This article will dive deeper into these hallmark steps of securing seed funding to build and iterate your startup.
We’ll cover what seed funding is, how to determine how much to raise and how long it should last, what material is needed to raise it, and what types of investors are a fit for your early-stage startup.
What is Seed Funding?
Think of your startup as a seed that has the potential to grow into a vibrant tree. Pre-seed funding would be planting the seed. Seed funding would be watering the seed so it grows.
Seed funding is the vehicle for your startup to continue the progress made in your pre-seed stage by iterating on your idea or minimally viable product/service using funds from accredited investors like venture capital funds, angel investors, and or crowdsourcing campaigns. It’s typically the second round of investment a startup gets in its life cycle being pre-seed the first.
Seed funds are generally used for:
Developing a sales-ready version of your product or service by hiring talented engineers and designers.
Acquiring customers by spending on marketing and getting validation on your key product/service assumptions (product-market-fit).
After closing a seed funding round, you’ll receive checks or have funds wired into your company bank account in exchange for preferred equity, convertible debt, or a simple agreement for future equity (SAFE).
Why Should You Raise Seed Capital?
After having met the milestones from your pre-seed round, it should be more apparent that the product or service you’re developing has the potential to satisfy the customer needs of your target market.
However, it’s likely that what you’ve developed so far doesn’t meet the exact specifications of a sales-ready product or service. If that's the case, you’ll need more cash to cover costs like product development, core team employee salaries, customer acquisition, and infrastructure expenses. That’s where seed capital comes in.
When to Raise Seed Capital?
You should start raising seed capital 4-6 months before you’ve finished deploying the funds from your pre-seed round. This timing should give you and your team enough time to pitch to your existing and new investors and show them that your startup's traction and trajectory are worthy of the next round of capital.
When you decide to start raising a seed round, it shouldn’t surprise your existing or potential investors. As a founder, it’s your responsibility to consistently communicate with your investors in the form of monthly updates and to form relationships with new investors before you need to raise.
Timing is critical to ensure your checking account doesn’t hit zero. You have an obligation to your employees and their families - they rely on your startup's payroll checks for their livelihood.
How Is Seed Funding Different From Pre-Seed Funding?
Seed funding comes after pre-seed funding. Until pre-seed funding came on the scene in 2014, seed funding was the earliest funding round a startup went through, hence adding the Latin-derived prefix of “pre’ to seed.
Traditionally, the differences between the two were clear-cut, but they’re getting blurrier these days. There are three things you can look for to find if a round is a pre-seed or seed one:
The total amount of money raised.
The valuation of the startup after investment.
The traction of the startup at the moment of raising.
Seed startups usually raise anywhere between $1M-$5M at post-money valuations of $5M to $15M, have products or services anywhere from 50-75% of the way towards product-market-fit, and might even have significant traction with customers.
In contrast, pre-seed startups usually raise $50K-$1M at post-money valuations lower than $10M, have products or services that are anywhere from 0-50% of the way towards product-market-fit, and don’t have much traction with customers (might only be in conversations with potential users or beta testers).
How Is Seed Funding Different From Series A Funding?
Seed funding comes before Series A funding. Series A is the first of the sequential lettered fundraising rounds Series A, B, C, etc.
Compared to the blurry differences between seed and pre-seed, the differences between seed and Series A are more clear-cut.
Series A startups raise anywhere from $2-$20M with lots of variations in valuation. They generally have established proof of product-market-fit by delivering revenue at a consistent growing cadence and have validated various customer acquisition channels.
How Does Seed Funding Work?
The business law mechanisms of seed funding for startups and investors are complicated. Venture deals can be more of an art than a science since they continue to evolve even today.
As a pre-face, as a startup founder, you should get the help of a general counsel with venture financing experience. We urge that you go with a highly recommended lawyer from founders who have successfully raised before.
At a high level, after you’ve pitched an investor your startup’s vision and have gone through their due diligence process, you’ll receive a formal letter expressing their interest in investing and their terms. As it’s called, this term sheet has many nuances across the different types of financing, but we’ll cover the high-level general themes.
