Seed Funding: What It Is and How It Works
May 8, 2023
‘Seed funding’ is the funding for a startup that happens when it is at the seedling stage i.e., inception, ideation, or the beginning stage. Seed funding is the first stage of investment for a business – where the business could consist of only a product idea and is still in the market validation process. Pre-seed or 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.
Seed funding is typically provided by angel investors, venture capitalists, or other private investors. Most companies raising pre-seed and seed funding are valued at somewhere between $1 million and $6 million. The amount of funding can vary widely, but it is usually in the range of ₹1lakh to ₹1crore. Seed funding is usually used to cover the startup costs of the business, such as developing a product prototype, conducting market research, and hiring staff.
As the funding comes at the inception or MVP stage, the risk and return compensate each other, by getting equity stake at a lower valuation but with higher existence and scalability risk involved.
Sources of Seed Funding
There are different types of investors who provide seed funding:
Crowdfunding: Crowdfunding is the practice of raising a small amount of funds from a large pool of individuals to finance a new business venture,
typically via the Internet. Crowdfunding is considered illegal in India, however few of the popular online crowdfunding platforms such as typically via the Internet. Crowdfunding is considered illegal in India, however few of the popular online crowdfunding platforms such as SeedInvest Technology, and GoFundMe platforms.
b. Incubators: Incubators can help early-stage companies grow, and generally invest small amounts of money at the ideation stage of the company. The purpose of investment majorly includes workspace assistance, networking opportunities, and mentorship programs. Demo days or pitch events are also common.
c. Accelerators: Accelerators focus on assisting startup growth. In return for a set % of shares, they give startups a set amount of funding. Many provide indirect funding through mentorship opportunities or hosting networking events, demo days, or pitch events. Some accelerators also provide workspace assistance, such as access to technology and services that can help companies develop faster.
d. Angel Investors: Angel investors are usually an accredited set of high net-worth individuals who invest seed capital for startups in the form of shares or convertible notes which allows money to be converted into shares. The angel investor benefits from an "early investor" discount. Angel investors are typically investors who provide seed funding but also provide advice and guidance to help the business grow.
e. Angel Platforms: The specialized platforms allow the investors to invest much larger amounts of money, to get larger ownership stakes, and to earn greater potential gains. Angel groups are often made up of investors from many different sectors and markets who will decide as a group whether or not to invest, how much they should invest, and under what terms.
f. Corporate seed funding: Bigger companies may look to invest in your business as a way of generating new ideas, and sources of talent and to move into new markets.
g. Personal Savings: Often known as “Bootstrapping” - many founders use their personal savings to fund the early stages of their startup. The benefits are that personal savings may not need to be repaid or come with equity obligations - however, it may create financial issues for the founders.
Crowdfunding: Crowdfunding is the practice of raising a small amount of funds from a large pool of individuals to finance a new business venture, typically via the Internet. Crowdfunding is considered illegal in India, however few of the popular online crowdfunding platforms such as typically via the Internet. Crowdfunding is considered illegal in India, however few of the popular online crowdfunding platforms such as SeedInvest Technology, and GoFundMe platforms.
b. Incubators: Incubators can help early-stage companies grow, and generally invest small amounts of money at the ideation stage of the company. The purpose of investment majorly includes workspace assistance, networking opportunities, and mentorship programs. Demo days or pitch events are also common.
c. Accelerators: Accelerators focus on assisting startup growth. In return for a set % of shares, they give startups a set amount of funding. Many provide indirect funding through mentorship opportunities or hosting networking events, demo days, or pitch events. Some accelerators also provide workspace assistance, such as access to technology and services that can help companies develop faster.
d. Angel Investors: Angel investors are usually an accredited set of high net-worth individuals who invest seed capital for startups in the form of shares or convertible notes which allows money to be converted into shares. The angel investor benefits from an "early investor" discount. Angel investors are typically investors who provide seed funding but also provide advice and guidance to help the business grow.
e. Angel Platforms: The specialized platforms allow the investors to invest much larger amounts of money, to get larger ownership stakes, and to earn greater potential gains. Angel groups are often made up of investors from many different sectors and markets who will decide as a group whether or not to invest, how much they should invest, and under what terms.
f. Corporate seed funding: Bigger companies may look to invest in your business as a way of generating new ideas, and sources of talent and to move into new markets.
g. Personal Savings: Often known as “Bootstrapping” - many founders use their personal savings to fund the early stages of their startup. The benefits are that personal savings may not need to be repaid or come with equity obligations - however, it may create financial issues for the founders.
