise the seed capital you need, you can:
- Earn it yourself: Consider getting a part-time job or finding passive income streams to raise your own funds. It can be hard to juggle a job with entrepreneurship, so be sure you can set aside enough time to work on starting your business.
- Talk to friends: Friends are likely to be supportive of your idea. While your friends may not be able to contribute a lot of money to help you start your new business, you can try to pool funds from several friends together, which may be substantial enough to cover some business startup costs.
- Try crowdfunding: Ask numerous individuals to invest in your business on social media or through other resources. In exchange, you’ll need to offer these investors free products or other gifts.
- Ask family members: Speak with your family members about your idea and get them interested in providing you with seed capital to get up and running. While you may feel comfortable with your family, it’s important to present a feasible business plan and answer tough questions so your family members know you’re serious about this venture.
It’s tough to mix business with personal relationships, so be sure your friends and family members are understanding about the fact that they may lose money on their investment. In most cases, a single source of funding won’t provide you with enough seed capital to start your business. You may need to enlist the help of a few different sources to raise the funds you need.
How Does Seed Capital Work?
Raising seed capital to start your business is the first phase in the investment process. After you’ve procured your seed capital, chances are you’ll need additional investments to continue building your business, then to work on growing your company. You’ll enter the other three phases of investment in the following order:
- Venture capital: You may enter the venture capital phase while you’re still raising seed capital. If you have a solid business plan, approach a venture capitalist firm to invest in your company. In exchange for funding, you may need to give away some of your company ownership in the form of shares, called equity financing. This gives the investors ownership in your company and the right to have a say in the future decisions you make for your business.
- Mezzanine funding: Once your business is established, you may need more funding, which you can attempt to raise through mezzanine financing. Funding is generally provided to help you reach the next phase in growth after your business has proven successful, but it’s usually associated with a high interest rate.
- Initial public offering (IPO): When you’re ready to trade your company shares publicly on a stock market, you’ve reached the initial public offering (IPO) phase. If this phase is successful, your seed and venture capital investors will start to make their money back and you can raise sufficient funds to grow your business.
As the first phase of fundraising, seed capital is generally only enough funding to cover the startup costs of your business. Once your business has proven successful, you may need to raise additional funds to continue growing and expanding.
Seed Capital and Angel Investors
If you’re having trouble raising seed capital for your business venture, you may need to enlist the help of an angel investor to cover some of your startup costs. If an angel investor provides $1 million or less to help with your business, you’re probably taking on a loan.
In this situation, you’re required to pay the loan back plus interest once your business starts making money. If this is the agreement you make, be sure you thoroughly understand the terms and conditions of the loan, including when the investor expects to be paid back, the interest you’re required to pay, and if there’s collateral for the loan.
Angel investors who contribute more than $1 million are likely to ask for seed equity in return. In this case, the angel investor is a co-owner of your business and has ownership shares. The investor has voting rights on important company decisions and they can choose to hold on to or sell their stock at any time.
Why Is Seed Capital Important?
When you get investors to provide your new business with seed capital, it immediately adds value to your product or company. When others see the potential in your idea and prove their belief in its success by providing early funding, it shows you’ve presented a solid business plan.
However, it’s important that your investors know the risk they’re taking and stay prepared to potentially lose money. If you enlist the help of angel investors or venture capitalists, make sure you’re comfortable with the deals they’re offering in exchange for seed capital.
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This post was updated February 19, 2020. It was originally published February 19, 2020.