What is Seed Money?
Seed money refers to the funds a startup raises to launch its product or business. It usually comes from friends and family, co-founders, or angel investors in exchange for equity.
Seed money is usually used to fund a business during its launch phase when it’s small but full of promise (just like a seed). This form of early-stage financing helps startups grow faster and overcome barriers more efficiently, paving the way for future financing from venture capitalists or an IPO.
But everything starts with seed funding: like planting a seed, this type of financing will hopefully grow the business into a strong operation that generates a return.
How does seed money work?
Seed capital is the first stage of funding a business. It’s used for a business in its very early stages and typically isn’t a lot of money (under $1M).
Startups typically use seed money for launch-related expenses like:
- Rent or real estate
- Employees and payroll
- Product development
- Production and distribution
- Marketing and audience analysis
Keep in mind that seed funding isn’t the same as venture capital. Venture capital usually comes after seed funding because it requires institutional investors and significant sums of money. Seed money is usually a smaller amount with less complexity, which makes it a great option for early-stage startups.
The pros and cons of seed money
Seed money helps startups make their vision a reality. But this type of funding comes with pros and cons that you need to weigh carefully.
Seed money pros:
- It accelerates the startup more quickly, growing it faster than it would have without funding.
- Seed funding decreases the risks of funding the startup yourself or applying for personal debt.
- If you attract the right type of investors, seed money can give you access to valuable mentorship.
Seed money cons:
- Some seed money deals require you to give away a lot of equity in your company early on.
- If you take on a loan, you need to be able to pay back that loan, plus interest.
- Accepting investments means your business has to comply with certain regulations.
Seed money provides a much-needed jolt of life to a brand-new business, but it isn’t without risk. Make sure you’re ready to give away equity or pay off debt when you accept seed funding — otherwise, you risk losing everything.
Where to get seed money
At this stage, the business is a startup with an unproven model. While you can always try to finance the business through a bank loan, most financial institutions won’t extend financing to an early-stage business because it lacks a track record.
Instead of bank financing, many early-stage startups source seed money from:
- Bootstrapping — This happens when you source funds either personally or from your friends and family. Since most entrepreneurs don’t want to put their own finances on the chopping block, bootstrapping funds usually come from your network. Keep in mind that it’s very risky to accept seed money from friends and family. If the business doesn’t do well, it could put a strain on your personal relationships. While it can be easier to get a “yes,” you have to enforce boundaries. Treat your friends and family as the investors they are so you can succeed together.
- Debt — Seed money debt usually comes from angel investors, not a bank. In this scenario, an investor extends a loan to you in exchange for seed money. You’ll need to pay back the loan with interest, but this does mean you don’t give up equity in your company. If you anticipate meteoric growth over time, this could put more money in your pocket.
- Equity — Equity deals are a common way to raise seed money. You ask an investor for seed money in exchange for stock or a share of ownership in your company. This is great if you don’t want the burden of paying off debt right now, but it will make it difficult to control your company when you give away more equity.
- Crowdfunding — Platforms like Indiegogo and GoFundMe allow you to crowdsource products without giving away equity. You can offer steep discounts to your crowdfunding partners in exchange for their early purchase supporting your startup.
- Convertible securities — The most common type of convertible security is convertible debt. This deal usually starts out as a loan but converts to equity. If you’re trying to appeal to a risk-averse investor, you might use a convertible security agreement to secure seed money.
- Angel investors — High-income investors usually fund startups as “angels.” They typically finance seed money as a loan if the amount is under $1M and do equity deals if it’s above that threshold.
- Incubators: You can join an incubator program to solidify your startup ideas, design a product, and clarify your vision. Y Combinator is a well-known example, but there are incubators available across the globe.
Remember, the purpose of seed funding is to get your business off the ground. After you acquire seed money, you’ll create a track record that allows you to apply for venture capital dollars and, eventually, an IPO.