You may have read the phrase “Seed Round” and wondered: what does that really mean? And if I’m looking for startup funding, is that what I should tell investors I’m looking for?
We’re going to break it down for you, and also define related phrases such as “Seed Stage,” “Seed Funding,” “Seed Money” and “Seed Capital.”
What Does ‘Seed’ Mean in Seed Round?
There are two related but different meanings of the word “Seed” when you’re talking about startups.
One has to do with the stage of development of your company. This is often referred to as “Seed Stage.”
The second has to do with the investment specifics, including:
- how much (if any) equity money you have already raised
- who provided that previous equity investment (friends and family? Angels? VCs?)
- whether the investment round is preferred shares or a convertible note.
And because there are two different meanings of the word “Seed,” what people actually mean when they say “Seed Round” can be pretty dramatically different.
Making this even more complicated, there is an element of “marketing to investors” and company valuation in this context, which has changed over time. Here is an excellent blog post by VC Mark Suster on this topic.
That means some entrepreneurs today want to call a funding a “seed round” when ten years ago it was called a Series A. See below for what that means!
What is a Seed Stage?
Unfortunately there is no universal, super clear, widely accepted definition of Seed Stage. Like a lot of startup related phrases, Seed Stage of development extends across a wide range and the border is fuzzy between what comes before Seed Stage and what comes after.
Here are the general “stages of development” of a startup that might want equity capital. These are terms most often used in the investment world, but unfortunately they aren’t always used in the same way. So if you’re confused it’s because you’re paying attention!
- Idea Stage
- Seed Stage
- Early stage
- Growth Stage
An Idea Stage company is at the very beginning of the process. An entrepreneur, or a team, has a business concept, but not much else. They have no prototype, they haven’t talked to many or any potential customers, they may not have a team, and they likely don’t have much of a business plan. And the founders haven’t quit their jobs yet!
What does Seed Stage mean? It’s when you have actually started your startup! You are making some progress but the road ahead is still long. Here are four elements of a Seed Stage business:
- The founding team is anywhere from just one person to two or three founders plus a small team of individual contributors, but more senior management is still needed.
- A product or service prototype is starting to be developed, or it may be all the way through initial development and has been released as a Minimum Viable Product.
- You’ve at least started talking to potential customers (seriously, you haven’t? do it now!), and may have a few early customers, but you’re still learning a lot about them.
- You may have some ideas about your go to market strategy (or maybe you’re still learning what that means!), but you don’t yet have enough information to validate your marketing ideas.
Seed Stage can go on for a while and covers a lot of territory.
What about Early Stage? The word “early” can mean very different things to different people, so again don’t be surprised if you find or hear very contradictory things.
In terms of equity investors, Early Stage tends to be relative, and it’s different for different investors. If a VC web site says that they invest in Early Stage companies, don’t be afraid to ask them what they mean by Early Stage. Here is the range of answers to expect.
- The senior management team is anywhere from 50% hired and working full time, to 100% on board but still learning to work as a team.
- The product or service has been out for at least “a little while,” but maybe longer, and the team has a pretty good idea what the future product development roadmap looks like.
- Early customers may still be Early Adopters, and there’s likely some work to do before the Early Majority customers can be reached.
- Similarly the go to market strategy is well defined and execution on the strategy has started, but the metrics aren’t quite where they need to be yet to create a profitable business long term.
If you want to understand the Scaleup stage, see our video on Scaling Your Company. And after you’ve made progress on Scaleup and matured your business processes, you are in more predictable Growth Stage mode. Once you reach that Growth Stage you will be attractive to Private Equity funders.
Exit Stage has to do with investors getting a return on their seed money by either selling the company, or taking the company public in an IPO. While it’s listed above as #6, it can happen anywhere from Early Stage to Growth Stage.
What Does ‘Round’ Mean in Seed Round?
Equity investment often happens in an organized “round” for both business and legal reasons. An investment round such as a seed round:
- Has a target amount for total seed money to be raised
- Often has a minimum amount necessary to “close” the round
- Offers all investors the same investment terms
- Provides the same legal documents to all investors
- Often finishes with a scheduled closing date when signed legal documents and money (checks or wire transfers) are exchanged.
