It’s a long-standing tradition for business owners to frame their first dollar earned; but for most businesses to take off, they’ll need access to money far earlier on. Some startup founders may be able to get by using their own funds, but most will require outside funding at the beginning of their development to create the infrastructure needed to support a scalable, thriving business. Finding that early-stage funding can be challenging, so securing a startup’s first official investment is a milestone worthy of its own (metaphorical) frame.
Early-stage seed funding is an umbrella term used to describe the earliest investments a startup seeks, including both pre-seed and seed funding. Your early-stage funding happens before the first VC funding round and is used to become self-sufficient, help reach your next funding goal, and start generating profits (and that framable first dollar). Before you start looking for it, here’s what you need to know:
What to Know Before You Raise Funds
Time is Money
In the startup world, time is money, so don’t delay too much in finding funding. It may cost you precious time and dollars that you need. The second-biggest reason startups fail is due to running out of money; so don’t wait until you reach that point to look for financing elsewhere.
Not All Money is Equal
While it’s important not to dawdle when securing startup funding, making a deal with the first interested investor just for the sake of speed isn’t the way to go. Not all money is equal, so don’t jump at the first investor you speak to. Make sure the money you’re taking on won’t cost you your sanity or values and don’t overly dilute your company from the start. Taking enough time to find the right fit is worth it.
Be Prepared With All Your Data and a Great Pitch
When it’s time to pitch to potential investors, be ready to go with all the information they’ll need to know about your company. Chart out your projections for the business so it’s easy to understand, and develop an engaging pitch deck that’s comprehensive yet concise. If you’re meeting with more than one investor, be prepared to repeat yourself and answer any frequently asked questions.
Play the Long Game
Remember, it’s not about obtaining money quickly. It’s about finding a source that will support you financially and turn into a long-term relationship. Aside from the funding, part of that long-term relationship may also include mentorship and access to their network – especially if you’re looking for angel investor funding. Think about what qualities, skills, and experience you’d want in a long-term partner and look for those qualities when seeking funding.
Types of Early-Stage Seed Funding
The two most common types of early-stage seed funding are pre-seed and seed funding.
The pre-seed funding stage may include or follow a friends and family funding round. From there, you can open up the round to your personal connections who may know local angel investors or incubators with experience funding startups. Pre-seed funding is used to develop a prototype and make it to the next round, seed funding.
Seed funding is often the first round involving accredited investors. Just as its name suggests, this funding becomes the “seed” planted to grow a successful company, with the money going toward hiring a team, performing market research, perfecting the prototype, and basic operational costs. Seed funding typically comes from angel investors.
Convertible Debt vs. SAFE vs. Equity
One thing to know about pre-seed and seed funding is that it may be structured as simple agreements for future equity (SAFEs), convertible debt, or equity. While equity used to be the standard, more and more startups (especially those in Silicon Valley) are turning more toward SAFEs and convertible financing.
Convertible debt is a loan from an investor that utilizes a convertible note, which consists of a principal (amount invested), interest rate (usually around 2%), and a maturity date (when principal and interest will need to be repaid). The idea is that it eventually converts into equity when the company begins equity financing. Some investors may delay their note’s maturity date, founders should always be prepared to pay it back in full with earned interest by the initial maturity date.
SAFEs are popular at startup accelerators like YCombinator because they serve as a convertible debt without the requirement for repayment, interest rate, or maturity date. SAFE terms are also usually simple, including a valuation cap (ceiling imposed on the price a SAFE will convert to equity in the future), the amount invested, and the discount (if any).
Equity involves setting a valuation for your startup at a per-share price and then selling these shares to investors. Calculating accurate valuations so early in a startup’s development can be tricky, which is why many have turned to SAFEs and convertible debt instead. Equity is also more complicated and time-consuming, but depending on your unique circumstances and investor, sometimes it’s the right fit.
When Should You Raise Early-Stage Funding?
Before starting the fundraising process, check in with yourself to determine if it’s the right moment.
- Are you working on an MVP, but need additional funding to complete it?
- Do you believe your product is a good fit for a particular market?
- Do you need more employee support to further develop your idea and turn it into a reality?
- Do you have some proof of traction or customer interest?
- Do you know exactly what kind of customer you’re targeting?
- Does your project match your user’s needs?
If you answered “yes” to all or most of these questions, that’s a good sign you’re ready to start raising early-stage funding.
How Much Money Should You Ask For in Your Early-Stage Seed Round?
How much money you ask for in early-stage seed funding is dependent upon what you need and what you’re valuation is. Remember not to give up more than 10-20% ownership of your company from this early stage or you may end up over-diluted. Again, that percentage of dilution will depend on your post-money valuation.
If your pre-money valuation is $800k and an investor is providing $200k, the post-money valuation of your business would not be $1 million. Since the $200k they invested makes up 20% of the $1$ million post-money valuation, they would then own 20% of your company.
While asking for as much money as possible might be tempting, it’s not usually the route you want to take so early on.
What Are Investors Looking For in an Early-Stage Startup?
While you won’t have too much to show investors this early, there are a few things we’ll be looking out for in companies they’re considering.
- Team – Do you have a strong leadership team? What skills does your team have to show? Do they have experience with other startups? Does everyone believe in the mission and the product?
- Market – Is your startup geared toward a new market that’s about to get big, or a huge market that’s ready to be transformed? These situations tend to be the best to introduce a new, innovative product or service.
- Innovation – What’s your differentiator? What makes you better than every other competitor in the space? How does that translate into a value proposition for the buyer?
- Traction – What do you have to show at this point? Have you created a minimum viable product (MVP) or are you making progress on it? Have you enrolled any pilot customers? Have you beta tested a product? What proof do you have that there’s a strong product-market fit and current demand for what you’re creating?
What Does a Typical Early-Stage Investment Proposal Look Like?
When it’s time to present your startup to potential investors, you want to impress. When I hear pitches or review investment proposals, there are a few things I’m looking for in particular. Be sure to include the following in your investment proposal:
- What current need in the market are you filling?
- How are you solving the problem?
- What’s your business model?
- What’s your founding story?
- What’s your target market and your estimated market size?
- Why now, and why you?
- What’s your differentiator?
- What’s your fundraising plan?
- What traction do you have?
- What are your next milestones?
- What do your financial projections look like?
- How much funding do you need?
How Do Seed Investments Differ From Venture Capital Investments?
Seed investments are the smaller investments you need for your early development stages that usually come from angel investors, while VC investments are the larger investments you need to scale your fully-formed business that come from pooled investor funds.
Start the Process of Raising Funds Today and Avoid the Common Mistakes That Kill Startup Fundraising Efforts
When getting started raising early-stage seed funds, move quickly, but carefully and always with intention. Remember that money is important, but it’s not everything. What matters most is finding the right investor, not the first investor. Getting the funds you need early on will increase your chances of success, and finding the right angel investor can help you get there.
If you need early-stage funding from investors who aren’t afraid to take risks on promising ventures, get in touch with Steve MacDonald of MacDonald Ventures.