Understanding Seed Funding

While founders of Startups have great ideas that may be enormously helpful to the society at large, raising funds in the initial period to accomplish and materialize the idea becomes a very tough task. As such, Seed Funding is done to help Startups to start their business.

During the initial period, Startup Founders may raise funds via various incubators or even raise funds from Angel Investors. This differs from the process of Seed Funding.Angel Investors are mostly individual investors who invest in the Startups and also provide operational expertise sometimes. On the other hand, in the process of Seed Funding, investors only invest in the Startup for a financial return. In case of Angel Investors, the investors are given a share in the equity share capital of the company or other convertible debt instruments. This may not be the case with Seed Funding.

Stages of Seed Funding

Pre-Seed Funding Stage

In this stage, the Startup is required to attract funds from the founder directly or from his family and relatives.

Seed Funding

In this stage, the actual seed funding takes place. This stage typically represents the first official money that a business venture or enterprise raises. Angel Investors, Venture Capitalists, Incubators, etc. invest in Startups at this stage primarily. Angel Investors are more common investors at this stage.

Series A Funding

Once a business has developed a track record (an established user base, consistent revenue figures, or some other key performance indicator), thebusiness may opt for Series A funding in order to further optimize its user base and product offerings. Opportunities may be taken to scale the product across different markets.

In Series A funding, investors are not just looking for great ideas. Rather, they are looking for companies with great ideas as well as a strong strategy for turning that idea into a successful, money-making business.

Series B Funding

Series B rounds are all about taking businesses past the development stage. Investors help startups get there by expanding market reach. Companies that have gone through seed and Series A funding rounds have already developed substantial user bases and have proven to investors that they are prepared for success on a larger scale. Series B funding is used to grow the company so that it can meet these levels of demand.

Series C Funding

Businesses that make it to Series C funding sessions are already quite successful. These companies look for additional funding in order to help them develop new products, expand into new markets, or even to acquire other companies. In Series C rounds, investors inject capital into the meat of successful businesses, in an effort to receive more than double that amount back. Series C funding is focused on scaling the company, growing as quickly and as successfully as possible.

Specific Issues that might be faced by Startups

Vulnerability of Brand Name

In the world of business, there are innumerous brands having various trademarks to differentiate their products. Also, trademark serves an important purpose of preventing a business from losing out on customers who rely too much on brand value. As such, in the initial days of a Startup, the Startup ordinarily does not possess enough knowledge or resources to secure its brand name. As such, sometimes, a trademark used by one startup may be passed off by another business in the same industry.

These problems may be resolved by registering a trademark with the Trademarks Registry.

Vulnerability of Business Ideas

While a Startup may have an excellent idea and may even be able to commercialize the idea upon getting required resources, the process of Seed Funding is such, that it requires the founders to disclose their business idea. As such, the Startup becomes vulnerable to certain losses that it might incur in the event that a competitor uses its idea. This happens because the business idea of the Startup is exposed.

To protect Business Ideas and safeguarding the interest of the Startups, a Non-Disclosure Agreement is required to be entered into which in turn will help to accomplish this task.

Compliance with Government Regulations

Often Startups may have issues complying with the regulations of the government. Issues such as faulty drafting of agreements statutorily mandated by the Government as well as incomplete compliance with tax regulations and the like, invite liability of the business itself.

To better comply with various laws and regulations existing in the country, a Startup must ensure proper drafting of agreements and complete as well as proper compliance with other laws.

Types of Seed Funding³

The following are the various types of sources for Seed Funding:

Crowdfunding: In recent times, crowdfunding platforms have become a trendy destination for seed funding. These platforms are generally open, and anyone can back the idea, concept, or product.

Corporate Seed Funding: This is a very good source of seed funding as start-ups gain more visibility because of the big corporate investors. Large companies like Google, Intel, and Apple support start-ups regularly with seed funding. Such investments can prove to be very useful for new firms to build their brand.

Angel Investors: These are the investors who invest seed funds in a start-up in return for equity ownership or convertible debt.

Incubators: These investors, along with providing small seed funds, focus on helping the new ventures through training and often also provide office space. Many leading educational institutes, like IITs and IIMs, also provide such services. Generally, Incubators do not ask for equity holdings from start-ups.

Accelerators: These investors mainly focus on helping the new firms in scaling-up rather than supporting them in early-stage innovation. They also provide help through various training, mentoring, and giving networking opportunities. Unlike most incubators, accelerators usually take equity.

VC funding:Venture Capitalists are the high-end investors that invest in a new venture after looking into various parameters such as market conditions, founder vision, growth potential, etc.

Start-Up India Seed Fund Scheme

Any Startup which is duly recognized by the Department for Promotion of Industry and Internal Trade, Government of India and has not been incorporated before 2 years from the date of application, shall be eligible for the Seed Fund Scheme. Under this Scheme, the Government of India provides the platform for Startups to connect with Incubators. Incubators provide necessary monetary and non-monetary support to Startups thereafter. Also, angel investors and venture capital firms are made available to Startups at this stage. Also, it becomes easier for Startups to get loans from banks since banks give loans to only ‘asset backed’ businesses.

What should Start-ups be careful about

Start-Ups registered with Start-Up India Seed Fund Scheme should be careful about the fact that they are statutorily prohibited from using the money they receive as seed fund, for any purpose other than the ones for which the said money was given. This means that for every purpose which may not be covered for seed funding, however important may be, the funds for the same shall have to procured by the Start-Up by itself or by way of loans from banks.²

In case, the Start-Up is not registered with the Scheme, the Start-Up must be very cautious of the legal issues that might arise. Also, proper drafting of agreements are required since the same will ensure safety of the Start-Up.

Conclusion

It can be concluded that the Government of India has provided various avenues to Start-Ups to help themselves, however, a lot depends on how things are actually done by a Start-Up. Also, proper compliance with laws and regulations play a very important role in this sphere. As such, drafting of agreements, timely filing of returns and the like must be done properly. This is very essential for a Start-Up even though it might be in the Seed Funding Stage since the Start-Ups must have a proven track record and good health due to which investors may invest in the Start-Up.

References

1. https://www.investopedia.com/articles/personal-finance/102015/series-b-c-funding-what-it-all-means-and-how-it-works.asp.
2. Point 8, Gazette of India, https://www.startupindia.gov.in/content/dam/invest-india/Templates/seedfund-gazette.pdf.
3. https://tavaga.com/tavagapedia/seed-funding/.