After entrepreneurs secure commitments from enough investors that the target dollar amount can be reached, the round closes, money is in the startup’s bank, and entrepreneurs can go back to building the business, at least for a little while!
Sometimes a single seed round can have multiple closings. This is especially true when individual angel investors are interested, a convertible note is planned instead of priced preferred shares, and the minimum amount has already been raised. Then, the entrepreneur sometimes rounds up one angel investor at a time and closes on them individually. Convertible notes make that legally possible and affordable.
Alternative Sources of Seed Funding
Before you pursue a Seed Round, make sure you have at least considered alternative sources of Seed Capital (another name for Seed Money or Seed Funding) when you are at the Seed Stage of development.
When you are just starting up, there are many different options for Seed Money. That’s what this blog is all about, right! There are Four Colors of Money for Entrepreneurs, and Seed Rounds are all about just one color – Equity. How about the alternatives?
Bootstrapping your Seed Funding can include:
- Investing your existing financial assets if you have any – savings, retirement funds, home equity, or selling valuable hard assets like property, cars or jewelry
- Reducing your need for seed money by cutting costs – working at home, finding cheap used computers, and so on – and by bartering or promising stock in return for help
- Getting customers to pay upfront for services or products you deliver later, anything from web site design to Kickstarter funded gadgets.
But you wouldn’t say “I just closed a bootstrapping Seed Round.” It’s more like a continuous process of creatively finding and saving cash.
Grants and prizes are often targeted at seed stage companies. College business pitch competitions often offer cash prizes, as do other pitch competitions. Federal research grants target seed stage companies. And there are a few accelerators that provide grant funding but don’t get any of your shares in return.
If you have decided that Equity Seed Funding is right for you now, the next step is to figure out what type of investor is right for you. In general those include:
- Angel investors individually
- Angel investor groups
- Online angel crowdfunding and “super angels”
- Venture capital seed funds.
As far as I know, Accelerators don’t consider their investment to be a Seed Round, even though it’s a Seed Funding of Seed Capital. Confusing, right? But the rest of these sources of equity Seed Funding will generally be participating in a Seed Round.
Which brings up a good question.
What is a Series A round of financing?
Back in the good ol’ days of venture capital – that’s when I was at Accel Partners – the first institutional investors in a company invested in a Series A round of financing. The lawyers called it Series A because it was the first preferred shares to be issued by the company.
The term “institutional investors” refers to the way venture capital firms are organized, as well as where they get their money from.
VCs are investing and managing investments over a very long period of time – at least a decade if not multiple decades. So they build a company – an “institution.”
And, they are raising money from pension funds, university endowments, insurance companies, and other institutional sources of money. And sometimes wealthy individuals as well.
Since those earlier days of venture capital, the industry has grown, evolved, and become more complicated.
Some individual angel investors write big checks themselves, as big as a small institutional venture capital firm. Or, they organize syndicates through Angellist, or become “super angels” by raising money from other angels and running it like a venture capital firm.
Are these Series A? Smart people may disagree. But I’d say no.
And, convertible notes were invented, flourished and now dominate Seed Rounds. When your company issues convertible notes, there is nothing in the legal documents that says Series A.
And sometimes institutional venture capital firms will invest for the first time in a convertible note rather than preferred shares. Is that a Series A? Smart people may disagree, but I’d say no.
Despite the evolving complexity of funding startups, I think it’s helpful to think of the Series A round of financing as:
- The first equity financing from an institutional venture capital firm that is
- Preferred shares
- Signifying the company is at an Early Stage of development (or later), past the Seed Stage as discussed above.
Should You Be Looking For A Seed Round?
To summarize, then, you should be looking for a Seed Round if:
- You’ve decided that equity is the right choice for you now, versus boostrapping, grants and prizes, or debt
- Your business is beyond the Idea Stage and firmly into the Seed Stage of Development, but still not ready to scale
- You do not yet have institutional venture capital, and you don’t think you’re ready for it yet
If this has raised more questions, like “Seed Round or Series A?” that’s ok! Don’t get too hung up on the words and focus on how much you need and who you need it from. That’s more important than what to call it.