Raising money for a startup is one of the most difficult tasks for entrepreneurs. Startup companies require to raise money to hire staff and rent office, and most importantly, they need money to grow.
They are required to convince people to invest money in their business so that they can execute these tasks successfully. Initial money raised by a company is called “seed” funding.
In this article, you will learn about everything a fund-raiser need to know about seed funding to start their business.
What is seed funding?
Seed funding is also known as seed money and seed capital. It is a kind of equity-based funding where a businessman or entrepreneur persuade investors to invest money in a business in its initial days in exchange for an equity stake.
An investor gets partial ownership on the business based on the basis of capital invested by him, and on the other hand, a business owner gets initial capital to support his idea and take it off the ground. An investor can sell his share or portion in exchange for money after the company becomes successful.
What is the purpose of seed funding?
A majority of startups cannot breathe without startup funding. Most of the times, it is difficult for funders and his family and friends to finance a startup to the level when it becomes profitable. (The meaning of startup here is a company which is developed to grow fast).
It is known that high growth companies require to burn initial capital to withstand their growth before it starts making a profit. A few exceptional companies can raise funds for themselves easily.
Cash not only helps companies to live and grow, but it is also important for small tasks such as public relations, hiring key staff, sales, and marketing, etc. for the competitive advantage. Therefore, all startups are required to raise money.
The good news for such startups is that there are many investors who want to invest money in potential startups. But the bad news is fundraising is not a piece of cake. The process of convincing investors to invest in your business is often arduous, long, ego-deflating, and complex.
However, it is a path that every company must walk.
When is the right time to raise money?
Investors only want to invest their money if they find the idea compelling, and when they believe that the founders have the potential to realize their vision, and the idea described is sufficiently large and real.
Money can be raised when founders are ready to describe their story, and you should raise money whenever you can. For some founders, it is enough to have a reputation and a good story to raise money, and for others, it requires a product, an idea, and customers adoption to be able to convince investors to invest money in their business.
The only product is not enough to persuade investors, but it should have the potential to fit in the market, and the product should be able to experience growth.
Therefore, founders should plan to raise money only when they have figured out the opportunity in the market, their customer segment, and its rapid rate of growth. A businessman should be able to impress investors if they want their money.
People who can raise money without making mention above are very rare. However, others should work on their product and prepare beforehand before they ask an investor to invest in their business.
Requirements for Seed Funding
Followings are the things that you must have with you before you go out to raise money in the market.
#1 Create a business entity by incorporating:
Create a business entity as S-corporation, LLC, or C corporation before starting doing any work from your business. Moreover, you can’t raise any money, merely having an idea, and you need to have your idea business incorporated.
#2 Apply for trademark registration and business registration:
It is one of the most important tasks that you must not take lightly as there would-be competitors of your business when your business becomes successful, and you certainly don’t want people to steal your ideas.
#3 Create an NDA agreement:
It is important to create an NDA agreement to protect your idea from getting stolen until you are working on converting it into the business.
#4 Apply for provisional patent:
A provisional patent is important to protect the technology that you use in your business.
#5 Prepare for your tax filing and regulations:
It is important to start filing for your tax as soon as you have registered for your business. This includes creating and keeping a cap table and keep updating it from time to time whenever a new transaction takes place in your business.
#6 Create a projected balance sheet for your business:
Make a projected balance sheet which will contain your financial plan for the next 18-24 months. That plan should describe where and why do you need money. Don’t forget to include monthly actual as it interests your investors more.
#7 Prepare a stunning pitch for your investors:
It is very important for you to work on your pitch to convince your investor. Make sure that you are well-aware about your business and ready for an explanation of your idea, market size, etc. don’t forget to work on to prepare back up and detailed information for everything that your investor might ask.
After preparing all the above documents, you are all set to ask for money from your investors. In the next section, you will learn about the step by step process to raise money through seed funding.
Step 1. Preliminary Step
Unless you are very lucky, no investor would want to invest in your business on the basis of intuition. Therefore, you should spend enough time preparing both headlines and a detailed explanation about your business as your investors would be interested in both.
