Posted on
October 8, 2020
~
min read

Seed funding for startups

Detailed example of a seed funding round for startups

Julian Droste
Founder, Digital Marketer & SEO

When you start a company, you will probably lookout for a seed investment at some point in your early venture.

When you have reached this stage, called the seed stage, your venture has come to the point when you plan to raise money, usually from a high net-worth person.

Let us say you begin planning to raise money. The first step you do is decide how much money you need for growth and how much equity an investor will get in return for his investment.

A quick example:  if an investor gives you 50.000$, and you decide they, in return, get 10% of your company's equity, it means that your company is worth half a million dollars (post-money).

Now you still own 90% of your company.

From now on, whenever you need more money to grow your startup, you'll raise funds from venture capital firms since you have left the seed-stage with your very first investment.

Let's imagine you start looking for VC money. You do cold outreaches, send hundreds of emails, and visit large pitch events.

At some point, one VC is willing to invest in your company. You start negotiating about your company's value and how much equity you are ready to give away.

You decide to raise 200.000$ dollars from this venture capitalist. The seed investor, your very first investor who owns 10% of the company, agrees to this deal, but only if you make sure that the company's value is more than half a million dollars.

Do you wonder why he is interested in this number (It is getting a little bit complicated right now )? It is because when he invested 50.000$, your startup was worth half a million dollars. If the VC is now investing 200.000$, the seed investors' (and yours) equity will be diluted.

Why so? Because your company has to emit new shares for the VC, it will have an increased amount of shares now representing 100% of your company.

Your earlier investor now owns less than 10%, and you'll own much less than 90% now. So every time you raise money, you and your investors will get diluted. However, as long as your company's value increases with each investment, everyone will be happy because their shares are now more valuable than before.

Whenever you raise more money, the previous investors usually have "a pro-rata right." This means that they have the right to take part in the investment. As a result of bringing new money to the company, their shares don't get diluted. They still own the same percentage of the company. This is a standard rule that is written down in your investment contracts.

Here are a couple more things you need to know about seed investments.

No.1 - Don't ever value the company that you started too high early on.

Imagine your company is not growing as quickly enough as you have planned. You have a lot of expenses and only a small amount of revenue.

You start seeing your burn-rate climbing and feel the need to raise more money - but now with a lower valuation of your company than it was when your first investment took place. Your seed investor could now say: "I disagree on this investment. You told me your company is worth $500.000, but now you raise more money at a lower valuation? My shares will be diluted too much."

You are trapped in an investment nightmare when this happens. So our tip is to value your company not too high in the first place. Try to stay level! S

No.2 - Make sure you perform a background check on your investors.

Whoever you raise money from usually accompanies you for a long time on your journey of becoming a successful entrepreneur.

You have to be sure about having a good gut feeling when thinking about your investor. You are going to spend a ton of time with him/her.

You also should know that most of your time spend with your investor will be when the company is in bad shape. If everything is running great, everyone will be satisfied and busy working on different projects. There is simply no need for your investor to focus on what you are doing. However, if your company does not perform well, you will get a lot more attention from your investors- which isn't a good thing. Due to this, a good relationship between you and your investor that sustains these situations is vital.

Overall, this is an excellent example of how a standard seed funding investment looks and what your seed investors equity happens when a venture capital firm invests in your business.

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Julian Droste
Founder, Digital Marketer & SEO

Writer, content producer and SEO Julian Droste is the author and father of our entrepreneur-helping blog and website. Since the beginning of 2015, Julian has created over 400+ articles about a wide range of topics e.g., math, biology, chemistry, history, engineering, and many more.

His passion for entrepreneurship, presentations, and speeches led him to basetemplates where he can share his experience in building a startup with future entrepreneurs.

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