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seed funding

Page history last edited by PBworks 15 years, 4 months ago

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Table of Contents:


 

Seed Funding for a new business

 

A relatively small amound of financial capital provided to start development and prove the concept. It rarely involves initial marketing.

 

Benefits: seed funding may be necessary during the planning phase

Drawback: seeking funding so early in the businesss, you may give up more control than you need to.

 

Potential sources of research funding: (list companies that fund research:)

 

 

General information:

 

Seed funding is investing capital to begin a new project, so that it has enough funds to sustain itself for a period of development until it reaches either a state where it is able to continue funding itself, or has created something in value so that it is worthy of future rounds of funding.

 

Seed funding involves a higher risk than normal venture capital funding, as the investor does not see any existing project to evaluate for funding. Hence the investments made are usually lower (in the tens-thousands to hundred-thousands of dollars) as against normal venture capital investment (in the hundred-thousands to millions of dollars), for similar levels of stake in the company.

 

Investors make their decision whether to fund a project based on the perceived strength of the idea and the capabilities, skills and past history of the founders.

 

Seed money is money that is used for the opening for a new business to pay for such preliminary stages as market research and product development. Potential business owners may use savings, remortgage, or raise funds from family and friends. A more business oriented option is to seek out angel investors, venture capitalists or accredited investors who may have an interest in the business and would be willing to invest in it. Seed capital does not need to be a large amount of money. Many people start up new business ventures with $10,000 or less. Seed money is not venture capital.

 

Seed money can can also come from financial bootstrapping. Bootstrapping in this context means making use of the cash flow of an existing enterprise. If an entrepreneur focuses on selling products and ensuring early payment, this is the most obvious way of generating seed money. However, as well as raising the bridge, an entrepreneur can lower the water. Other means of garnering or conserving seed money include purchasing second-hand equipment rather than new or leasing rather than buying; paying sales people or agents on commission rather than having people on the payroll.

 

Frequently an aspiring entrepreneur may think that he or she must spend all their early energy on raising finance, but often too much money is more disabling than too little. If cash is tight, the startup will be concentrated on essentials. Even after revenue is being earned, cash flow management will be the most significant determinant of early survival.

 

 

 

 

Early Stage Seed Capital:

 

 

startup incubators  

model:  introduce new companies to Venture Capitalists...offering startups seed funding, guidance, and connections in exchange for equity.

 

 

 

When seed funding is better than Series A

 

 

It’s surprising how often I meet with first-time entrepreneurs who tell me they need $5 million.

 

Not many companies need that amount in their first round of funding. Much of the time, what they need at the earliest stage is enough money to prove the concept and mitigate some initial risk. Often, what they require is seed funding, more on the order of $250,000 or $500,000.

 

So why do entrepreneurs think they need so much money right out of the gate? Some seem to be attempting to finance their way to profitability, but more often than not they think they need to ask for several million to get the attention of VCs. It’s become a bit of an urban legend: VCs won’t take an entrepreneur seriously if they ask for less than $5 million. That tall tale belongs in the archives with the one about how alligators live in the sewer system.

 

An entrepreneur’s risk spans three areas: team, technology and market. They can determine how much funding they need by asking themselves one question: Can a small amount of money dramatically reduce one or more of these risks in six months?

 

By securing only as much capital as they initially need in a form of a seed round, entrepreneurs do themselves a big favor. First, assuming they take the seed funding as a bridge round which will convert into an eventual A round, they suffer no dilution. Second, they ensure themselves a much better valuation when they do eventually secure an A round because they have reduced one or more key risks during the seed period. Third, with this small amount of money, the entrepreneurs can get more insight and information on whether their idea is worth investing their own valuable time in before they have to make the multi-year commitment that comes with larger investments.

 

So what do I mean by reducing risk across these three areas? Let’s look at a few examples:

 

Reducing team risk:

 

The team is what makes or breaks startups. A great team can work together and find a market opportunity that can be attacked. Since all team members have different strengths, finding other founders with complementary skills and similar passion is critical for success.

