Seed Funding for Tech Startups - Everything You Need to Know
Creating a startup from scratch was never an easy task, but in today's saturated tech startup landscape, it is becoming increasingly difficult for startups to even get off the ground with their seed round of funding.
Historically, many startups were able to self finance the initial seed funding round by looking to family, friends, and personal finances. Today, seed fundings can range upwards of a million dollars, making bootstrapping a much more difficult task to undertake. The high cost of entry into the tech startup industry has led to the slow phasing out of bootstrapping in favor of other funding methodologies. The new normal for a startup is to gain investors during the seed stage of funding.
With tech startups being amongst the most densely populated startup genre, it can be difficult for a startup to stand out during the seed stage of funding. Simply having a good idea might have been able to convince investors in the past, but now the stiff competition has raised the bar for investors as to what they are looking for in a tech startup. What used to be a “nice to have” quality in a startup is now the standard for investors.
Having a full understanding of the funding stage and what it means for both startup and investor can make a large impact on the ability of a startup to get funded. Below is a discussion of everything you need to know about seed funding for tech startups.
What is Seed Funding?
Startups are a unique business entity because they are able to obtain capital through the inherent value the startup has.
In simpler terms, startups are able to turn an idea from thin air into a business that has value that can then be utilized to negotiate for capital. Startups are unique in this manner because traditionally, the need for capital was satisfied through banking institutions in the form of small business loans. These loans are offered, and in return, the bank requests interest to be paid on the money owed. Startups utilize their equity and value as a bargaining chip to gain funding from investors. The utilization of equity rather than debt allows startups more control over their funding process.
Seed funding is the very first round of funding that a startup conducts. Typically a seed round of funding is needed to get key components of the startup up and running. This can include the purchase of machinery needed for production, hirings, and more.
Getting funding in the seed stage is a key component to giving a startup the traction it needs to propel itself out of pre-seed startup purgatory and into series A and beyond.
Seed funding distinguishes itself from other funding rounds because it is the most lucrative funding stage for investors. Investors are able to get the most equity per amount invested during the seed round of funding.
The main drawback to investors with seed funding is the amount of risk that is taken on by investing so early. There are no guarantees for investors and by investing in early startups they do not increase these odds. Many venture firms feel that funding during the seed stage is too risky.
Exceptions like M13 exist that see the early establishment of a relationship as a way to mentor and help a startup create sustainable growth. This is the more advantageous approach by far because early startups can often benefit greatly from non-monetary assistance.
How to Get Seed Funding
Getting seed funding is a difficult task to undertake for a startup, but a basic understanding of what investors are looking for can make the journey to full funding much easier.
The basic principle of gaining investor funding is to minimize the perception of risk to an investor as well as adequately describing the future potential and revenue of a product. These two combined convey a message of confidence and make it much easier for an investor to decide if your startup is worth the risk.
To minimize perceived risk and get investor interest, a startup can work on a multitude of different areas to better their chances. These can include solidifying product-market fit, creating a diverse and talented founding team, creating a concise pitch deck, and outlining all of the investors’ expectations and how you plan to meet them.
Seed funding can be achieved through a variety of different avenues and investors.
A common investor at this stage is the angel investor. Angel investors are individuals with accumulated wealth that then utilize it to make seed investments in startups.
Another group that can get a seed startup funded is venture capital. Venture capitals can provide seed round funding and are a great method for startups to get funded early on. The reason venture capitalists are a great choice is that they often have more to offer than just capital for a startup within their portfolio.
What Do Tech Startups Use Seed Funding For?
Knowing how to get seed funding is an important skill for startups but an equally important skill is understanding how to utilize the money invested to begin creating a business.
Getting funding is only a part of the battle as a startup needs to prove that they are capable of managing money in a way that delivers results. Having a good reputation with funding management will help in funding rounds later down the road.
For a seed round of funding, the capital typically will go toward the following:
- Market Research
- Product Research and Development
- Proof of Concept
- Internal Infrastructure
Research and development as well as market research are vital for an early-stage startup. With not a lot of commitment down one particular path, an early startup could easily pivot their idea to gain them a larger audience or more desirability based on the results of their research. Seed funding can allow a startup to have a full review of the product or service being delivered to ensure that there is a market demand when the product launches.