Below, we’ll analyze three types of financing: Equity Financing, the typical one; Debt Financing, a common alternative; and SAFEs, a newest kind.
When startups are incorporated, founders must specify the number of common stock or equity they’d like to create. From here, you can assign yourself and other founders ownership of the company by rationing out pieces of the total common stock pie.
During equity financing, investors choose to buy equity in your company in exchange for their investment. However, investors want their particular class of stocks, called preferred stocks, which have different ownership rights than founders’ common stocks. If and when your startup has a successful exit, investors will convert their preferred stocks into common stocks identical to yours and your employees. So there’s no point in getting too lost in the details as we’d like to assume you’re going to succeed in your ambitions to exit your startup.
When discussing equity financing, you’ll often hear the question, “what is your startup’s valuation?”. The valuation is important because it dictates how much of your company you are selling and the price your potential investor will pay for a piece of your company.
There are two ways to talk about valuations: pre-money and post-money. The pre-money valuation is what the investor values your company before the investment. The post-money valuation is simply the pre-money valuation plus the potential investment amount.
If you raise $1M at a $4M pre-money valuation, your post-money valuation is $5M. Since the investor invested $1M and the company is now worth $5M post-financing, the investor bought 20% of your company.
These economic terms are the basics of equity financing. If you want to dive deeper, we highly recommend the book Venture Deals by Brad Feld.
Convertible debt is another form of venture financing that allows investors to get ownership of your company for their investment.
A convertible debt is basically a loan with a distinctive characteristic: when your company raises a future Series A round of equity financing, the money loaned to your company via the convertible debt Seed round converts into stock (likely preferred) under the terms listed in the term-sheet.
In exchange for providing you with convertible debt, the lender gets a modest interest rate (5%-12%) or a discount (10%-30%) in the next round's price. The discount on the price per share is appropriate since your early investors have to be rewarded for investing before the full Series A financing round happened.
Let’s dive into a quick example. Assume you raise $1M in convertible debt from angels, with a 20% discount on the next round. Six months later, a VC offers you to lead a Series A round of a $2M investment at $1 a share. Your financing will be for $3M, although the VCs will get 2M shares ($2M at $1 per share), and the angels will get 800K Series A shares ($1M at $0.80 per share).
In some cases, convertible debt includes a “valuation cap”. Without this, convertible debt investors are price takers, meaning they are at the mercy of the valuation and, consequently, the price per share negotiated by future Series A investors during the equity financing. As you can imagine, this lack of control is unacceptable for some investors, so they determine a valuation cap that sets a ceiling at the point at which the conversion price caps.
Convertible debt financings were a lot more common pre-2013, the year Y Combinator, the first accelerator in Silicon Valley, released its Sample Agreement for Future Equity (SAFEs). Convertible debt was mainly used because the term sheets were more straightforward for lawyers to draft up and therefore cheaper than equity financing term sheets. As we’ll cover in the next section, SAFEs are now the defacto most inexpensive and dominant design of raising seed rounds.
Simple Agreements for Future Equity (SAFEs)
SAFEs started out when Y Combinator set out to take the best parts of convertible debt (short length and low legal costs) and make them better.
SAFEs are essentially convertible debt without the debt, meaning an investor has a contract that gives them the right of future preferred shares in a startup whenever the startup does its first full equity financing. However, with SAFEs, startups aren’t on the hook for the interest payments on the debt when things don’t go according to plan.
The SAFE contracts couldn’t be friendlier or more efficient for both investors and founders. You can ratify the two-page document in a day, enabling the investor to wire the money into your bank account as soon as possible so you can get back to the building.
The two need-to-know terms in SAFE negotiations are post-money valuation caps and discount rates:
Post-money valuation cap states the maximum post-money price per share that investors can convert at your startup’s future first equity round.
Discount rate is a flat percentage discount off the price per share set by your future equity round investors that your previous seed investors get.
