For early-stage founders, seed funding is often the first external investment they seek to accelerate growth. But how does seed funding work, and what does it mean for ownership and control?
In this article, we’ll break down the essentials of seed funding—how it impacts ownership, how much control founders retain, and why early-stage investors are critical for startup growth.
What is Seed Funding, and Why is it Important?
Seed funding represents the initial round of investment a startup raises to fund early-stage development. It’s usually acquired from high-net-worth individuals or angel investors who believe in the business idea’s potential. This stage is called “seed” funding because, like planting a seed, it’s the first investment meant to grow the business from its roots.
- Funding vs. Loans: Founders are advised to pursue equity funding instead of loans at this stage. Banks typically require quick repayment, which can be risky for a startup in its infancy.
- Legal Structure: Before seeking seed funding, founders should work with a lawyer to properly register the company, ensuring compliance and clarity on ownership.
“If you need money to grow, don’t get a loan because banks… can take everything. Make sure to talk to a lawyer, register your company.”
How Does Ownership Work in Seed Funding?
One of the biggest questions founders have is about ownership—how much of their company will they retain after seed funding?
As a founder, you decide the terms of the investment, including the percentage ownership you’re willing to offer in exchange for capital. Here’s a breakdown of how ownership works during this phase.
- Valuation and Ownership: If an investor provides $100,000 for a 10% stake, the company’s valuation is set at $1 million (based on the investment amount divided by the ownership percentage).
- Dilution: With each new funding round, your ownership decreases as new shares are issued to incoming investors. However, the increased valuation can offset the impact of dilution.
“If they give you a hundred thousand dollars and get 10% of the company, then that means your company is valued at a million dollars… You own 90% in this hypothetical example.”
Key Takeaway:
Early ownership is in the founder’s hands, but with each new investment round, ownership percentages will adjust.
The Role of Seed Investors and Their Expectations
Seed investors often play an active role in your startup, offering guidance, resources, and connections beyond just capital. However, they also expect returns, which means they’ll look for value growth in future funding rounds.
- Board Influence: Seed investors commonly secure a board seat, giving them a voice in major decisions. This ensures they’re involved in how their investment is utilized.
- Future Rounds: Seed investors are generally open to new investors joining, provided each funding round raises the startup’s valuation. This protects their investment from being devalued due to dilution.
“Every time you raise money, the previous investors usually have what’s called a pro-rata right… so they don’t get diluted.”
Key Takeaway:
Seed investors are partners in your journey and may seek a board position to safeguard their interests.
Valuation and Its Long-Term Impact on Fundraising
Valuation can significantly impact your ability to raise funds in the future. While it’s tempting to aim for a high valuation early on, this can limit future funding options if growth does not keep pace.
- Avoid Overvaluing Early: Setting an excessively high valuation at the seed stage can deter future investors. If your valuation declines in later rounds, early investors may feel reluctant to continue their support.
- Investors’ Due Diligence: When selecting investors, choose individuals who align with your vision and will support your growth journey. A problematic board member can create more challenges than benefits.
“Every time you raise money… make sure you do a thorough background check on [investors]… A jerk board member is worse than being in a bad marriage.”
Key Takeaway:
Keep early valuations realistic and select investors who are committed to your vision and supportive of long-term growth.
How Much Ownership Do Founders Retain?
As the company grows and raises additional rounds, founders typically end up with less than 50% ownership by the time the company goes public. While this may seem like a significant decrease, it’s a common outcome and doesn’t necessarily limit a founder’s influence if they have a strong relationship with the board.
“Most entrepreneurs that start companies… by the time their company goes public, they own way less than 50%… but the board loves them.”
Key Takeaway:
A lower percentage doesn’t mean less influence if the board supports the founder’s leadership.
Final Thoughts
Seed funding can be transformative, providing the capital needed to bring a startup to life. However, it comes with its challenges, primarily around ownership and control. To maintain influence while raising funds, founders should:
- Set realistic valuations: Avoid overvaluation to keep future funding options open.
- Choose investors wisely: Ensure they align with your vision and can support your journey long-term.
- Prepare for dilution: Accept that ownership will decrease over time, but strong board relationships can sustain founder influence.
By understanding these dynamics, founders can seed funding successfully, setting up their startup for growth without losing their vision along the way.
