Key Takeaways

  • Seed money is vital for launching startups, covering early-stage needs like product development and market research.
  • Sources include bootstrapping, angel investors, equity crowdfunding, corporate seed funding, and convertible securities.
  • Choosing between public and private seed offerings has legal implications, including SEC compliance.
  • Startups must avoid common mistakes such as giving up too much equity or ignoring investor contracts.
  • New sections below expand on strategic planning, investor criteria, funding stages, and pros and cons of each funding type.

Seed Money: What Is It?

Seed money is used to fund the earliest stages of a new business, potentially up to the point of launching your product. Seed money may come from a variety of sources, including debt and equity offerings. Usually, an investor will exchange money in exchange for some equity or share in the company. The seed money is intended to support the early operations of the business until it begins to create a profit or is ready for additional investors.

Common uses of seed money include the following:

  • Product development.
  • Market and demographic research.
  • Hiring a key team member.
  • Obtaining critical facilities or equipment.
  • Initial production and distribution.

Seed money is different from venture capital because the latter comes from institutional investors, are usually much larger sums of money, and involve extreme complexity in drafting the contracts for the investment. Seed money, on the other hand, comes in before the investor has a project to evaluate, and so the amounts invested are typically lower than that of venture capitalists.

How Seed Money Fits into the Startup Lifecycle

Seed money is typically the first official equity funding stage in a startup’s lifecycle. It often follows personal investment by founders and precedes Series A funding. This early-stage capital is used to transform an idea into a viable product and build a foundational team. Unlike later funding rounds, seed money is high-risk, as there is often little proof of market traction or profitability. As such, seed investors rely heavily on the strength of the business concept and founding team.

Why Is Seed Money Important?

Seed money allows you to launch a business when you don’t have the means to do so on your own. You may not have the personal savings to do so or may feel that the risk is too great.

While seed money often requires you to give up shares of your company, a small share of a highly successful company is better than 100 percent ownership of nothing.

Professional Angel Investors

These investors help pool resources for entrepreneurs who form startups. They will either provide seed money through a loan or by purchasing equity in the company. If it’s a fairly small transaction (under $1 million) the transaction is usually a loan. If it’s over that threshold, professional angel investors will usually use seed equity, where the investor will buy preferred stock, get voting rights, and essentially become co-owners of the startup. These are more complex transactions but are more beneficial to investors as the company grows.

Reasons to Consider Using Seed Money

You may want to use seed money in the following situations:

  • You have insufficient assets to personally fund your startup.
  • You want to accelerate your growth.
  • You want to reduce your personal risk.
  • You want to avoid overextending your personal credit.
  • You want to partner with an investor who can also provide strategic advice.
  • You want to partner with an investor who will take ownership of your business and potentially advance further funds in the future.

Reasons to Consider Not Using Seed Money

You may want to avoid using seed money for the following reasons:

  • To preserve equity.
  • To avoid debt payments that reduce your cash flow.
  • To avoid disputes over money if seeking seed money from friends or relatives.
  • To reduce the costs of regulatory compliance.
  • Because investors may demand a premium due to the riskiness of investing in an early-stage company.
  • To avoid sharing ownership or management of the company with another investor.

Seed Money Options

You have several options for obtaining seed money.

  • Bootstrapping: Bootstrapping avoids seeking outside seed money. Instead, you yourself make an initial personal investment and fund your growth with your early profits. It is the least expensive and most expensive form of funding. Sound impossible? Facebook received its initial funding through bootstrapping.
  • Debt: Debt most commonly comes in the form of bank loans or personal loans from friends and relatives. Angel investors and venture capitalists may also prefer to issue loans to companies in their early stages rather than making equity investments.
  • Equity: Equity is selling shares of ownership in a company (e.g., selling stock). The investor receives a share of ownership, future profits and possibly voting rights.
  • Convertible securities: A convertible security is issued in one form but later changes into another. The most common example is convertible debt. What started as a loan may change into shares of equity-based on preset conditions. This usually happens if the loan wasn’t repaid quickly enough or when the loan contract included either a company or investor option to convert to equity.
  • Crowdfunding: Crowdfunding on platforms like Kickstarter and Indiegogo has nearly surpassed venture capital as a source of seed money. You can now take crowdfunding to a new level by offering investors equity shares in your company with the JOBs Act rather than just product discounts.
  • Corporate seed funding: major companies like Google and FedEx will often offer seed funding to promising companies that could be a potentially lucrative acquisition in the future.

Evaluating the Best Type of Seed Money for Your Startup

Each seed funding type comes with trade-offs. Here’s how to evaluate what’s right for your business:

  • Bootstrapping is ideal for founders who want full control and can manage without external input.
  • Angel investors bring capital plus industry connections and mentorship, but usually require equity.
  • Convertible notes delay valuation discussions but may dilute ownership during future rounds.
  • Equity crowdfunding gives access to a wide pool of investors but may increase administrative burden and require disclosures.
  • Corporate seed programs offer resources and strategic alliances, but alignment with the corporation’s goals is essential.

