30 Apr How to Ascertain the Optimal Amount for Your Seed Round
Seed capital or funding is the initial capital required to get the company on its feet. It is not only crucial in helping companies start with its preliminary operations such as market research, product development and establishing a business network but also sets the stage for their future valuation.
Usually seed capital is sourced from the founder’s own savings or borrowings from relatives and friend and in some cases even crowd sourcing platforms. Since this is considered as a high risk investment the amounts invested are usually not very high. However, with the growing scale, cost of technology and resources, seeking outside funds for starting a business has now become imperative.
How much is too much?
For an entrepreneur having a solid product or technology, a robust business plan or the requisite know how is half the battle won but what fuels his efforts is having optimal financial resources at his disposal to transform his vision and plans into actionable.
That brings us to the most pertinent question – How much seed capital should one raise.
There are two decisive factors that one should take into consideration while calculating the seed capital requirements.
- Cash Burn and
- Quantifiable Milestones.
What is Cash Burn?
The rate at which a company uses its start-up capital to fund its operations before it has generated a positive cash flow is referred to as the cash burn rate. It is imperative that the Company calculate an accurate burn rate in order to arrive at the optimal seed capital requirement.
The burn rate includes manpower, operational costs and spending on infrastructure. A high burn rate that exceeds forecasts implies that the company has far too many resources than what is required at the current stage of development and will result in depletion of capital. The efforts of the company should be on minimizing the burn rate either by deploying the most appropriate number of resources required be it manpower or operational expenses, or generate revenue in some form to offset the burn rate.
What are Quantifiable Milestones?
The key to a successful start up is the ability to translate the business plan into achievable and quantifiable milestones. A milestone could be the hiring of a key manpower resource, launch of a product or service, making the first sale, or entering a key collaboration. These milestones will determine how much capital will be required to be raised at different stages of the business in order to keep the business running till a steady stream of cash flow starts coming in.
The best time to raise funding is considered to be right before or shortly after a key milestone. These basically act as an enticement to a potential investor and also as an opportunity to convince them of how profitable it will be to a business to complete a particular milestone. The positive outcome from a recent milestone might act as reinforcement for investors to keep investing further. It also creates a sense of urgency in the investors to not let go of a hot deal and join the bandwagon before the company has fully taken-off. One more factor to consider is the amount of capital needed to reach key milestones.
Arriving at the Magical Number!
Hence to answer the question of how much seed capital to raise, you need to add your expected cash burn, expected milestones and the amount required to reach those milestones.
For example: Suppose you are a gaming company with 5 employees who draw a salary of $2000 a month and also incur $10,000 a month in operational and rental expenses. You expect to launch a new game into the market in 6 months time but will need $50,000 as pre-launch development and marketing expenses. The seed capital required in this scenario would be as follows:
6*($10,000+ $10,000 ($2000*5)) +$50,000 = $1,70,000
This would be the base amount. A business also has to consider the possibility of any contingencies or delay in launching the product and hence a buffer amount can be added to the above figure to face any exigency.
A Word of Caution
The most important aspect to bear in mind is the propensity to seek more than what is required or seeking too less. Either of the situations is not ideal as they lead to far-reaching consequences and may prove detrimental to the business.
Raising more funds than required may provide temporary benefits of not having to worry about financial wherewithal’s for a considerable period of time; however, they can lead to fiscal laxity and mismanagement and have an adverse impact on valuations, making it difficult to raise further capital.
Raising too little poses its own set of challenges as an under-funded company may have to seek funding repeatedly and will be unable to meet any unforeseen exigencies. Hence it is imperative that the seed capital should be raised only after careful consideration and accounting for all possible scenarios.
Unlike in the past, seed funding today, in most cases, does not require parting with equity stake in the company, it is usually financed by debt instruments that can be converted into equity at a future date. Whatever may be the source of the funds, a judicious and cautionary approach in spending seed capital and ensuring that the company is in a better position one year down the lane after raising and using the requisite capital will set the ground for how Venture Capital funds will evaluate the company in the future.
Disclosure: I/we have no positions in any stocks mentioned, (if any) and no plans to initiate any positions within the next 72 hours.
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