Seed Funding for Startups: 17 Things Startups Must Do BeforehandStartup Law ResourcesVenture Capital, Financing
Raising seed funding from investors for your startup could be very complex. Follow our guide on the 17 things startups must do before raising seed funding.9 min read
This article assumes that you already know what “seed money” means. But if you need more information on the topic, please take a look at this introductory article on seed money.
Are you looking to start a company? If so, you may be looking for seed money to get your business off the ground. While considering how to bring in seed money, here are some things for you to consider:
1. Understand the Difference Between Seed Funding and Venture Capital
Seed funding and venture capital are very similar, but there are three key differences.
Seed funding arrangements give more flexibility than venture capital.
The seed funding due diligence process is less complex.
Seed funding is available at lower minimum investment sizes.
2. Consider Forming a Corporation or LLC in the Early Stages
Most startups in the seed funding phase operate as unregistered sole proprietorships or partnerships. When you're looking for investors, it's probably a good time to think about forming a corporation or LLC.
Aside from the other benefits that come from forming a corporation or LLC early on in the process (i.e. potential personal liability shield from debts of company), formation is essential if you expect to raise any money. However, be aware that some experienced investors may have their own particular investment requirements, and may insist that your company be formed as a particular type of entity or formed in a particular state. For example, some investors might not be interested in making an investment unless your company is registered as a Delaware corporation (Learn how to incorporate in Delaware here).
If you decide that you’d rather wait before forming a particular type of entity, you should at least be familiar with your business structure options so you can make an informed decision when the time comes. You can click here to learn more about why investors prefer startups to incorporate in Delaware over other states.
It’s also a good idea to look into whether or not your business is subject to any state or local licensing requirements, or other regulations. The more your business grows, the more likely it is you'll attract the attention of regulators.
3. Do Not Overlook Securities Laws
This is an important area that is far too often overlooked, even by the most seasoned of entrepreneurs. If you raise money (or even attempt to raise money by offering an investment contract to someone else) in such a way that violates a securities law, not only could you be subjecting yourself to penalties, but you could become personally liable for the losses of those who eventually do invest in your company.
Securities laws are complicated. This doesn’t necessarily mean that you will be forced to register with the Securities and Exchange Commission (SEC). The law provides certain “safe harbors.” To ensure that you work within the safe harbors of the law, we recommend that you consult with a securities attorney prior to selling any stock, membership interest, or even offering any investment contract to anyone.
4. Protect Your Intellectual Property
If the success of your startup is predicated on an application, trade name, slogan, business process, method, recipe, copyright, or some other proprietary information, then the protection of your intellectual property is critical. To the extent it’s possible, your company will need to keep exclusive control over your brand and technology.
Make sure you actually own the rights. This may come into play if your startup’s proprietary asset arose from work you may have done for an employer, or while you were working for someone who may have had control over the things you used to create the proprietary asset.
When applicable, start the patent or trademark process. It’s a good idea to protect the company’s intellectual property as early as possible - even before any investors are brought on board.
Be careful what rights you give up. Licensing deals, exclusive distribution arrangements, and similar deals involving intellectual property can be solid business moves, but they can also be anchors to failure if they are not properly considered. Consult with an attorney to discuss your company’s intellectual property.
5. Understand Your Funding Options
Subject to securities laws, there are several options for how a company can raise money and from whom it can raise itHow
Equity: Selling equity in your company gives up ownership but keeps you from having to make ongoing payments.
Debt: Taking out loans preserves ownership, but it can be hard to get a decent interest rate or even a loan at all if you have not yet started to generate revenue.
Convertible Notes: Convertible notes start as loans and turn into stock. They lower an investor's risk of losing their investment and reduce your own risk of misvaluing your company in the early stages.
Friends and Family: Getting money from people you know is often easier and faster than turning to outside investors. But that’s not always the case. Read UpCounsel’s guide on raising money from friends and family here.
Angel Investors: Angel investors often provide mentoring and strategic advice in addition to money. You may pay a premium for their expertise, but if they help accelerate your growth, it is frequently worth it. Make sure you know the things that angel investors expect startups to know beforehand.
Crowdfunding: Crowdfunding lets you build up capital with small investments from a large number of people. While you'll miss out on the strategic relationship of an angel, a smart crowdfunding campaign can help your marketing go viral as your company is raising money. However, before you rush into crowdfunding, learn more about the various crowdfunding legal traps and issues.
Incubators and accelerators: Incubators and accelerators provide groups of startups with workspace, business advice, and potential funding. They are often sponsored by universities, industry organizations, or individual companies. Be prepared before applying for any accelerator program. Take a look at UpCounsel’s guide on accelerator programs and what to prepare beforehand.
6. Prepare Important Documents for Investors
When you approach investors, you need to explain why they should invest in your company:
Business Plan: Your business plan should be a highly-detailed overview of how you plan to grow and your current financial status.
Executive Summary: The executive summary is a short summary detailing the most important points of your business plan.
Presentation / Pitch Deck: This is a slideshow highlighting what's in your business plan but organized in a way that better tells the story of your business. Photos and videos of your product in action are also appropriate.
