6 Rules To Raise Seed Capital The Right Way
September 21, 2015
You have an idea, you’ve done your homework and now you need to secure some capital beyond what your wallet can cover whether it’s to start creating a prototype or to begin actual development.
While seed funding is often the easiest round of funding to obtain, it’s also the foundation on which you’re building your entire business. Make sure it’s solid.
Friends and family are second only to personal savings and credit when it comes to seed funding sources for startups. And there’s a good reason for that. Investing in a startup with no financial statements, incomplete (or nonexistent) corporate structure, and no assets or intellectual property to speak of is the very definition of high risk. Who else is going to hand you the thousands to tens of thousands or more to get your company off the ground?
That’s why very few entrepreneurs can avoid relying on their personal networks for funding when first starting out. The key to making that work is to be deliberate, cautious and clear when setting expectations. Starting with a shaky foundation is setting yourself up for failure whether you’re talking code or organizing your company’s financing and legal structure. Here are six rules for making sure everyone’s on the same page.
Overvaluation is one of the biggest mistakes a startup can make and one that can really hurt friend and family investors in the long run. Appreneurs are optimistic by nature so it’s not surprising, but fixing overvaluation after the fact is difficult if not impossible. Research how much similar app startups are valued at (https://angel.co/valuations) and think about consulitng an accountant or lawyer to estimate market rate. Start with comparables and conservative financial projections to determine a value and then test it. How much of an offer would you need to see, realistically, before you’d sell? $500,000? $100,000?
That rich uncle might look like a juicy prospect, but if he’s never invested in a startup or is in an industry wholly unrelated to the mobile space or specific industry you’re targeting, you should cross him off your list now. Well-connected friends and family are worth their weight in gold and seed investors that will be stepping stones for follow-on financing will get you much further much faster. And don’t rush to set up meetings with anyone and everyone. Limiting your list to accredited investors–those who earn a minimum of $200,000 per year or have a net worth of at least $1M–will also eliminate potential legal problems when it comes time for IPO.
Ask for help, not money. A modest investment is great, but connections are what can make your company grow long-term; if people are interested in investing, they’ll offer. If not, at least you’ll get them working on your behalf to generate other leads.
Offering prefered shares is a way to offer a higher return on investment in exchange for limited engagement. However, having a bunch of different investors with different kinds of shares can be incredibly difficult to manage, especially when you’re focused on launching and maintaining a business. Unless you have a background in finance or are experienced with those kinds of fee structures, it’s best to keep it simple. You can always add complexity later in the lifecycle of your company.
You have a ton of confidence in your business concept–as you should–but, the fact is, 90% of startups never make it out of the seed phase. It is essential friends and family understand just how risky the investment is that they’re making because the last thing you want to do is jeopardize your relationships. There should always be a repayment plan or equity exchange in place, but consider straight-up asking them if they’re willing to lose their investment entirely. It’s a harsh reality of the seed stage.
You’ve gotten to “yes.” Now is the time to hire a professional. You should be prepared to provide all investors, including early-stage friends and family, with official, detailed and binding documentation about the investment structure. There’s no faster way to burn bridges than to hand out nothing more than a smile and a promise in exchange for seed capital. Treat your friends and family like the investors they are and, chances are, they’ll continue to be your champions as your company matures and grows.