Raising outside capital or selling part of your company is common for small business owners and entrepreneurs… however, it can also be very daunting.
As a small business owner you are an expert in your own field, but stepping into the World of raising seed capital can feel like going to a foreign country, where nobody speaks any English.
In other words, you’re lost.
And while you’ll not be fluent in the language of seed capital, today, we’ll give you an introduction so you can at least find your way ‘round after reading this article.
1. Who are the seed capital investors?
The first question to ask is: Who are the seed capital investors? The answer is pretty short and they fall into three categories.
- Friends and family: The easiest category to ask for money. Often, friends and family can provide capital if they like your idea, however, they will often not be of good use in terms of providing business guidance.
- Business Angels: There are thousands of business angels out there, ranging from local hobbyists to Jeff Bezos. Most Business Angels are hobbyists who buys into an idea and the team, more than they buy into numbers and rigorous business diligence.
- Seed venture capital funds: Speaking of rigorous business diligence is where seed venture capital funds come in. These are very professional and will often require numerous meetings. Further, they will have multiple partners involved in the decision-making process.
2. How do I know how much capital to raise?
Assuming you are spending more capital than you are getting in, the answer is very simple: You need to raise capital to keep you alive for the next ~15 months.
Sounds easy, right?
Probably not, so I’ll give you a quick example:
- You’re a tech firm
- You need 4 software developers on your team
- They each cost $200k per year where you’re located
- You don’t have any other material costs
- You expect revenue of $300k over the next 15 months
On the cost side, you’ll need 4*$200k = $800k. However, you will also make $300k which brings your funding need down to $500k. That is what you’re looking to raise.
3. What is my company worth?
You know, you need to raise $500k. However, you still have no clue what your company is worth. So, how much equity you’re willing to give away?
For a seed capital round, the rule of thumb is to give away 20-25% of the equity in your company.
In other words, if you raise $500k and give away 25% of the equity your company valuation is $500k / 25% =$2m. If you give away 20% of the equity the value is $2.5m.
4. Focus on getting the right people on board, not your valuation
When raising seed capital, one of the fundamental mistakes many make, is to focus on the valuation instead of the people. However, after the seed capital round, you will still hold the majority of the equity and hope you can grow this company into something huge.
To grow it into something huge, you’ll likely need outside expertise and that’s very important when raising seed capital. Ideally, this outside expertise should complement your skill set.
Assuming you’re a founder with a technical background you’ll likely need someone that can:
- Help with the strategic plan
- Provide sales and marketing capabilities
- Does not necessarily need to have strong technical capabilities
In other words, the valuation the investor bids at is only a small part of the equation, when evaluating a bid.
The question then becomes: How do I know if they’ll bring anything to the table? The answer is to do your own due diligence on the investor, just like you would when hiring staff.
5. Practice your presentation and know your numbers
Ever watched the TV show Shark Tank?
Have you ever noticed how quickly the ‘sharks’ lose patience with founders who don’t know their numbers?
And what do you think of those people who don’t know their numbers?
You’ll probably think they look amateurish and that’s exactly what the Sharks think as well. First impressions are everything when meeting investors, and here are three guidelines to remember:
- Practice your pitch, to give a good first impression
- Know your numbers
- Start doing your due diligence on the investor right away. Are they asking good questions, and do I want to work with these investors?
Ready to talk the seed capital language?
As you can see, there’s a lot to learn about raising seed capital, but I hope this article has given you a thorough introduction and made the entire process less daunting.
Steve Rice is a finance professional who helps small business increase their productivity at BlueTieSlides.com. For any questions, you can find him on Twitter.