Elevator Pitch: You have about 30 seconds to catch an investor's attention and to convince them to read your documents. A good elevator pitch briefly tells your story often with a hook such as "we're the Netflix of … ."
Consider (and Reconsider!) the Non-Disclosure Agreement (NDA): If you can painlessly get your investors to sign an NDA - have at it! But is it worth the risk of driving away a potential investor? In some cases, perhaps not. Take all factors into consideration when deciding whether or not NDA’s are needed. Specifically, consider balancing all of the interests involved, such as the obvious interest in protecting the IP, against the overall likelihood that an investor is going to actually steal your company’s IP, while also factoring in the potential investment that could be lost.
7. Build a Team of Advisors
Entrepreneurs are faced with many tasks and challenges. Even the most experienced business people aren't experts in all facets of the enterprise.
Bringing in advisors who have expertise in certain fields where your management team is perhaps lacking experience or know-how can help keep you on the right path to growth, and maybe even help your company avoid the valuation or management mistakes often made by inexperienced entrepreneurs.
8. Understand Your Company’s Own Term Sheet
When you ask for an investment, there's more in play than how much money you get and how much of your company you give up. An investor will often ask you to sign a term sheet that covers additional rights. This might include:
And many others...
Even though raising money may be your company’s main goal, these terms may significantly impact your company’s future flexibility and profitability. In other words, these terms may end up costing you more than you bargained for. Be sure, at a minimum, that you understand the basics before you start negotiating and giving away certain rights.
9. Know Your Value and Capitalization Table
The capitalization table details who owns shares in your company, the respective ownership percentages, and how share percentages could be affected by certain events, such as, for example, in the event any outstanding options are ever exercised, or should any outstanding convertible loans be converted into equity.
Before your company takes any action, your management team should consider the way such action may affect capitalization in the short-term and long-term. Common early mistakes include giving up too much equity or raising initial funds at too high of a valuation. Both can make it harder for new investors to come in without restructuring your existing investors' stakes.
10. Be Disciplined
Seed money should achieve a specific goal. Don't raise money just because you think that's what startups are supposed to do. Figure out how much money your company needs to execute the next step in its plan, factor in some costs associated with the money raise, and make that resulting amount your goal for the next round.
Whether it’s an advertising campaign, purchase of new equipment, or hiring a new employee with a key skillset, determine a budget for that need and raise only that amount. Don’t forget, however, to factor in any costs attributable to the money raise itself, such as fees to attorneys and others.
Save fundraising for future goals, for a later date. If you raise too much now, you could end up giving away too much of your company. Additionally, if you have excess funds on hand, you may be tempted to increase your burn rate to unsustainable rates, and this may lead to you having trouble raising more money when you really need it. So be disciplined!
11. Set Milestones
Milestones help cement your plan and keep you on track once you start raising money. Set realistic targets for sales or customer numbers with specific dates by which to achieve those goals.
When you set a milestone, your business plan should tell you exactly how to reach it. If not, you know you need to revise your business plan or your expectations before you pitch to investors.
Once you have an investment, milestones will keep your company from resting on its early success. They'll also help you determine if you're getting the expected return on the money you raised — and if not, what you need to change in the future.
12. Build Momentum
Investors want to see some sort of momentum. Whether it's profits, sales, subscribers or even just a successful Kickstarter campaign, numbers show that you have more than just an idea.
This can be difficult since you're often trying to use seed money as the launching point for your idea. But if you can find a way to launch a prototype or beta service on your own, you'll be in a much better position when you ask for investments.
13. Be Ready to Scale
Sometimes, businesses are a victim of their own success. Businesses that quickly attract attention may find themselves overwhelmed with orders and suffer permanent damage to their reputations when they're unable to fill them in a timely manner.
If your plan for seed money is to expand your reach, be sure you're already capable of scaling up to meet the new demand.
14. Know How to Overcome Objections
If you never hear the word "no," you either got incredibly lucky or asked for far too little. Valuation, doubts about your business plan and personal preferences are just a few reasons investors say no.
Think about any possible reason an investor might say no to investing in your business and have a solution ready for every concern.
15. Set Limits on What You'll Give Up
Before you ask for an investment, know what's important to you and what you're willing to give up. How much of your company do you want to keep? Do you want to be in control? Are you keeping enough equity for future funding rounds?
One way to gain flexibility is to consider options such as preferred stock and convertible debt. This will give you more negotiating room without going beyond your limits.
16. Get a Lawyer
Even if you're getting seed money from a professional investor, you'll want to have your own lawyer to help you. A lawyer's job isn't just to make sure the basic legal requirements are met. Lawyers also promote their clients' interests.
An investor’s lawyer will be looking to get the best deal possible for the investor, even if it comes at your expense. Only your own lawyer has a legal obligation to push for what's best for you.
There are plenty of places to find a good lawyer. You can ask for referrals from people you trust. You can even check with your local bar associations. Or you can use a service like UpCounsel. UpCounsel has access to experienced business lawyers all over the country.
17. Raise Venture Capital
Assuming all goes well with the seed investment, you should be ready to raise larger amounts with venture capital.