Internal infrastructure and hirings are needed early on to establish a good startup culture and a team that delivers results. Founders of startups tend to be experts within their given field of expertise but are unable to do all the tasks required to run a startup.
Seed funding allows a founder to seek out help through selecting talent and allows a startup to get out to market faster and more effectively.
What Are The Advantages to a Seed Funding Round?
Seed funding carries advantages for both founders and investors. The majority of the benefits arise from an early establishment of a relationship between founders and investors. Even though seed level startups are riskier than series A, there are many attributes that make seed funding a good choice for investors.
The main advantages for startups are that a startup can prove funding money management, get to market faster, and receive non-monetary value from its investors.
Series A funding is typically the point in which a startup receives the most influential funding round. To secure series A funding, a startup needs to have many ways to prove to investors that their startup is capable. Having a seed round of funding greatly increases the likelihood of getting series A funding because it illustrates the capacity of a startup to properly manage funds in a way that delivers results.
In the world of tech startups, the race is on to not only to create a high-quality product but to also become the first to the market.
Being the first to market can have large advantages as untapped markets are able to propel a startup to much greater heights. Seed stage funding gives a startup the momentum it needs to quickly and effectively get to market. Getting funding early allows the founding team to worry less about securing funding and allows for more time to strategize and develop.
The last advantage of seed funding for a startup is the ability to partner with investors that have the best interest of the startup in mind. Investment firms like M13 are able to give startups an edge above the competition by giving them access to entrepreneurial resources. This can include the VC’s network of investors for later funding rounds, access to market insights, and much more.
Gaining a seed investor can greatly improve the success of a startup because ventures like M13 give guidance and resources on top of funding alone.
What Are the Funding Stages?
To have a true understanding of the seed funding stage, it is important to understand it in context to other funding stages. Seed funding is only the beginning for many startups as funding stages are continuously needed throughout the startup lifecycle.
The funding stages are as follows:
- Series A
- Series B
- Series C
The seed stage is the very first round of funding for many startups.
The seed stage is followed up by the series A funding stage. This stage is typically funded through venture capitalists. Series A funding is typically utilized to take the low yield production up a notch to reach more users and customers. Series A is about scaling up operations from the initial seed stage.
Series B funding is typically utilized to ramp up production and customer reach. The transition after series B funding is similar to the transition of a small business to a larger business. Startups seeking series B funding tend to be well established and have valuations between $30 and $60 million.
Series C funding is one of the last rounds of funding that a startup undertakes. This round is usually utilized to get a startup ready for going public or getting acquired. The initial public offering (IPO) is a big deal for a startup going public. In the best interest of all the shareholders, a startup wants to ensure they get the best IPO possible.
Why Invest During Seed Stage Funding?
The advantage for investors is that an investor will get more equity per dollar spent and that an investor can become an active participant in the startup's growth.
During seed-stage funding, many startups typically have not had a valuation performed on the startup. Seed round funding is typically when the valuation of the startup begins and as such the valuation is the lowest of any other funding round. The saying “the early bird gets the worm” applies directly to the world of startup investors as the earlier an investor is able to provide funding, the higher the return will be if the startup succeeds.
The other advantage for investors is that they are able to assist an early startup to become successful. Venture firms like M13 take the time and effort to give founders the tools and resources they need to succeed. Assistance with creating a solid startup culture, promoting diverse culture, and assisting with business decisions are all things a committed venture firm can offer founders. This is an advantageous quality for investors because it is a way they can ensure these startups have a better chance of succeeding, and increasing the chances of success increases the likelihood of getting a return.
Seed funding is amongst the earliest stages for funding and investors can have dramatic influences on a developing startup.
In summary, seed funding for tech startups is more than just another funding round. It is the very first funding round that can have large future implications for the success of a startup.
Gaining helpful investor assistance, building investor relations and confidence, and being able to get the ball rolling as soon as possible are all outcomes that come from the successful seed round of investments.
Startups that are able to raise seed funding need to deliver results to ensure they are able to gain future rounds of funding. Gaining seed funding is the first mile in the marathon of creating a successful startup.
Starting off on the right foot with seed funding can allow a startup to outrun the competition and become a valued business.