We’ve covered the different mechanisms for raising a seed round. You should feel confident and have the legal resources needed to succeed when you’re in the same room or Zoom with investors ready to give you a term sheet.
How much money to raise depends entirely on your startup's needs, industry focus, and the funding market. However, the general rule of thumb for seed is to raise enough money to find product-market-fit because if you’re in a large market, product-market-fit usually comes with significant revenues and the ability to be profitable (earn less than you spend).
If you succeed in becoming profitable, not only will you find it easier to raise an A round in the future, but you’ll also be able to survive without new funding if the funding environment dries up, which happens from time to time.
With that being said, certain kinds of startups will need various follow-on rounds of funding before reaching profitably. Startups building deep-tech physical things like electric vehicles, new drugs, autonomous drones, or new semiconductors, can often require hundreds of millions of dollars before obtaining product-market fit and becoming profitable.
Your goal in these cases should be to raise as much money as needed to hit whichever milestones investors agree will suffice for you to unlock your next check, which will usually be 12 to 18 months after your seed round.
At Failory, we studied 8,769 seed rounds and discovered that the average amount raised in a seed round by US startups is $3,034,212, while it’s $2,978,363 for startups in the rest of the world.
Largest Seed Funding
Like many things in life, the outliers can be entertaining to learn about. At the time of writing, the award for the largest seed funding round goes to Fraction, the Canada-based property FinTech startup that helps consumers refinance their mortgages and get 40% of their home's equity value back in cash.
Fraction raised a mind-blowing CAD 219M seed round in Feb 2021; a significant portion of the round was venture debt from banks. Still, there was also an undisclosed equity financing component from traditional early-stage investors.
Realistically, very few startups are building in spaces where your business model involves handing your customers hundreds of thousands of dollars in cash. So don’t expect to raise amounts anywhere near that for your seed round, especially if you’re a first-time founder building a software business that doesn’t have high cash-flow barriers to entry.
How Much Dilution Is Given In Seed Rounds?
At a high level, dilution is when a shareholder’s ownership becomes smaller proportionally because new shares are offered to new investors.
There are a lot of nuances that go into how much dilution founders give away in seed rounds. Let's just start off with the edge cases that might become red flags to employees or future investors looking at joining your company at some point in its journey.
If you give away 30% or more in your seed round alone, it might be the case that as you continue to give more equity to employees and later-stage investors, you’ll be left with such a small amount of the company that it becomes unmotivating and affects your performance.
In the other extreme, suppose you dilute yourself 10% or less during your seed round. In that case, it might be perceived 1) your growth or product plans aren’t ambitious enough for this to become a unicorn, or 2) your investor's ownership might be so low that they won’t put in as much effort supporting you compared to other portfolio companies where they have more significant ownership positions.
The sweet spot is anywhere between 10-30% dilution. If you can manage to give up as little as 10% of your company in your seed round, that is great, but most seed rounds will require around 20% dilution.
In any case, the amount you are asking for must be tied to a believable plan of product and growth milestones. This plan will buy you the credibility necessary to persuade investors that their money will grow substantially and that you have a plan to do it. It is usually good to create multiple scenarios assuming different amounts are raised. It shows that you’re thinking deeply about deploying your investor's capital.
A bulletproof method is to assemble a data sheet with the seed-stage valuations of your most similar competitors or adjacent space companies and use their previous seed-stage traction as data points for why you should get an equal or better valuation from your investors.
Later on, we’ll cover what other documents you should have to explain how much you are raising, at what valuation terms (dilution), and to achieve what with the capital.
6 Sources of Seed Funding
1) Venture Capitalists
Venture capital funds will likely be your go-to source if you’re looking to raise amounts comparable to the average seed round (~$3M).. Venture capital (VC) funds are investment vehicles that manage the money of Limited Partners (LPs) like high-net worth-family offices, University endowments, and employer pension funds by deploying them into startups with high-growth opportunities. At the seed stage, VCs usually write checks anywhere in the range of $500K-$2.5M.
