‘Can we get sunflowers?’ asked my three-year-old daughter. ‘Can we?’
‘I want to get tomato seeds’ demanded my seven-year-old who secretly wanted sunflowers but couldn’t bring herself to agree with her younger sister.
‘Easy guys’ I tried to explain. ‘We have our wires crossed a little. I was talking work not horticulture, and it was not real seeds that I was talking about. I have a client asking about raising funding for their new business venture. I wasn’t talking about actual seeds as in gardening’.
As a look of confusion and disappointment instantly spread across their faces and I realised that I now had an unscheduled detour to a garden centre to include in my journey to save the weekend, I started thinking about just how many people understand the concept of ‘seed’ funding and what to expect with the process.
To help, I wrote this short guide.
So what is seed funding?
The term ‘seed’ funding is generally used to describe early investment capital of a relatively low value raised when the business is in its infancy. In layman’s terms, the cash needed to get a business concept up and running.
Seed capital often comes from the business owners themselves or from their family or friends. Where this is not possible, then it is raised from external ‘angel’ investment.
Because the business is usually at a very early stage and the amount of money is relatively small, the ‘seed’ description is applied. This capital is the seed from which the business can grow.
While friends and family of the business owners are usually prepared to take a leap of faith with a business concept, external angel investors will usually require a little more than a good idea and that is where business advisers like myself tend to get involved. Hence the call that my daughter over heard and the subsequent confusion.
Preparing for and securing start-up funding requires careful planning and execution. It is important to get the offering right if funding is to be secured. Understandably, third parties don’t readily invest in business concepts without being satisfied that they will evolve into something more.
Securing external seed investment
External investment seed capital investment will usually come from affluent private individuals commonly described as ‘angels.’ Angels typically invest their own funds in return for a share of the ownership of the company. This is different from venture capitalists who invest capital from funds that they manage. VC’s ordinarily invest at a later stage when the business is further down the track.
Before investing, external investors / angels will wish to interrogate the concept, the planning and the strength of the business. Investing in start-ups is inherently risky so to minimise this risk, investors need to have confidence that the business owners know what they are doing and that there is something slightly more solid to the investment than just what sounds like a good idea.
A proven track record of successfully starting up and running businesses is always helpful. As is the ability to explain the potential of the business concept and how it will generate a return on the investment.
Investors will expect to see the documents that evidence any assertions or claims that have been provided to encourage their investment. These may include short-term and long-term business plans, records of any intellectual property rights that have been secured, company documents showing how stock has been assigned or will be assigned, the CVs for the management team, and just about anything which is capable of demonstrating the successful prospects of the business.
Agreeing to provide equity
Once a potential investor has been found, then the discussions move on to how much and for what return. If you have ever watched ‘Shark Tank’, it will give you a feel for the terms on which external investors are willing to provide seed capital. Both the amount of capital offer and the percentage of stock required in exchange, usually require careful negotiation.
If the business concept is a good one, then it is important to start-up owners to protect their ownership rights and to receive an investment commensurate with the share in the equity that they are providing. It is however important not to place a realistic value on a business because if the value it is too high, then no one will invest.
Once an investment has been agreed in outline, it is important that the arrangement by a commercial lawyer before anything is signed.
If the contracts are right, then the business owner has the seed capital and the business can grow.
Crowdfunding
Crowdfunding is another means of raising early seed capital. It is the practice of funding a project or venture by raising monetary contributions from a large number of people, often through third-party internet intermediaries. This method is very popular at the moment in the tech and creative space.
It can be both equity and non-equity based. In the case of the latter, rewards are often provided to the investors. These can include royalties, access to products, etc. The rewards can vary depending on the nature of the business and what it produces.
Crowdfunding can be a low-cost method of raising start-up capital. Caution is however necessary because an unsuccessful crowdfunding exercise has the potential to impact negatively on a company’s ability to raise finance from elsewhere.
I will produce a guide to crowdfunding as a separate article in the coming weeks. There are a number of unique considerations which warrant a separate discussion.
So where do I start if you wish to raise external seed capital?
As always speak with your accountant, lawyer or business adviser who should be able to give sound advice on this issue. They can advise on capital raising options and should be able to put you in touch with potential angels or intermediaries.
If they cannot, then please give me a call as I can.
And where do I start once I have my seeds?
Buy them, plant them, care for them and watch them grow. You will soon have beautiful sunflowers. We are now back on the topic of actual seeds, right?
If you have any questions or need further help, again please feel free to call. I have two little ‘angels’ who would be happy to provide guidance on the complexity of seed growing.