 

Reducing technology risk:

 

The most amazing idea in the world is worthless if you can’t get it to work in a prototype or alpha. The founders of Eye-Fi used their own money and sweat equity to initially finance the company, taking in seed funding to build their first prototype Wi-Fi-enabled SD card. By the time the company went out to raise an A round, Eye-Fi had more than 100 users of the product and tremendously useful feedback from those early users. (One reason why my firm invested in Eye-Fi’s series A.)

 

Reducing market risk:

 

And the most amazing technology or product in the world is worthless if there isn’t a market with potential buyers willing to suspend their disbelief and buy from a startup. For example, if a product for the data center cannot solve a “Top 5” CIO pain point that will exist when the product comes to market, sales cycles will be long and growth will be slow. The team at Riverbed figured this out and launched a product that helped enable data center consolidation, a top priority for CIOs. (Riverbed is an investment that was made while I was at Lightspeed Venture Partners).

 

When entrepreneurs have a great team developing a solid technology concept that they know first-hand will solve an urgent market need that exists―or will exist when they come to market―those companies are ready for Series A funding.

 

But in the kind of market that’s so prevalent today, where many great ideas are competing for questionable demand, entrepreneurs need to mitigate key risk factors before they take on too much capital. For those companies, the seed of financing could be just what they need to help their seed of an idea grow into a successful company.

 

 

 

 

Examples of Seed funding:

 

If you’re a budding entrepreneur, check out a program being launched today by Highland Capital Partners. It allows selected teams to spend the summer at Highland's office -- either in Massachusetts or California – which includes access to Highland investment professionals and other relevant resources. In fact, two of last year’s teams ended up getting seed funding from Highland. Info on how to apply can be found here.

 

 

 

 

Valuations:

 

 

Venture Capital Method of Valuation

 

Valuations and internet companies

Internet business plans dont matter (how to value internet companies)

Venture Capital

business valuation

 

valuing a firm

 

 

 

 

 

Using "Options" to value a startup:

 

The core of the NPV analysis assumes that you are sitting at time T=0, and that you have one decision to make.... You first calculate the expected cash flows, and then you discount them to the present value to compare NPV of the various choices.  If the project has a positive NPV, you accept the project, if its negative you reject it.  

 

The problem with this analysis is that it doesn't properly value Options.   You  often have the choice to invest more at a later date.  You might have the option to invest just a little now...to get the project rolling, and then if its going well...then you invest a little bit more at a later date.  This is the essence of the Venture Capital Method of Valuation.   This is often referred to as a "decision tree" analysis which handles risk in a more sophisticated manner.   With this method, you value the firm today assuming that future decisions will be optimal (even before knowing what those decisions are going to be).

 

Starting a project is like purchasing a call option.  If further information is revealed that makes the investment seem attractive, then you have bought the right to that investment in the future.   In general, it is in investors best interest to not exercise the call option immediately, but rather to wait until the end of the time period to see what new information is presented.

 

The problem with standard NPV analysis is that it does not consider the very real world flexibility that most managers (and Venture Capitalists) face.   An NPV analysis might show that a project should not be undertaken, but thinking in terms of options, you might be willing to invest a little for the option of being there in the future.  This explains alot of seed funding of a few million dollars of Silicon Valley companies (that no-one but Venture Capitalist's can figure out why they are being funded).   Sometimes, its just a matter of believing in the vision of the entrepreneur, or the idea, or seeing potential for untapped market share, and a little VC money makes sense (if not in an NPV world).  By allowing the investing firm to change its investment policy later according to new information, a seemingly unwarranted investment can be justified. 

 

Managers that just use NPV are ignoring real-world flexibility in their analysis.

 

 

External Links

 

 

 please visit Tech Crunch for more info

 

 

 

 

 

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