When you have more than one VC fund participating in your seed round, it’s called a syndicate or party round. At the seed stages, it’s in your interest as a founder to have more value-add investors participating in your round because that’s more VCs providing counsel, introducing you to potential customers, persuading top engineering talent to join, etc.
A hypothetical $3M party round seed-stage scenario to hammer in the concept:
VC Firm 1 writes a $1.5M check (50%) - lead investor.
VC firm 2 writes a $750k check (25%).
VC firm 3 writes a $750k check (25%).
Since they invest other people's capital, VCs usually have more established due-diligence processes that will require weeks of back and forth to get a conviction on investing in you. This is why it’s often recommended that you start forming relationships with VCs before you start formally fundraising.
The best path for determining if a seed stage venture capital firm fits you is by visiting their website. Their website should include a portfolio page that can help you paint a picture on what sectors the firm likes to invest in. Also, by cross-checking with funding announcements, you can determine the firm's check size range and if they lead rounds or follow other firms that lead.
2) Angel Investors
The most founder-friendly investors in your seed round will likely be Angel investors. Angels are high-net-worth individuals using their bank accounts to write checks to startups they believe in.
Angel investors invest anywhere from $1K to $1M, but the average check size is in the range of $25K to $100K. If you’re raising a traditional seed of $3M, angel investors will likely make up a minor part of your total round.
Since Angels aren’t deploying others' money, they are often the sole decision-makers; this allows them to decide whether they want to invest in you quicker than institutional funds like VCs.
Angels usually made their money as successful operators or exited founders, so having them on board as value-add investors can be dynamite for your growth, especially if the angel investor has direct operating experience in your space.
3) Angel Funds / Angel Syndicates
Founders usually establish relationships with angel investors before VCs. However, when it came time for founders to raise seeds, angels were losing the potential to maximize their ownership that came from this early exposure because they couldn’t write larger checks.
That’s why angels came together to create a new vehicle, called angel funds or syndicates, to multiply the amount of dry powder they could deploy into promising startups.
At their core, angel funds are very similar to VC funds, except the fund's LPs are other angels with startup investing experience. Therefore, the angel investors collectively share the burden of sourcing new startups and performing due diligence on potential investments. This allows angel funds to compete with VC funds in their check-writing abilities of $500K-$1.5M.
However, with more money comes a more complicated decision process. So don’t be surprised if an angel investor invests in your startup personally as other angels in the syndicate pass, or the fund cannot agree collectively to invest in you.
4) Friends and Family
At the seed stage, it’s uncommon for friends and family to be involved as a potential funding source.
When you’re talking to VCs about receiving a $1M investment into your round, they’ll have to make sure their potential investment meets all federal security regulations, including not having even a single unaccredited investor in the round.
Since most founders don’t come from a place of privilege where their friends and family are accredited under US laws, they won’t be able to invest. In the US, to be considered accredited by securities law, you must provide documentation that proves that:
Your annual income has been at least $200K ($300K with a spouse) for the last two years.
Your net worth is over $1M, individually or with your spouse, not including your primary residence.
Some modern laws have created loopholes for unaccredited investors to invest in startups through equity crowdfunding which we’ll cover in the next section. That’s usually how you’ll see friends and family getting involved with seed rounds.
The All-In-One Newsletter for Startup Founders
Every week, I’ll send you Failory’s latest interviews and articles and 3 curated resources for founders. Join +20,000 other startup founders!
5) Equity Crowdfunding
While equity crowdfunding is less common in the seed round than in earlier rounds, it might provide a viable source of investors for your seed round.
Equity crowdfunding platforms use a loophole in the 2012 JOBS act to allow early-stage startups to raise up to $5M in capital per year from the crowd, including non-accredited investors. Thanks to Regulation CF, you can raise as little as $50 checks from thousands of people through platforms like Republic, Start Engine, and WeFunder.
Investors that invest in you through crowdfunding platforms will be very passive. Meaning they won’t be providing value-add services alongside their money like angels or VCs do.
