What is Seed Financing?
Seed financing (also known as seed capital, seed money or seed funding) is the earliest stage of the capital-raising process of a startup. Generally, seed financing is considered the first stage of startup financing.
Seed financing is a type of equity-based financing. In other words, investors commit their capital in exchange for an equity shareholding in a company. Generally, the exchange is done in a less formal approach relative to other forms of equity-based financing such as venture capital.
Uses of Seed Capital
Seed capital is primarily used to support the initial company’s operations. For example, proceeds from the seed financing can be spent on market research or the initial steps of the product development (e.g., the creation of a prototype), as well as some other essential operating expenses such as legal costs.
The capital can be generally raised from family members, friends, or angel investors. Angel investors are the most crucial players in seed financing as they are able to provide a substantial amount of capital for startups.
Seed Financing as an Investment Vehicle
Seed financing is the riskiest form of investing. The rationale behind the financing model is that it implies investing in a company in its earliest stage of development, far before it generates revenues or profits. Due to such reasons, venture capitalists or banks usually avoid seed financing.
In addition, seed financing is probably the most complicated form of investment. In this type of investment, a potential investor does not have enough information to make a completely informed decision. In most cases, the key factors for a successful seed investment include the viability of the idea behind the product or service developed by a company and the ability of its management to realize the idea.
The soft skills of the company’s management also play a crucial role in making the right seed investment decision; however, management experience is not always significant. For example, many tech giants such as Facebook and Google were founded by individuals with almost zero experience of running a business.
At the same time, despite the risky profile of seed financing opportunities, they may provide immense return opportunities to investors. One of the most notable examples is American entrepreneur and venture capitalist Peter Thiel’s investment in Facebook.
In 2004, Thiel became Facebook’s first outside investor after contributing $500,000 in exchange for a 10% stake in the social networking giant. In 2012 and 2017, Thiel sold most of his stake in the company, earning more than $1 billion in total for his shareholdings!
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