Where does the initial seed money come from?

Seed capital explained

Updated December 30, 2021

Seed capital is the initial funding needed to start a new business and cover startup costs like business proposals and research. It also covers proof of concept, which demonstrates that a business idea is feasible. Investors during this stage usually include friends, family, and people close to the business owner. Once a business is established after the seed stage, a company can get investments from venture capitalists, angel investors, and financial institutions. 

To gain a better understanding of seed capital, it’s important to learn about how seed capital works, the types available, when you need it for your business, and the difference between seed capital and venture capital (VC).

Seed Capital Definition and Examples

Seed capital is the initial round of funding a business receives to get started. In its early stages, a business may not have an established reputation or even a tangible product or service to attract higher-tier investors like venture capitalists and banks. 

With typically just an idea in tow, these founders rely on their own savings (known as boot strapping), or else close friends, family, or so-called angel investors to fund early business costs to develop their concept.

Seed capital is often used to pay for:

• Business plans
• Market research
• Prototype development
• Office rent
• Equipment
• Legal costs
• Patent costs
• Early-team payroll
• Consultancy fees
• Marketing budget

Seed capital is the earliest stage of the startup funding process. There are generally four rounds or series of investments a company can receive in total: seed, Series A funding, Series B funding, and Series C funding.

• Alternate definition: Early-stage investments
• Alternate name: Seed funding

How Seed Capital Works

An idea itself may not be enough to get investors or financial institutions interested in giving a business money, which is why seed capital plays a crucial role in legitimizing and solidifying a founder’s business concept. The investment amount can vary but seed funding typically ranges from $250,000 to $2 million.

In exchange for investments from early investors like family and friends, a founder may offer certain benefits or forms of capital. “This type of capital can come in the form of a gift, a loan, or a return deal for equity in the future company,” said Zain Jaffer, a San Francisco-based venture capitalist and CEO of Zain Ventures, in an email to The Balance.

According to Jaffer, new businesses often fail, so these ventures are considered high risk. But early investors looking to gain high rewards often want to invest before the company valuation is too high. 

Types of Seed Capital

Seed capital can come from many sources: the founder’s own funds, their family and friends, angel investors, and even crowdfunding. Here is a closer look at each type of seed funding.

Owner Funds

Sometimes, the only capital a founder or business owner has is their own money. However, this can be enough to get the business past the development stage and in front of professional investors. What’s more, by self-funding, owners can bring their business to life without giving away equity too early on. 

Family and Friends Funding

One of the most common types of seed capital comes from those closest to the business owner. Family and friends are more likely to believe in the business concept because of the personal relationship, and their only concern may be with the return on their investment. 

Dealing with close loved ones can create its own set of liabilities if owners aren’t careful. Be aware of the informal nature of business dealings with family and friends, and be transparent with them about the risks involved.

“A friend or family member investing, without prior experience investing in early-stage businesses, might not have clear expectations of any kind—or worse, unrealistic expectations,” said Phil Leslie, managing director at TechNexus Venture Collaborative, in an email to The Balance.

An investment from a relative or friend is still an investment that owners should document clearly. The last thing a business owner needs is misunderstandings that can lead to broken relationships and legal issues. 

Angel Investors

Angel investors are typically high-net-worth individuals who invest in the early stages of a business in exchange for an equity share. These investors are looking for a solid return; a startup with a good management team and business plan; and the opportunity to play an active role in the form of mentorship, board membership, or even management. 

Crowdfunding

Crowdfunding can be an ideal, accessible way for new companies to gain seed capital. Founders can set up an online campaign on platforms like Kickstarter, IndieGoGo, AngelList, SeedInvest, and WeFunder to allow a target audience to invest in their company. 

Crowdfunding can involve equity-based crowdfunding, in which a founder gives equity or potential future return in the business. However, with rewards-based funding—in which businesses provide investors exclusive experiences or early versions of their product—as well as donations and marketplace lending, founders with a solid idea don’t need to give away equity to raise crowdsourced capital.

Do I Need Seed Capital?

In an email to The Balance, Gregory Rozdeba, president of Toronto-based digital life insurance firm Dundas Life, said, “Seed capital is an appropriate source of funding if you have a viable business idea, but you cannot fund the idea yourself and do not yet qualify for a business loan from a financial institution.” Some founders and business owners don’t have the funds or access to the startup capital that professional investors and financial institutions offer. If this is your situation, seed capital might be necessary to pay for research, business equipment, research, or consultants to develop your ideas.

You should be cautious about giving away too much equity early on. Too many investors with a stake in the company can make your business less attractive to higher-tier investors in the future.

Seed Capital vs. Venture Capital

Most VC firms invest in companies that have established proof of concept. Also, VCs can choose to invest in a business in the early stages of seed funding, but there’s usually a heavy focus on financial returns.

“Seed capital is distinct from venture capital because it does not involve an entrepreneur securing equity in the company being formed,” said Jenna Lofton, a New York-based certified financial advisor and investor, in an email to The Balance. “This type of financing is often (but not always) provided by family or friends to avoid diluting their interest when more external financing may be required in order to grow,” 

How to Get Seed Capital

Seed capital usually involves investments from friends and family, making it a unique way to start a company. Because of these personal relationships, seed capital can often be easier to gather than other types of capital. But it’s not always easy to convince people you know to loan you money or invest in your business idea. 

“The main aim of seed capital is to support a startup until it is able to attract further funding or generate its own cash flow,” said Rozdeba.

The best way to raise seed capital is to present your business idea professionally, even if your investors are your close friends and family. It’s essential to set the terms of the investment exchange in writing and consider how much equity you’re willing to give away. 

Key Takeaways

• Seed capital is the initial funding source needed for a business startup to establish the business and attract more funding later.
• Seed capital usually comes from family and friends but can be garnered from crowdsourcing, angel investors, and the business owner’s funds.
• Seed capital differs from venture capital in that it does not involve the founder securing equity in the business being formed.
• One of the main goals of seed capital is to support a startup until it can attract further funding or generate its own cash flow.

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