Most importantly, a business plan and other important documents are essential to convey your business as a lucrative investment opportunity that no investor would want to miss out. Therefore, you should prepare correct legal structure, executive summary, business plan, pitch deck (presentation), capitalization table, list of target investors, network.
#1 Correct Legal Structure:
You need to prepare all the above-mentioned documents to prepare a legal structure to raise money for your business idea.
#2 Executive Summary:
The executive summary is a written “elevator pitch” for your business. Investors can read more about your proposal and rather than keep wondering to find out the core of your business.
#3 Business Plan:
A business plan is a detailed case of your business. It should consist of all transactions to date, market research, the amount of investment raised, financial forecast, etc.
#4 Pitch Deck (Presentation):
Prepare both writing material and material that you can present standing in front of your investor.
#5 Share the capitalization table:
You may need to get the assistance of a solicitor to prepare your capitalization table. This will make the structure of your company’s shares before and after the investment.
#6 Prepare a list of target investors:
This list will be useful for yourself. Research about the investors you want to target and tailor your documentation accordingly.
It is not an essential part of the part. Find out the potential people who can help you to introduce to potential investors. In addition to this, you can also seek out the help of your solicitor who can have lots of contacts that can be useful for you.
Once you have found a potential investor, followings are the steps that you are required to follow once an investor has shown interest to invest in your business.
Step 2: Due Diligence
Due diligence refers to investigatory work done related to a transaction, for example, investment in which detail the corporate and contractual status of your company and research into the financial.
You will need to provide documents such as budgets, corporate information, key suppliers, forecasts, customers contracts in place, employment and employees contract, a schedule of leases or property, schedule for intellectual property, details of other investors, equipment owned by company, bank loans, shareholders, VAT and tax filing, any existing litigation, and insurance documentation, etc. to your investors.
Step 3: Term Sheet
The term sheet explains the terms on which your investors are going to give you money. It can be a convertible note, taking equity in your company, or any other type of arrangement. It will also mention all the conditions that you are required to meet to receive funding.
It will also contain decision-making rights and decision about the dilution of shares. It is not necessary to be a legal document. It should contain long-form documents so that your investor can go through all minor details.
Term sheet can either be prepared by an investor or by the entrepreneur. But in either case, it should be prepared under the guidance of solicitor to make each term clear, and your solicitor can negotiate most favorable terms on your behalf.
Step 4: Long Form Documents
After the completion of the headline terms agreement and due diligence, the next step is to prepare long-form documents. This is usually the job of your solicitor. It will implement the arrangements for funding.
Followings are the documents that must be included in long-form documents.
#1 Vesting provisions:
It is designed to protect an investor from situations such as a key member leaving the business soon after getting an investment.
#2 Investment agreement or shareholders agreement:
The agreed terms will be mentioned in this document in more detailed terms. This can be referred by your future investors if they want to know about the control of your existing investors on your business.
#3 Articles of Association:
According to this article, it will govern all the operations conducted by the company once the investment is made in the business.
#4 Subscription Agreement:
According to this document, you make a promise to sell a certain number of shares to the investor. It also contains the price of the share and agreement made by an investor to pay that price.
Step 5: Receive cash/ closing date
Closing date for the agreement will be scheduled. On that date, the agreement will be signed, and funds will be transferred. This step is done when all the conditions for the investment are met.
Step 6: SEIS/ EIS
SEIS stands for Seed Enterprise Investment Scheme, and EIS stands for Enterprise Investment Scheme. It refers to tax relaxation for early-stage investors if they purchase shares of certain qualifying companies.
This is done to encourage startups. You can take the help of your solicitor to know that whether your company qualify for this or not before the investor can get tax relief on purchasing shares of your company.
Step 7: Administration and Accounting
There are immediate actions your solicitor is required to take a right after securing investment. This will include updating the company’s share register, issuing share certificates, and registering with the company’s house.
In addition to this, you are required to keep your bookkeeping and accounts up to date once you have external investors in your company.
You will also be required to report to your investors as per the reporting obligations of your investment terms. You can be asked to report about the financial health of your company by your investors.