This might sound ideal if you’re a seasoned startup veteran with multiple exits under your belt and an extensive network. But, if you’re a first-time founder, there is something to be said about taking money from people who have been in the arena with other startups in the past.
Accelerators and incubators are the closest things the startup world has to a University for startup founders. They teach you the first principles of ideating and building startup companies. There are thousands of accelerators worldwide (here’s our list of 2,500+).
Different accelerators write checks ranging from $25K-$500K at different terms, but they generally take between 5%-10% equity of your company in exchange for their services. That it’s relatively expensive capital dilution-wise for a pretty small check that might not be enough to satisfy your entire seed round needs.
You usually see founders going through accelerators in the earlier pre-seed stages. An important caveat is that some accelerators like Y Combinator and SOSV have their own separate continuity funds that invest in the seed rounds of startups that graduated from their accelerators.
It’s usually perceived as a strong signal by other institutional investors when these accelerator continuity funds decide to invest in a startup they are evaluating.
Wrapping up, you should now have a pretty good understanding of all six types of investor sources for your seed round. The stereotypical seed round has a couple (2-3) VC funds with one clearly leading and then value-add angel investors to fill out the rest of the round.
According to Docsend, on average, it takes founders 39 different investor meetings to close a seed round.
How long it takes to pitch that many investors will depend on how good you are at getting introductions to investors through your network and how hot your startup is compared to other opportunities in your target investors’ pipelines.
According to Docsend, 37% of successful founders close a Seed round in 1-6 weeks, 32% take between 7-18 weeks, and the rest take 19 weeks or more.
Your priority as a founder should be to find the most valuable investors for your particular startup at a healthy pace that doesn’t lead to burnout. If it’s taking too long, it’s probably a signal that you should pause requesting meetings and go back to reevaluating your pitching strategy.
If you are constantly developing relationships with investors throughout the year before beginning to fundraise, you might be able to preempt the diligence and close quickly when you do decide to start raising funds.
How Long Should Seed Funding Last?
How long seed funding should last depends on many factors that vary across industries. The general piece of advice is that it should last you as long as you and your team need to either:
1) Find product-market-fit where you can be profitable and not have to raise money again.
2) Hit the product and go-to-market milestones that future Series A investors believe that shows your startup can continue to grow and therefore give you more money.
Since building technology is expensive, this usually translates to 14-18 months worth of operating cash flow (burn rate) until you may run out of money (runway). If you find profitability, you’ll be self-sufficient and gain months of runway.
Suppose you’re not profitable and have 4-6 months of runway remaining. In that case, you owe it to your employees and previous investors to start fundraising so that you are never put in a position that can’t pay payroll obligations.
How To Approach Investors For Seed Funding
Everyone has minimal time, and you want to be highly respectful of your potential investors' time by doing your homework before approaching them.
You should create a list of potential investors you think are a fit because they’ve invested in a company or space similar to yours in the past, and you have a compelling story on why that investor is right for you.
Get to know them by consuming their content online, and look to form a long-term relationship because even if they don’t invest in your startup today, they might invest in another of your startups at some point. Empathy is the keyword for approaching investors: put yourself in their shoes and treat them like you would want to be treated.
How to Find Investors
Finding potential investors is an art that requires some excellent detective skills.
There are open-sourced lists on AngelList, Crunchbase, and Twitter of angels, syndicates, and seed-stage VCs who might match you and your startup. If you’re in an accelerator, they’ll likely have a private list similar to the public lists.
Your best source of investors is other founders, as it’s a lot easier to set up a meeting with an investor if you receive a warm introduction from a founder they’ve invested in before or have a strong relationship with.
If you find a target investor but don’t have anyone in your network that knows them, try and form genuine relationships with founders that appear in their portfolio where there might be business synergies. That way, when an investor asks how well they know you, it doubles as a positive referral.
Serendipity is beautiful, so don’t rule out attending in-person conferences if it's safe for you and joining local and digital tech communities to find other ambitious founders and engineers. You never know who might be the person who makes the life-changing introduction.
What Documents Should You Have?
