The seed round of fundraising, sometimes called the angel series, is the first round of raising startup funding from a formal investor (or, more generally – from a third party, i.e. someone not necessarily accessed through your network).
Angel funding is used to determine the strategic goals and direction of the company: it funds your initial research into and refinement of your product and its potential market. This usually includes product identification and development, marketplace orientation, demographic targeting, and setting up a team.
This stage of a startup is exciting – you are still in the process of charting your course. It is also very challenging: you don’t have provable business success yet. You probably have a minimum viable product, and an idea with potential, but in all likelihood not much more. You are asking seed investors to fund the next step of your startup: transforming potential into commercial reality.
Because of the high risk associated with seed rounds, angel funding is often raised from multiple angel investors, each contributing a relatively small share of the angel startup capital.
At this stage, it is usually still too early for reliable company valuations, and for that reason angel funding rounds are often structured as convertible notes or SAFEs, although it can be in the form of equity grants or loans. This will depend on your startup’s unique situation.
Regardless of the form, investors will do their due diligence. How to be prepared for the first serious due diligence in your company’s lifetime?
Recent Developments in the Seed Financing Ecosystem
Until recently, seed financing was relatively simple, and along with that the due diligence process as well. It was not uncommon for early investors to base their decision solely upon their impression of, and relationship with, the founding team. Due diligence was minimal and relatively painless.
However, times have changed. Raising seed funds is a far more complex process today. There are new VC firms which explicitly target brand new, early stage startups (so-called “super-angels” or “micro-VCs”). There are also new options for seed finance, such as AngelList Syndicates which allows angels to pool their resources together.
One of the consequences of this increase in the institutionalization of seed funding is increased scrutiny during due diligence. It is no longer the informal process it once was.
A Due Diligence Checklist for Seed Rounds
A seed investor knows that you don’t have a provable business case to the same extent that a later stage startup has. In later rounds, due diligence will consist of investors scrutinizing your financials, contracts, corporate structures, intellectual property portfolio, liabilities, workforce, licenses, etc.
For a seed round, the emphasis is much less on ascertaining your current legal situation (which is probably nascent, simple, and unrefined). Rather, the emphasis is on confirming your potential. As such, investors focus on three questions: (1) How much potential value can this startup create (2) What is the probability of this potential realising? (3) How much time is needed for that potential to realise?
How to Prove Your Potential
The first part of your proving your potential is knowing what it is. Are you planning on a billion dollar IPO, or a $50 million exit? Both can be attractive investments, but you need to know which you are selling.
The second step is proving that potential. Here, you’d want to refer investors to :
Your financial statements and the predictions that flow from it
Your product and its economic rationale
Your IP portfolio or your plans to secure IP protection
Your go-to-market strategy
Of course, this list will depend on your unique situation.
How to Prove the Probability of that Potential Realising
To convince your investors that your potential is not just a pipe dream but a real possibility, you should do two things: (1) Show why you are a safe bet, and (2) Acknowledge the risks you face, and outline your strategy for minimizing those risks.
You can show that you are a safe bet in several ways:
Establish trust in, and the credibility of, your management team
Point to early successes
Provide detailed and realistic predictions for the future
Illustrate the market need for your product
Acknowledge competitors and show your competitive advantage
More importantly, perhaps: acknowledge the risks. Every startup faces risk. That is normal. The best way to convince investors to take the risk, is to clearly show that you are aware of it, and you are planning for it. Be candid about your biggest challenges, and have strategies for addressing them. Be sure those strategies are measurable, concrete, and possible.
Provide a Timeline
Investors are not only worried about whether they will see a return on investment, they are also worried about when they will see that return. Again: be candid and realistic. And have a timeline for your plan.
This list provides a rough guideline and a framework for thinking about securing angel funding. It is by no means exhaustive: allow yourself to be led by the circumstances.
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