There are several different methods of financing a new venture, but they can be lumped roughly into four different stages – and everyone who is starting a business should get to know them better. Seed capital is the first stage, when you raise funds to start a business. It is often followed by venture capital, in situations where a company can justify additional financing based on growth expectation and is viable for venture funding. The last stages can include mezzanine funding and public offerings, but let’s get back to the first two of them. This article assumes that your business is structured as a business corporation.
What is Seed Capital
Seed capital refers to cash you have collected to start a business. The source of that cash can be anyone or anything (your savings, cash you borrowed from your family – sometimes referred to as “love money” etc., bank loans). So seed capital is the starting fund for your business. Seed capital providers can be people from your private life but there are also individuals and organizations who would invest and fund the early capital needed for starting a business. However, it is often difficult to get a large amount of money from seed investors because it involves funding a business at its earliest and riskiest stage and also because the sources of these funds are often very limited. Venture capitalists see this type of funding as risky because when a business is at its earliest stage the team, business model, and market have not yet been proven.
Very close to seed capital, and sometimes considered seed capital, is angel financing. When a business is in the late start-up stage but more money is needed for its growth, you can search for angel investors who can help you fund the business. Professional angel investors provide later stage start-up companies with seed capital by offering a loan or purchasing equity. Generally, seed capital investments range from tens of thousands to hundreds of thousands of dollars. Angel investors often come from a similar industry as the start-up and can bring both funds and experience as they would have typically succeeded in the field.
Seed Equity, Seed Loan
Seed capital can come in the form of seed equity or seed loan. If you applied to get a seed loan, you may need less legal paperwork than for acquiring seed equity – although a bank may want personal guarantees to back any such new venture loans. The legal paperwork for seed capital involves putting together term sheets that basically outline the terms between an investor and your business. This document usually covers sections such as funding, corporate governance and liquidation in detail as they relate to your start up. Even prior to detailing the term sheet, angel investors and seed investors typically require a business plan outline which generally comes in the form of a 10-20 slide PowerPoint presentation, referred to as a pitch deck.
Once you get commitments for funding via term sheet, investors would then be expected to sign a subscription agreement. In addition, there are a few associated corporate governance related items that would need to be completed in order to close the financing.
Under any of the above scenarios, a lawyer should be consulted on any legal paperwork required.
What is Venture Capital
Venture capital implies cash that will be used to help start and establish a business, typically once proof of concept and early sales have been established. Venture capital amounts are often much larger compared to seed capital raises. Where your typical seed capital raise would be in the range of $250K to $2M, a venture capital range would typically be a minimum of $5M up to $20+M. It is money you need to accelerate growth for activities such as major marketing campaigns, capital investment for expansion, and improvements to manufacturing processes or to supply much larger inventories that require more funds. In rare cases, venture capital can be provided by a wealthy individual, but in almost all cases venture capital is provided through a venture capital firm or organization.
A Venture Capitalist
Venture capital in Canada in the 80s and 90s used to be structured through Labour Sponsored Investment Funds, which received preferential tax treatment. Venture funds can be made up of any source of capital, whether it is private money, a spin off from a large corporation, or a pool of money raised for this specific purpose. Sometimes people invest in venture funds because when successful, venture funds can and should return an outsized return to the fund holders. A “venture capitalist” then is basically a term of art that refers to either someone investing on behalf of or is somehow associated with a venture capital fund. As noted above, venture capital investments range from five to twenty million plus dollars. Though the amount is high, the investment risk is still lower than the seed investment risk because the business should be somewhat established at this point in its development.
The venture capital industry in Canada continues to evolve and, as the world shrinks, there is an increasing number of US firms available and potentially interested to provide businesses with financing. If you are ambitious and motivated to build a great business, you should consider all options available to accelerate your business growth. But before you do that, feel free to contact one of our corporate lawyers to get some professional advice.