Seed capital is the initial funding required to start a new business and to cover startup costs such as business proposals and market research, among other things.
A proof of concept is also covered, which is used to demonstrate that a business idea is feasible. During this stage, investors are typically friends, family, and other individuals who are close to the business owner.
A company can receive investments from venture capitalists, angel investors, and financial institutions once it has reached the maturity stage of its development after the seed stage.
Learn about how seed capital works, the different types of seed capital available, when you might need it for your business, and the difference between seed capital and venture capital in order to gain a better understanding of this important concept (VC).
Related: What is a business model?
Seed Capital Definition and Examples
Seed capital is the first round of funding that a company receives in order to get off the ground.
It is possible for a company in its early stages to lack a well-established reputation or even a tangible product or service that would allow it to attract higher-tier investors such as venture capitalists and banks.
With only an idea in hand, these founders rely on their own savings (known as “boot strapping”), or on the generosity of close friends, family, and so-called angel investors to fund the initial costs of developing their concept and launching it into the market.
Seed capital is frequently used to pay for the following:
- Business plans
- Market study/research
- Development of prototypes
- Rent of office.
- Legal fees and expenses
- The cost of a patent
- Payroll for the first-team roster
- Fees for consulting services
- Marketing budget (in dollars)
It is important to note that seed capital represents the very first stage of the startup funding process. There are typically four rounds or series of investments that a company can receive in total: seed funding, Series A funding, Series B funding, and Series C funding, to name a few examples.
Alternative definition: Investments made in the early stages of a company’s development. Seed funding is another name for this type of funding.
How Seed Capital Is Utilized
It is possible that a business concept/idea alone will not be enough to pique the interest of investors or financial institutions, which is why seed capital is so important in legitimizing and solidifying a founder’s business concept.
Although the amount of investment can vary, seed funding is typically in the range of $250,000 to $2 million.
In exchange for investments from early investors such as family and friends, a founder may offer certain benefits or forms of capital to those who invest later.
In the opinion of Zain Jaffer of Zain Ventures in San Francisco, because new businesses fail frequently, these ventures are considered high risk. Early investors, on the other hand, who are looking to reap significant rewards often want to invest before the company’s valuation has risen too far.
Types of Seed Capital
It is possible to obtain seed capital from a variety of sources, including the founder’s own funds, funds from family and friends, angel investors, and even crowdfunding. Here is a more in-depth look at each type of seed funding available.
Funds provided by the owner
Sometimes the only capital a founder or business owner has is the money they have saved up for the venture.
It is possible that this will be sufficient to move the company past the development stage and into the hands of professional investors. Furthermore, by self-funding, business owners are able to bring their ideas to life without having to give up too much equity too soon.
Funding from family and friends
Those who are closest to the business owner provide one of the most common types of seed capital to the company.
The personal relationship between family and friends increases the likelihood of them believing in the business concept, and their only concern may be the return on their investment.
Having to deal with close family members can result in additional liabilities if the owners are not careful.
NOTE: Always be mindful of the informal nature of business dealings with family and friends, and be open and honest with them about the risks that may be involved.
A friend or family member investing, who has no prior experience investing in early-stage businesses, may not have clear expectations of any kind—or worse, unrealistic expectations.
An investment made by a relative or friend is still an investment, and the owner should keep detailed records of it. Misunderstandings that can lead to broken relationships and legal issues are the last thing a business owner needs.
Angel Investors are individuals who make investments on a short-term basis.
Investors in early-stage companies, known as angels, are typically wealthy individuals who make investments in exchange for a share of the company’s future profits. Interested investors are looking for a solid return on their investment, as well as an established startup with a strong management team and business plan, as well as an opportunity to participate actively in the company through mentorship, board membership, or even management.
Crowdfunding can be an excellent and easily accessible method for new businesses to raise seed capital.
The creation of an online campaign on crowdfunding platforms such as Kickstarter, IndieGogo, AngelList, SeedInvest, and WeFunder allows founders to reach out to their target audience and solicit their investment.
Equity-based crowdfunding, in which a founder contributes equity or a potential future return in the business, is one type of crowdfunding that exists.
Rewards-based funding, in which businesses offer investors exclusive experiences or early versions of their product, as well as donations and online marketplace lending, eliminates the need for founders with a sound idea to surrender equity in order to raise crowdsourced capital.
Is Seed Capital Required for My Business?
If you have a viable business idea but are unable to fund the idea yourself and do not yet qualify for a business loan from a financial institution, seed capital may be an appropriate source of funding.
Some entrepreneurs and business owners do not have the funds or access to the startup capital that professional investors and financial institutions can provide for their ventures. It is possible that seed capital will be required to pay for research, business equipment, research or consultants to help you develop your ideas if this is the case for you.
IMPORTANT: You should be cautious about giving away an excessive amount of equity in the beginning. In the future, having a large number of investors with a stake in your company may make your company less attractive to higher-tier investors.
Comparison of Seed Capital vs. Venture Capital
The majority of venture capital firms invest in companies that have demonstrated proof of concept. Additionally, venture capitalists (VCs) can choose to invest in a business during the early stages of seed funding, but there is typically a strong emphasis on financial returns.
Jenna Lofton, a certified financial advisor and investor in New York, explained the difference between seed capital and venture capital. “Seed capital is distinct from venture capital because it does not involve an entrepreneur securing equity in the company being formed,” she said.
In order to avoid diluting their interest when additional external financing may be required in order to grow, “this type of financing is frequently (but not always) provided by family or friends,” says the author.
Methods of Obtaining Seed Capital
Seed capital is typically comprised of contributions from friends and family, making it a one-of-a-kind method of launching a business.
Seed capital is often easier to obtain than other types of capital because of the personal relationships that have been established. However, persuading people you know to lend you money or invest in your business idea is not always an easy proposition.
The primary goal of seed capital is to provide support to a startup until it is able to attract additional funding or generate its own cash flow.
Even if your investors are close friends and family members, presenting your business idea in a professional manner is the most effective way to raise seed capital. It’s critical to put the terms of the investment exchange in writing and to think about how much equity you’re willing to give up in exchange for the investment.
Seed Capital Summary Notes
Seed capital is the initial funding source required for a business startup in order to establish the business and attract additional funding in the future.
In most cases, seed capital comes from family and friends, but it can also come from crowdsourcing, angel investors, and the business owner’s own funds as well.
Seed capital differs from venture capital in that it does not entail the founder acquiring equity in the company in the process of being established.
One of the primary goals of seed capital is to provide support to a startup until it is able to secure additional funding or generate its own revenue.