How Are Startups Valued During The Seed Round?
Startup valuation during a seed funding round is hard. This is why most investors find alternate ways like convertible notes, SAFE, and KISS to invest first and find the valuation afterward. However, some startup investors do find methods to value a startup at the seed stage. These methods include:
Berkus method: In this method, various qualitative elements like a sound idea, prototype, etc., are given weightage to decide on the final valuation of a startup.
Relative Valuation: Funding out the similar peers that have recently raised funds and understanding the valuation multiple and using the average multiple to compute the value.
Scorecard method: The scorecard Method is to determine the median pre-money valuation of pre-revenue/early-stage companies in the similar region and business sector of the target company and then to assign the weights to different factors that you can compare to other companies from your industry and region.
Berkus method: In this method, various qualitative elements like a sound idea, prototype, etc., are given weightage to decide on the final valuation of a startup.
Relative Valuation: Funding out the similar peers that have recently raised funds and understanding the valuation multiple and using the average multiple to compute the value.
Scorecard method: The scorecard Method is to determine the median pre-money valuation of pre-revenue/early-stage companies in the similar region and business sector of the target company and then to assign the weights to different factors that you can compare to other companies from your industry and region.
Seed Funding Trends
Despite the funding slowdown, 2021 emerged as the year with the highest seed money between 2015 and 2022.
Early-stage businesses in India have remained appealing to both domestic and international investors thanks to their capital efficiency.
Between 2014 and 2022, Enterprise tech startups at the seed stage secured 860 deals – the highest among all the sectors. Fintech, Healthcare, and Technology are mostly funded sectors in India.
The funding spike of 2020-21 was majorly led by the increased adoption of digitization in an economy that was largely impacted by multiple pandemic-induced lockdowns and a low dollar interest rate regime.
There were 828 seed rounds closed averaging $941,000, while there were 242 Series A fundraises with an average size of $4.7 million.
Funding winter
Funding winter has impacted the overall start-up ecosystem. As per the recent Pwc report, fundraising has witnessed a downfall both in terms of volume and value. The entrepreneurs faced tough questions on valuations, business models, cash burn, etc. The industry has faced multiple down rounds and layoffs in the last 9 months.
However, it is worth noting that the early-stage companies were insulated to an extent. In the recent PwC report, the share of early-stage funding in Q3 2022 accounted for 70% of total funding vis-a-vis 60% share in Q2 CY22 (in volume terms), where the average ticket size per deal ranged from USD 4–5 million per deal. In value terms, early-stage deals contributed around 21% of the total funding in Q3 CY22 compared to around 12% in Q2 CY22.
The above numbers refer to the assumptions that early-stage funding is barred with the recent funding winter. Due to the simple fact that, the early-stage companies are because such startups are typically more agile, and leaner and offer a more attractive upside after the market recovers.
Source: PWC Report
How Seed Funding Works
The process of seed funding typically involves the following steps:
Pitching the Idea: The startup company presents its idea to potential investors in order to convince them to provide seed funding. This pitch usually includes a presentation and business plan that outlines the company's product or service, target market, competition, revenue model, and growth potential.
Negotiating the Terms: Once an investor is interested in providing seed funding, negotiations begin to determine the amount of funding, the equity stake the investor will receive in the company, and any other terms and conditions that may be included in the investment agreement.
Receiving the Funding: Once the terms are agreed upon, the investor provides the seed funding to the startup company. This funding is typically provided in exchange for equity in the company, meaning that the investor becomes a partial owner of the company.
Using the Funding: The startup company uses the seed funding to develop its product or service, conduct market research, and hire staff. The goal is to use the funding to reach key milestones that will help the company grow and attract additional funding in the future.
Attracting Additional Funding: As the company grows and achieves key milestones, it may seek additional funding in later rounds of investment. These rounds may involve larger investments from venture capitalists or other investors.
Conclusion
When starting a new business, one of the most important things you need to think about is funding. There are many ways to obtain the money you need to get your business off the ground, but one of the most common is seed capital.
Seed capital is a good way for entrepreneurs and investors to network and build relationships, but seed money should be repaid as quickly as possible. Make sure to weigh the pros and cons carefully before making a decision.
Overall, seed funding is an important type of investment that can help startups get off the ground and achieve their goals. Its unique features, such as its focus on potential rather than financial metrics, make it an attractive option for both investors and entrepreneurs. As the startup ecosystem continues to grow and evolve, we can expect to see more and more companies turning to seed funding as a way to fuel their growth and achieve success.