The term “Seed Funding” has to be one of the most preliminary terms which a founder cannot get out of her mind when starting her dream venture. Seed Capital is very crucial at a startup’s early stage, fueling it to form a great team, getting the minimum viable product ready and satisfying first 100 customers.
Seed Funding-What is it?
“Seed Funding” is the nascent-stage funding to finance the early growth needs of a Startup. Seed funding is the Capital or the First Round of Investment made in the Company in exchange for Equity.
Sources of Seed Capital:
- Friends and Family: Founders can seek Seed funds from their friends and family basis their personal relationship and goodwill.
- Angel Investor(s) or group(s) of Angel Investors: The Angel Investor(s) are particularly High Net worth Individuals (HNIs), who park their personal wealth (either individually or in Groups) in Startups by way of investment in Equity. They are high-risk takers and aim to capitalize on their investment when the startup raises further rounds of Equity funding. Angel Investors also provide mentorship, goodwill and a huge network to the startups, which augments business strategy, growth and builds brand image.
- Venture Capital Funds: Venture Capital Funds (VCs) are the investment funds that provide investment to the startups in the early phase in exchange for Equity. However, not all VCs are into seed financing and usually look to invest in growth stage after the startup has already raised seed capital. It is strongly advised that Founders read the investment thesis on VCs website to see whether they invest in early stage or not and then approach the VC. The VCs make substantial returns on their investment when they exit the startup; at the time of acquisition or takeover of the said startup by a bigger player which happens at a much higher valuation. Some of the Indian Startups, which are VC funded, are Paytm (Noida), YEPME.COM (Gurugram), Foodpanda (Gurugram).
- Crowdfunding: Crowdfunding refers to raising of funds from the “Crowd” i.e. from more than one investor(s) at the same time. Here, the startups put their business plan explaining the purpose of investment, the amount required and the projected cash flows on the Crowdfunding platform. If the Crowd-funders on the platform support the said business plan then they would contribute funds for supporting the same. Startups in India which have been Crowdfunded are Wishberry, Ketto, and BitGiving.
Important Paperwork involved in raising Seed Fundraising:
NON-DISCLOSURE AGREEMENT (NDA) is signed between the Startup and the potential investor(s). This is done at the time of commencement of the initial talks with the potential seed investor(s), and it is signed to ensure that the Seed Investor protects the secrecy and the confidentiality of the information being shared by the Startup (to facilitate Seed Investment). However, don’t straightaway talk about signing the NDA with your potential Investor as it might break the deal. Lot of Investors don’t like when Founders are very uptight about signing the NDA first before they proceed ahead with other stuff. You can sign it during rest of the paperwork or warmly put forward a request for signing NDA.
TERM SHEET is a significant document that envelops the deal structure by clearly elucidating the terms of investment including the price per share and the Pre-Money and Post Money valuation of the Company. It is non-binding in nature and the proposed investment is subject to formalisation by Share Subscription Agreement and the Shareholders Agreement. Term sheet broadly has two provisions — Economic Provisions and Control Provisions. Economic provisions govern the commercial part of term sheet and includes price per share, participation by Investors amongst other things. Control provisions lay out the powers, rights and preference Investors will have over Founders.
BUSINESS VALUATION REPORT evaluates the Fair Value (valuation) of shares of the Company i.e. the price per equity share of the Company as on the date of Seed Investment. The Higher the valuation of the Company, the more lucrative it appears to the potential Seed Investor.
LETTER OF INTENT (LOI) signifies the interest of the Investor in making the proposed investment in the startup; this is subject to the completion of the due diligence process, provision of additional information and fulfilment of certain conditions precedent by the Startup.
DUE DILIGENCE REPORT: The proposed investor conducts due diligence of the complete business of the startup. A positive Due Diligence Report further assures the investor about its investment in the startup.
SHARE SUBSCRIPTION AGREEMENT (SSA) is entered into by and between the Startup and the proposed Investor, thereby defining the mechanics of the proposed Investment in the startup. It is a share offer document by the Startup and promise by the Investor to subscribe to the shares of the startup that binds the parties to the deal and sets out the investment process to be followed.
SHAREHOLDERS AGREEMENT (SHA) is an agreement between the Investor and the existing shareholders of the startup thereby defining a common understanding between them with respect to the economics of the deal, the extent of control i.e. rights and privileges of the Incoming Investors, the duties and liabilities of the Founders, the Reserved matters, the terms governing the further fundraising, the Anti-Dilution measures, and the Liquidation Preference for the Investor(s).
For the purpose of drafting and executing all of the aforesaid documents, an experienced startup lawyer should be appointed for the task, as it involves in-depth analysis and understanding of the deal structure governing the future understanding between the parties and compliances with the laws of the land.
Consider the below points, before you initiate the Seed Fund Raising Process:
Before reaching out to the Investors for Seed Financing, the Founders should:
- Make a list of Angel Investors/HNIs/ Friends/Family/VCs they would want to approach to raise seed capital
- Do good Homework specifically on VCs and Angel Investors. This includes researching extensively on the kind of startups they invest in, when do they invest and what they look for in a team and the product before they invest. This is available on their Investment thesis generally found on their website.
- Chalk out a proper pitch deck explaining the problem you’re solving, how you’re solving, your team, total addressable market, competitors, the small roadmap of milestones and the business model.
- Consult or hire a good Startup lawyer, arrive at a fair valuation, get a draft term sheet, figure out how much money you want and how much equity you can give away. This really helps you in on the negotiation table.
- Plan on how frugally the funds will be utilized. Investors love frugal founders.
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