There comes a time in life when you want to work for yourself, buzzing with bright business ideas and backed up with a conviction to make it happen. Economics tells us that all four factors of production i.e. land, labour, Capital and enterprise are scarce and hence one must make optimum use of these resources to succeed in business. Its an era of start-ups and everyone who has this million-dollar business idea is searching for Seed Capital to get started with it. Todays column is all about Seed Capital and aspects relating to it.
What is Seed Capital?
Seed Capital is the initial money required to start a new business.The amount of money is generally small because the business is still in its conceptual stage and the funds are required to finance the preliminary activities such as research and development, marketing research, etc. Thus, seed capital is required to cover the initial operating expenses until the product and services start generating the revenues on their own.
Sources of Seed Capital
Friends and Family: Founders can seek Seed funds from their friends and family basis their personal relationship and goodwill.
Angel investors: The Angel Investor(s) are particularly High Net worth Individuals (HNIs), who park their personal wealth (either individually or in Groups) in Start-ups by way of investment in Equity. They are high-risk takers and aim to capitalise on their investment when the startup raises further rounds of Equity funding. Angel Investors also provide mentorship, goodwill and a huge network to the start-ups, which augments business strategy, growth and builds brand image.
Venture Capital Funds (VCs): These are the investment funds that provide investment to the start-ups in the early phase in exchange for Equity. However, not all VCs are into seed financing and usually look to invest in growth stage after the startup has already raised seed capital.The VCs make substantial returns on their investment when they exit the startup; at the time of acquisition or takeover of the said startup by a bigger player which happens at a much higher valuation. Some of the Indian Start-ups, which are VC funded, are Paytm (Noida), Foodpanda (Gurugram).
Paperwork involved
Non-Disclosure Agreement (NDA) is signed between the Startup and the potential investor(s). This is done at the time of commencement of the initial talks with the potential seed investor(s), and it is signed to ensure that the Seed Investor protects the secrecy and the confidentiality of the information being shared by the Startup (to facilitate Seed Investment). However, don’t straightaway talk about signing the NDA with your potential Investor as it might break the deal. Lot of Investors don’t like when Founders are very uptight about signing the NDA first before they proceed ahead with other stuff. You can sign it during rest of the paperwork or warmly put forward a request for signing NDA.
Term Sheet: is a significant document that envelops the deal structure by clearly elucidating the terms of investment including the price per share and the Pre-Money and Post Money valuation of the Company. It is non-binding in nature and the proposed investment is subject to formalisation by Share Subscription Agreement and the Shareholders Agreement. Term sheet broadly has two provisions i.e. The Economic Provisions and The Control Provisions. Economic provisions govern the commercial part of term sheet and includes price per share, participation by Investors amongst other things. Control provisions lay out the powers, rights and preference Investors will have over Founders.
Business Valuation Report: evaluates the Fair Value (valuation) of shares of the Company ie the price per equity share of the Company as on the date of Seed Investment. The Higher the valuation of the Company, the more lucrative it appears to the potential Seed Investor.
Share Subscription Agreement (SSA): is entered by and between the Startup and the proposed Investor, thereby defining the mechanics of the proposed Investment in the startup. It is a share offer document by the Startup and promise by the Investor to subscribe to the shares of the startup that binds the parties to the deal and sets out the investment process to be followed.
For the purpose of drafting and executing allthe aforesaid documents, an experienced startup lawyer should be appointed for the task, as it involves in-depth analysis and understanding of the deal structure governing the future understanding between the parties and compliances with the laws of the land.
So, if you are waiting to take the plunge in your own business, hope this article helps you to take the first step forward by understanding the dynamics of Seed funding. Remember to do your homework such as researching extensively on Angel investors and Venture Capitalists and the type of start-ups they invest in, and things they look for in a team and the product before they invest.Chalk out a proper pitch deck explaining the problem you’re solving, how you’re solving, your team, total addressable market, competitors, the small roadmap of milestones and the business model. Remember it is never too late to be what you might have been, so trust the magic of new beginnings.
