A Guide to Micro Seed Funding

 

Traditional Businesses and Funding Options

Traditionally, growing a new business from its initial stages to profitability can be very capital intensive.  If one is developing a physical product, there are prototyping costs, manufacturing costs, marketing costs, hiring costs, and more, which can add up to millions of dollars.  Of course, most entrepreneurs do not have millions of dollars to dedicate to their venture so they will look to raise money from outside sources.  

Investment is provided to the company in stages, or rounds.  Oftentimes, the first round is raised from family and friends who trust the entrepreneur and believe in the business model.  At this point, the risk and potential reward are high.  Since investment at this stage is made when the company’s valuation is low, the equity received for the amount of money invested is higher than it would be later in the company’s life when the valuation of the company has risen due to increased progress and decreased risk.

The next stage of investment will usually come from angel investors.  Angel investors are wealthy individuals, many of whom were entrepreneurs themselves.  They see lots of potential in the business and have faith in the management team.  Investment at this point still carries significant risk because the business may not have a fully developed product, customers, or revenue.  The angel round could be raised from an individual person or a syndicate of angels who have pooled their money together.  The amount raised ranges from the tens of thousands into the low millions.  

Venture capitalists (VCs) are different from angels in that they invest from a fund which contains money raised from wealthy individuals, investment banks, and other financial institutions.  According to a report published by Wilson Sonsini, the largest law firm in the valley, the average Series A venture capital round was $4 million in 2006. [1]  Venture capital money is used by the business to truly accelerate growth in terms of hiring, development, marketing, and working capital.  Like angels, VCs utilize their network of contacts to facilitate business development deals, gain press coverage, and initiate acquisition talks.  While VCs provide a substantial amount of capital, they generally require a higher level of involvement and restriction on the business, such as majority board control and minimum exit levels.  These restrictions depend on the level of negotiating leverage of the entrepreneur.  For instance, if the entrepreneur has prior experience running a successful company, he/she would be able to negotiate more favorable deal terms.


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Notes:
[1] http://www.startupcompanylawyer.com