Seed Capital - Cash Equity?

Seed capital refers to the type of financing used to form a startup. Funding is provided by private investors—usually in exchange for an equity stake in the company or for a share in the profits of a product. Much of the seed capital a company raises may come from sources close to its founders, including family, friends, and other acquaintances. Obtaining seed capital is the first of four funding stages required for a startup to become an established business.

Understanding Seed Capital

A startup company may need more access to funding and other sources. Banks and other investors may be reluctant to invest because the company has no history, established track record, or measure of success. Many startup executives often turn to people they know—family and friends—for initial investments. This financing is referred to as seed capital.

Seed capital—also called seed money or seed financing—is referred to as such because it is money a business raises in its infancy or early stages. It doesn't have to be a large amount of money. Because it comes from personal sources, it's often a relatively modest sum. This money generally covers only a startup's essentials, such as a business plan and initial operating expenses—rent, equipment, payroll, insurance, and research and development costs (R&D).

The primary goal at this point is to attract more financing. This means catching the interest of venture capitalists and banks. Both are inclined to invest large sums of money in a new idea that exists only on paper if it comes from a successful serial entrepreneur.

Special Considerations

A startup typically has to move through four distinct phases of investment before it is genuinely established—seed capital, venture capital,?mezzanine funding, and an initial public offering (IPO). As mentioned above, seed capital tends to be just enough to help a startup achieve its initial goals. If the company is successful in the initial phase, it may catch the interest of venture capitalists. These investors will likely invest heavily in the company before it moves further. So-called mezzanine financing is sometimes necessary to support a company in its introductory phase. This is usually available only to businesses with a track record—even at a high interest rate. The final stage is when early investors get their payday. When a young company goes public with its IPO, it raises sufficient capital to keep growing and expanding.

Seed capital is one of the four phases of investment, along with venture capital,?mezzanine funding, and an initial public offering.

Seed Capital vs. Angel Investing

Professional angel investors sometimes provide seed money through a loan or in return for equity in the future company. These investors are generally high-net-worth individuals (HNWIs) and may come from the personal network of a startup's founder(s). Angel investors often enjoy a hands-on role in helping develop a company from scratch. If the angel investor contributes less than $1 million, the money is usually a loan. For the entrepreneur, this can solve the problem of attracting sufficient seed money, given the reluctance of financial institutions and even venture capitalists to take on considerable risk. When contributing more than $1 million, an angel investor typically prefers seed equity and becomes a co-owner of the startup and the preferred stockholder with voting rights.

Seed Capital vs. Venture Capital

Seed capital and venture capital are often used as synonyms, and they tend to overlap. Seed capital is generally used to develop a business idea and effectively present it to venture capital firms with large amounts of money to invest. If venture capital firms like the idea, they generally get a stake in the new venture in return for investing in its development.

Venture capitalists provide the lion's share of the money needed to start a new business. It is a considerable investment, paying for product development, market research, and prototype production. Most startups at this stage have offices, staff, and consultants, even though they may have no actual product.

Cash Equity Contribution

When all financing avenues appear closed due to a lack of prior commitments, the incompatibility of a preliminary stage with a "stand-alone" mini-project, or the absence of available working capital, all efforts must be concentrated on raising Seed Capital.

All companies seeking financing are generally required, or at least strongly expected, to have collected significant seed capital. Private lenders and investment funds almost universally need companies to have substantially self-invested or collected Seed Capital.

Some institutional lenders often require applicants to self-fund from 10-30% of the loan amount as a "down payment," proof of funds (POF) or proof of capability. Having Seed Capital proves some or all of the following:

(1) The company is solid enough to be "worthy" of funding.

(2) The project has won support from professional colleagues such that a lender should also believe in it.

(3) The founders believe in the project so much that a lender can trust them to implement it to generate revenues and repay the loan successfully.

The most common sources of Seed Capital are company founders, "friends and family" circles, private individual or corporate investors, including professional colleagues and industry experts, who can typically contribute approximately $100,000 each to give some preliminary operating capital.

Such amounts can reliably cover retainers for licensed banking institution services, legal work, collateral procurement, and other financial services, making clients bankable with collateral or asset backing. That lower level of "micro-finance" effectively allows a licensed institutional financial services provider to prepare and take a client to the total funding package for the entire project.

In standard practice, financial services professionals, firms, and institutions are "not set up" to assist clients with raising Seed Capital. Generally, no funding source can "give" that opportunity to a client. Professional sources must concentrate on large-scale total project funding. They cannot dilute or divert their resources to pursue minor private investors or relatively "nominal" amounts (compared to the tens and hundreds of millions of project funding package amounts).

Traditionally, project principals are required and expected to raise seed capital "on their own," on a personal level, tapping into their own life, career, professional, and other networking resources.