Don’t spend too much time developing diligence documents for a seed round. The three primary documents you will want are:
An executive summary.
Teaser pitch deck + Full pitch deck.
A video of you pitching your teaser pitch deck.
These are all assets that investors can share with other investors to get feedback on your company. So expect that anything on there can become public information.
Traditional executive summaries are one or two pages of primarily words and should include information about vision, product, team, traction, market size, and minimum financials (revenue, if any, and prior and current fundraising). The most crucial component is contact info so investors can reach out if they’re interested.
Pitch decks are visually driven graphics. Charts and screenshots are more impactful than lots of words. The teaser pitch deck is a shorter version of the full-pitch deck whose goal is to get you a meeting. The full pitch deck is the one you use to pitch during meetings.
Pitch decks have many components that can be mixed and matched to create your storytelling narrative. Below are some insights that should be included in your deck:
Your company, logo and tagline.
Your vision - How is the world different if you achieve your objectives?
The problem - What are you solving for the customer or user?
The customer - Who are your customers or users?
The solution - What have you created and how does it solve the problem?
The Total Available Market (TAM) - It should be over $1B, which shows the market is large enough to sustain $100M in revenue.
Market landscape - Who else is solving the problem, and how are you 10x better?
Current traction - List key stats/plans for scaling and future customer acquisition.
Business model - How do you make money and what are your unit economics and gross margins?
Team - Who you are, where you come from, and why you have what it takes to succeed.
Fundraising - How much have you raised, how much are you raising, and what will you do with the capital?
A video of you going through the critical slides in your teaser deck will help add a human being to the deck. Investors see so many decks that a passionate video can help you stand out in the endless sea of pitch decks.
How To Carry Out Meetings With Investors
There is a meager chance the person you are pitching will invest in your business, so don’t fixate on getting their money to learn from them.
A general paradigm is that for any given meeting with an investor, the chance it will result in funding is less than 10%. Therefore, if your only goal for that meeting is to get the money, you’re wasting 90% of your investor meetings.
VCs and angels are intelligent people, and since they see so many different companies, they might have a better idea of specific macro trends in your space than you do. So every meeting is a good way to learn and improve your business.
The proper use of time for an investor meeting is to spend 40% of the time explaining what you know about your business and 60% having a collaborative discussion and asking investors questions.
This is a solid signal to investors on what a potential 7-10 year long relationship with you might look like. If you’re coachable and seek to learn fast, it’s likely that after a couple of meetings they’ll get conviction into your vision.
Towards the end of every meeting, ask the investor to tell you how interested they are in investing in you on a scale of 1-10. If they reply 7 or higher, ask them what the next steps might be for them to invest.
How to Negotiate With Investors
After you’ve gone through the formal due diligence process with an investor and they extend a standard term sheet, you’ll enter a negotiation process. Both sides have needs, and it’s a matter of finding a middle ground for those needs.
The first thing to know is that they have way more experience than you do at negotiating venture deals. Therefore, the right approach is to avoid live negotiations so you can consult with your lawyer, other founders, or online resources in between asynchronous communications. Be super curious and ask investors to clarify why a position is essential to them.
It’s unlikely that investors will ever offer completely unreasonable terms. It becomes easier to bring data to the counterpoint if you know how or why they are anchoring on a term.
When it comes to valuations, sometimes investors just have target ownership numbers that they’re seeking because that's what they promised their LPs that they’d get in every startup. You wouldn’t know that unless you had a collaborative discussion during negotiations.
The bulletproof method of negotiating valuation is to bring the post-money valuations of similar seed-stage companies in your stage and ask for the mean or 25% higher if you have data to justify that you’re better than them.
Now that we’ve dived deeper into seed fundraising, you should feel comfortable with strategizing your seed fundraising approach for your startup.
You’re now armed with the knowledge needed to determine what type of investors are a fit for you as well as how to navigate the murky waters that are negotiating term sheets and dilutions. Also, you know how to prepare your pitch material and the winning mindset for approaching all investor meetings.
We wish you the best of luck on your fundraising journey!