Founders should consider their long-term growth plans, control preferences, and funding urgency when selecting a seed money path.

Public vs. Private Seed Money

Most seed money is raised in a manner that would typically be considered a private offering. This includes investments made by co-founders, family members, friends, and other people known to you. It also includes most bank loans, although banks are often reluctant to loan out to an unproven source like a startup. Investments by angel investors and venture capitalists are also usually private placements.

On the other hand, publicly seeking out institutional investors, issuing an IPO, or placing advertisements seeking investments may be considered a public offering. Public offerings are usually subject to heightened regulation.

It’s important to note that this private versus public distinction is not absolute. As a general rule, you must follow the strictest SEC requirements unless you qualify for a specific exemption. Additionally, your state’s law may add additional requirements.

The most common exemptions are found within Rules 504, 505, and 506 of Regulation D.

Common Mistakes When Seeking Seed Money

Avoid these mistakes when seeking seed money:

  • Publicly advertising that you’re looking for investors without following the SEC requirements for a public offering.
  • Offering equity or profit-sharing in a crowdfunding campaign except as provided for under the JOBS Act.
  • Giving up too much of your company and not having equity remaining for later financing rounds.
  • Taking on debt obligations that your current cash flows can’t support.

Additional Considerations When Seeking Seed Money

Also, keep the following things in mind:

  • What is a proper valuation for your company? This is one of the most crucial questions to ask because it determines the potential return on the investment. A good rule of thumb is to estimate the value of a startup five years from the present, then divide by 10 to reach a good, current valuation.
  • How important is retaining control to you?
  • Will you have adequate personal resources if your business fails or grows more slowly than expected?
  • Will asking people you know for money jeopardize your personal relationships especially if you can’t return their investment?
  • Do you have other options, such as low-interest credit cards or SBA loans?

What Investors Look for in a Seed Round

Seed investors are betting on potential, not performance. Here are typical criteria they assess:

  • Team Strength: Founders with domain expertise, commitment, and complementary skill sets.
  • Market Opportunity: A large, addressable market with room for scalable growth.
  • Minimum Viable Product (MVP): A working prototype or clear development roadmap.
  • Traction Indicators: Early users, customer feedback, or pilot sales (even if minimal).
  • Exit Strategy: Long-term plans for acquisition, IPO, or investor payout.

Having a compelling pitch deck and a credible plan for using the funds significantly improves investor confidence.

Steps to Obtaining Seed Money

Take the following steps to obtain seed money:

  • Create a business plan and financial statements. Sophisticated investors will require it. It will also help investors related to you understand where their money is going and the risks involved. Make sure you have a compelling ‘pitch’ when speaking with investors about your plan.
  • Have a clear plan for the money. Raising money without a defined need often leads to undisciplined spending that could harm future growth.
  • Use a legally binding contract for all investments regardless of amount or relationship. Even when not required, this will again prevent misunderstandings and protect the rights of all involved.

Stages of Startup Funding Beyond Seed Money

Understanding what comes after seed funding helps you plan your fundraising strategy. Here's how the sequence typically unfolds:

  1. Pre-Seed: Informal funding from founders, friends, and family. Used to develop the idea.
  2. Seed: Formal early investment used to build the product and validate the market.
  3. Series A: Focuses on scaling the business model and increasing market share.
  4. Series B and Beyond: Fuel growth, expand teams, and enter new markets.
  5. Exit: Acquisition, merger, or IPO, providing returns to early investors.

Seed investors often want visibility into your long-term funding roadmap and how future rounds might affect their stake.

Seek Legal Advice

Raising seed money touches on multiple legal issues including contract law, securities resolution, and possibly dispute resolution. Working with an experienced lawyer now can save you time, money, and frustration later. Search UpCounsel to find a qualified lawyer near you.

Frequently Asked Questions

1. What is the difference between seed money and venture capital? Seed money is early-stage funding for concept development and initial operations. Venture capital comes later, when a business has traction and seeks to scale.

2. Do I need a prototype before raising seed money? Having a prototype (or MVP) improves your chances but isn’t always required. A clear plan and strong founding team can also attract seed investment.

3. Can I use crowdfunding for seed money legally? Yes, under the JOBS Act, you can raise seed money through equity crowdfunding platforms, but must follow SEC rules for disclosure and investor limits.

4. How much equity should I give away in a seed round? Typically, startups give 10%–20% equity in a seed round, but the amount depends on the valuation and terms negotiated with investors.

5. Is seed money considered income for tax purposes? Generally, no. If the seed money is equity-based, it’s not considered taxable income. However, loans or convertible notes may have tax implications.