You may have heard the word “seed funding” being used in the context of startups. But what on earth does it mean? And why do you need it? Seed funding refers to the initial funding required for a start-up.
This is the money that you need to raise at the very beginning, before anything has really started. If your business idea is to develop an app, the seed funding would be required to lay the foundations for creating the app.
There are few types of seed funding:
- Using your own money,
- Using investments from friends and family,
- Crowdfunding and
- Angel investments
Let’s look at what each of these in detail and explore the advantages and disadvantages of each:
1. Using your own money
A lot of entrepreneurs use their own money to start up their own businesses – no one believes in your business more than you do! You would have either saved up this money or you have been using extra money that you accumulate as you go along. A fancy name for using your own money as seed funding is called “bootstrapping”.
Advantages of bootstrapping is that you maintain full control of your business and you are entitled to 100% of the profits. On the flip side (disadvantage), you also carry 100% of the risk involved with starting the business.
2. Using investments from friends and family
Asking for funds from friends and family to start a new venture is probably as old as funding itself. If they are not willing to support you, you probably have to refine your idea a bit.
Advantages of using funds from friends and family is that they do not focus too much on your credit history and have less stringent requirements for their return on investment. This means that they are less inclined to demand profits from the business. You would primarily maintain full control of your business and take advice from loved ones here and there. You would also be sharing the risk associated with starting a business.
Disadvantages are that you are not entitled to 100% of the profits. This could be considered expensive in the long-run.
While receiving money from friends and family is by nature informal, be sure to draw up agreements and sign them as you would with a bank for example. This will save you from hassle in the long-run.
Crowdfunding is a new form of raising capital. It is like using investments from friends on family, but on steroids. Instead of using the funds of your real friends and family, the entire internet network becomes your friends and family. An example of a crowdfunding in South Africa platform is Jumpstarter. While Jumpstarter Crowdfunding can raise large sums of money for your idea, the key is correctly managing the crowdfunds that successful Jumpstarter Project Creators have received.
- Donation based crowdfunding
Donation-based crowdfunding enables individuals to directly share their money with causes and projects that they feel strongly about and thereby empower others to create impact. This form of crowdfunding essentially involves backers donating varying sums of money to support a specific cause or project.
- Equity based crowdfunding
This form of crowdfunding gives each contributor a share of the business. With equity based crowdfunding, you give up a portion of the ownership of your business. And with that goes a portion of the profits. You may need to share in the decision-making when it comes for annual general meetings and shareholders get to vote.
- Rewards based crowdfunding
An example of rewards based crowdfunding in South Africa is Jumpstarter. This form of crowdfunding gives each contributor a reward.
With reward based crowdfunding, there is no ownership of the contributor. Instead, the contributors will each receive some sort of promised reward for investing in the business idea.
- Debt based crowdfunding
This is also commonly referred to as “crowd lending”, has proven to be a great alternative for startups, because although it is similar to acquiring a traditional bank loan, but often with competitive and lower interest rates, with more flexibility and options to secure resources.
For this reason, the owner of this business has an obligation towards the contributors which must be fulfilled once the business if up and running.
The trick with rewards based crowdfunding is to offer a reward that is not going to cost you too much. If your idea is hosting of an event, you can offer them complementary tickets. This will reduce your liability – otherwise you may run yourself out of business even before beginning.
4. Angel investments
Angel investors are described as being the opposite of venture capitalists.
Venture capitalists invest money in a business that is viable and that is prospected for high growth in the first few years. They also have an exit strategy to leave the business once the business has boomed and they have made their money. They exert significant control over the business to secure their end-goal.
Venture capitalists rarely provide seed funding – they rather focus on a small business that has high growth potential.
Angel investors on the other hand invest to help a start-up take its baby steps in exchange for an equity share or convertible debt. These are affluent people who seek to spend their money assisting entrepreneurs and start-ups spread their wings.
An angel investor would claim a percentage equity share in exchange for the funds provided but are not as rigorous as venture capitalists when it comes to how the business is managed. You would therefore need to split profits once they start rolling in.
These examples have served to educate you on wheat types of funding you can seek when looking for seed funding.
Sometimes government can provide seed funding but they attach limitations on how the money should be used. I have thus not included it with the general seed funding options.
It is important to understand in what position you and your business will be after receiving the funding you have applied for. Understanding this may cause you to steer away from choosing funding that does not suit your intended management style and profit sharing arrangement.
Be sure to choose wisely!