Why is it Difficult to Raise Seed Funding?
In the previous article, we have already learned what seed funding is and the various sources from which it can be acquired. It is important to mention that theoretically seed funding can be obtained from various sources. However, in real life, it is remarkably hard to obtain. There are very few entrepreneurs who are able to obtain seed funding.
In this article, we will have a closer look at some of the reasons which make obtaining seed funding difficult.
- High Failure Rates: Entrepreneurs who obtain seed funding have a very high failure rate. This is because of the reason that a lot of projects which obtain seed funding are aspirational in nature. This means that the success of these projects is predicated on a technology that may not even exist. Even if the technology does exist, a lot of times, entrepreneurs are not able to encourage more people to adopt it.
Startups in general have a high failure rate. About 90% of all startups fail within the first year. Hence, when investors are providing seed funding, they know that the odds are stacked against them. As a result, they are very picky about these investments and this makes it difficult for entrepreneurs to obtain seed funding.
- Lack of Organized Funding: When it comes to funding late-stage startups, there is a well-developed ecosystem. There are many venture capitalists who specialize in a certain product or industry. However, very few venture capital and private equity firms show an interest in making seed funding investments.
This lack of organized funding leaves entrepreneurs at the behest of their own friends and relatives or the unorganized market. These investors are often very difficult to convince. Even if they are convinced, they generally ask for a disproportionately high stake which disincentivizes investors from seeking funding from them.
- Competing with Established Companies: The reason why many established players do not want to invest their money in seed funding is that they already have the option of investing in many companies which have gone past that stage. Venture capital and private equity firms have several options to choose from which are less risky and more likely to provide returns.
Hence, companies requiring seed capital are in effect competing with much more well-established companies. These companies may already have a product and some of these companies may have also had some traction from prospective customers. This is what makes late-stage companies more compelling to investors and incentivizes them to ignore early-stage companies.
- Unstable Team: Investors often carefully evaluate the entrepreneur’s team members before they make a final decision about investment. Over the years, investors have realized that companies requiring seed funding do not have a well-established team.
It is common for some of the co-founders to exit the business and for some more co-founders to be introduced into the business at this stage. Since the leadership team is not stable, investors cannot properly evaluate and make their decisions. This is also one of the reasons that they avoid investing in businesses that are at the seed funding stage.
What is Traction and How can one obtain it?
Now, since we have seen the various reasons why seed funding is difficult to obtain, it is also important to know the characteristic which makes companies more likely to obtain seed funding. This characteristic is called traction and is often difficult to explain.
Traction is the state when a business is able to present a compelling story to the investors. It is possible that some investors based on the worth of the idea and on the reputation of the founders. However, it is important to note that most investors would want to witness some sort of statistics that makes a compelling case.
For instance, in the case of businesses that are based around information technology or applications, user adoption is considered to be a key parameter. For example, if the number of downloads of an application is growing at the rate of 10% per week, it is considered to be a positive sign by the venture capitalists. However, if the number of downloads is staying flat, this is considered to be a negative sign.
Traction is the investor’s way of evaluating whether the idea is being enthusiastically accepted by the target market. Companies which are able to portray such a compelling story through credible statistics which the investors believe in are much more likely to obtain seed funding as compared to other firms who are also making an attempt to do so.
To sum it up, seed funding can be incredibly hard to obtain. However, there are some steps that can be followed in order to increase one’s chance of obtaining seed funding.
Authorship/Referencing - About the Author(s)
The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.
- Seed Funding - Introduction
- Why is it Difficult to Raise Seed Funding?
- Documents Required for Startup Financing
- How Co-Founders Split Their Equity?
- Proof of Concept
- Minimum Viable Product
- What is Prototyping?
- Asset Light Business Model
- Advantages of Asset Light Business Model
- Disadvantages of Asset Light Business Models
- Cash Burn Rate: The Basics
- Managing the Cash Burn Rate
- Startup Financing and Term Sheets
- Key Terms and Conditions in a Term Sheet of Startup Funding
- Red Flags that Investors Need to Look out for in Term Sheet
- The True Cost of Owning a Property
- Valuation of Early-Stage Startups: The Mindset of Investors
- Pre Money and Post Money Valuation
- Start-Up Valuation: Advanced Concepts
- How Pre-Revenue Companies are Valued?
- Valuation Divergence - Meaning and its Importance
- How Do Option Pools Work?
- What are Capitalization Tables?
- Asset Sale vs. Stock Sale
- Financial Models for Startups
- Key Performance Indicators for Startups
- Restricted Stock Options (RSU’s)
- Veto Rights - Meaning and its Importance
- Financial Benefits of Incubators
- What are Unicorns?
- Why Startup Companies are Staying Private?
- Why Unicorn Companies Fail?
- Building a Startup Team
- Bootstrapping: Meaning and its Advantages
- Disadvantages of Bootstrapping
- Revenue Based Financing
- Convertible Notes and Startup Funding
- Pros and Cons of Convertible Notes
- Simple Agreement for Future Equity (SAFE)
- Keep It Simple Securities (KISS)
- Series A Funding
- Series B Funding
- Series C Financing
- Venture Debt in Startup Funding
- Pros and Cons of Venture Debt
- What is Venture Leasing?
- The Freemium Model - Different Types of Freemium Models
- Pros and Cons of Freemium Model
- Scalability and Startups
- Pros and Cons of Scalable Business Models
- Why Do Start-ups Fail After Receiving Funding?
- Start-ups and Arbitration
- What is a Revenue Model?
- Understanding Investor Focus on Burn Rate
- How Investors Evaluate Start-up Ideas?
- Government Regulations Which Impact Start-Ups
- What is a Start-up Accelerator?
- Managing the Operational Metrics of a Startup
- Different Types of Investors
- The Founder’s Dilemma
- Role of Social Media In Start-Up Funding
- Start-Ups and Public Relations
- Red Flags for Start-Up Investors
- IPO: An Exit Route for Start-Ups
- What is Acqui-Hire?
- How to Build a Start-Up that gets Acquired?
- Legal Issues Faced by Start-up Companies
- Corporate Venturing
- How Reverse Pitching Works?
- Aggregator Business Model
- Marketplace Business Model
- Difference between Aggregator and Marketplace Business Models
- Product as a Service (PaaS)
- Benefits of Product as a Service (PaaS) Model
- Disadvantages of Product as a Service (PaaS) Model
- The Co-Working Business Model
- How Co-Working Spaces Make Money?
- Peer to Peer (P2P) Business Model
- The Instacart Business Model
- The Goodleap Business Model
- The Twitter Story
- How Tesla Reinvented the Automobile Industry?
- How Epic Games Changed the Gaming Industry?
- The SpaceX Success Story
- The Stripe Business Model
- The TikTok Business Model
- Zillow Story - The Real Estate Marketplace
- How Business Cycles Affect Start-Up Companies
- Managing Start-ups During an Economic Downturn