Seed Capital

seed capitalSeed capital sometimes known as seed funding or seed money, is a form of securities offering in which an investor invests capital in exchange for an equity stake in the company. The term seed suggests that this is a very early investment, meant to support the business until it can generate cash of its own, or until it is ready for further investments. Seed money options include friends and family funding, angel funding, and crowdfunding.

Seed capital is the initial capital used when starting a business, often coming from the founders’ personal assets, friends or family, for covering initial operating expenses and attracting venture capitalists. This type of funding is often obtained in exchange for an equity stake in the enterprise, although with less formal contractual overhead than standard equity financing. Because banks and venture capital investors view seed capital as an at risk investment by the promoters of a new venture, capital providers may wait until a business is more established before making larger investments of venture capital funding.

Seed capital, venture capital, mezzanine financing and an initial public offering are the stages involved in financing startups. Seed capital is typically provided for market research, product development, prototype production or other early-stage operations. The business owner’s skills, business capabilities and track record, along with the product’s or service’s benefits, help determine how much seed capital investors may contribute to a startup.

Seed capital can be distinguished from venture capital in that venture capital investments tend to come from institutional investors, involve significantly more money, are arm’s length transactions, and involve much greater complexity in the contracts and corporate structure accompanying the investment. Seed funding involves a higher risk than normal venture capital funding since the investor does not see any existing projects to evaluate for funding.

The investments made are usually lower (in the tens of thousands to the hundreds of thousands of dollars range) as against normal venture capital investment (in the hundreds of thousands to the millions of dollars range), for similar levels of stake in the company.

Professional Angel Investors

Professional angel investors actively work with entrepreneurs in pooling resources and growing startups. These investors enjoy hands-on interaction while helping develop a company’s daily operations. Professional angel investors typically provide seed money through either providing a loan or by buying equity in the company.

When raising under $1 million, professional angel investors typically provide a seed loan. The paperwork is relatively straightforward and involves less-costly legal fees than seed equity. Interest rates tend to be lower, and the terms involve no restrictions. Also, future equity financing may be converted at a lower rate with a seed loan. In some cases, warrants may be issued so the professional angel investor may participate in company growth.

In contrast, when raising more than $1 million, professional angel investors typically utilize seed equity. Seed equity involves the investors purchasing preferred stock with voting rights and becoming co-owners of the startup. Seed equity transactions are more complex and expensive than those of seed loans, but may be viewed as more beneficial to investors when more seed money is needed.

Startup Capital

Startup capital is also referred to as seed money. Startup capital refers to the money that is required to start a new business, whether for office space, permits, licenses, inventory, product development and manufacturing, marketing or any other expense.

The money can come from a bank, in the form of a business loan; or from an investor, group of investors, or venture capitalist(s). In the case of a bank loan, the business will be expected to make monthly payments to pay down the debt plus any interest and/or fees. In the case of an investor, he or she will negotiate to provide that startup capital in exchange for a certain stake in the company.

Startup Companies

A startup is a young company that is just beginning to develop. Startups are usually small and initially financed and operated by a handful of founders or one individual. These companies offer a product or service that is not currently being offered elsewhere in the market, or that the founders believe is being offered in an inferior manner.

In the early stages, startup companies’ expenses tend to exceed their revenues as they work on developing, testing and marketing their idea. As such, they often require financing. Startup funding may be acquired via traditional small business loans from banks or credit unions, by government-sponsored Small Business Administration loans from local banks, or by grants from nonprofit organizations and state governments. Incubators can provide startups with both capital and advice, while friends and family may also provide loans or gifts. A startup that can prove its potential may be able to attract venture capital financing in exchange for giving up some control and a percentage of company ownership.

Because startups don’t have much history and may have yet to turn a profit, investing in them is considered high risk. Here are some ways that potential lenders and investors value a startup in the absence of revenues:

– The cost to duplicate approach looks at the expenses the company has incurred to create its product or service, such as research and development and the purchase of physical assets. However, this valuation method doesn’t consider the company’s future potential or intangible assets.
– The market multiple approach looks at what similar companies have recently been acquired for. The nature of a startup often means that there are no comparable companies, however. Even when there are comparable company sales, their terms may not be publicly available.
– The discounted cash flow approach looks at the company’s expected future cash flow. This approach is highly subjective.
– The development stage approach assigns a higher range of potential values to companies that are further developed. For example, a company that has a clear path to profitability would have a higher valuation than one that merely has an interesting idea.

Because startups have a high failure rate, would-be investors would consider not just the idea, but the management team’s experience. Potential investors would also not invest money that they cannot afford to lose in startups. Finally, investors would develop an exit strategy, because until they sell, any profits exist only on paper.


 

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