Seed Fund Fundas: How to identify the right investor, raise seed capital and make optimal use of the corpus

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© Chandra R Srikanth Seed Fund Fundas: How to identify the right investor, raise seed capital and make optimal use of the corpus

Note to readers: This is the second episode of a new series of articles designed to give our readers an edge on matters of competitiveness, upskilling/reskilling and knowledge gathering. Essayed in a lucid, snackable format, this #HowTo series would act as a tutorial, bringing in the most relevant voices on a subject, so that you benefit the most in your business or career. In this article, we take a look at the fundamentals of raising seed capital and then staying on course to spend it judiciously.

The fundamentals of seed funding are akin to the ground rules of seeding a plant. Just as the quality of seed procured goes a long way in determining the health of the plant, the profile of the seed investor and timing and quantum of the fund raise form the bedrocks on which quality start-ups get built.

Too many founders rush through this process often making costly mistakes. Let’s take a closer look at best practices associated with raising seed funds and the importance of spending the corpus the right way.

Right investor is half the battle won

The master key is to identify an investor who understands the founder’s business clearly and is willing to back the idea through thick and thin. The north star of a company cannot be profit alone. There has to be a greater purpose and it is up to the founder to choose an investor who understands that higher goal.

Says Sumit Gupta, co-founder and CEO of CoinDCX, India’s leading cryptocurrency exchange, “You need an investor who’s contributing to the returns.” The founder has the best context of what the start-up is building and the investor needs to align to that thought process.

“Let’s assume that Vijay Shekhar Sharma (Paytm founder) shows interest in seed funding your start-up. With him on board, you are not only getting finance but also someone who can open doors and take you to the right people,” says Gupta. Anyone can give you capital, but the quality of that capital is important.

Rohin Y, founder and CEO at LightSpeed AI Labs, says each investor has a particular investment thesis. It will be evident from their portfolio companies. Try to reach out to founders from the investor’s start-up portfolio to get a sense of the mindset and approach. Finding the right investor is like finding a co-founder. It’s a relationship built around mutual respect and trust. Investors are partners in your journey, who ideally, bring in valuable experience and expertise to the table and not just infuse capital, says Rohin.

Even if you are cold mailing investors to raise seed capital, draft it well. Seed funds don’t have too much time at hand as they receive hundreds of mails a week. The idea is to keep the e-mail short and to the point. Show them some proof of work, says Gupta of CoinDCX. The mail should address the problem that you are trying to solve, the market-size and the potential to scale fast. The pitch has to stand out. Talk to your friends who have raised funds in the past, ask for help and go to relevant industry events.

Investors are among your first employees. So, hire well.

Build a strong team using your seed capital

It’s equally important to decipher how the seed fund would be spent. Remember that you are raising money by giving away equity. Do not spend it irresponsibly.

Stockholm-based Kim Fai Kok, the co-founder of global angel syndicate Framtid and ex-founding team member of Truecaller, says that there are three critical aspects founders need to focus on at the seed stage. These include nailing the product-market fit, demonstrating that you can grow your customer base, hire great people and set the right culture. The team is your biggest strength. Spend enough time to pick your cherries.

“Now-a-days, the size of the seed funding is getting bigger and bigger. To give you some perspective, Truecaller’s series A round was $1.3 million, but that was nine years ago,” says Fai Kok. But today, investors exhibit a far greater risk appetite. The corpus raised at the seed stage is much larger now and hence the responsibility on the founder’s shoulders is heavier. This is where the quality of the team assumes great significance. A particular hire may be costly, but sometimes not having that person on board can be costlier.

One of the best investments you can make early on is to build and nurture your community and start shaping the company’s narrative that people can resonate with. At this stage, you should also begin experimenting across different channels to see how you can get your growth engine started, says the Framtid co-founder. Too many startups focus on pushing growth and acquiring users despite unhealthy unit economics and churning users at the seed stage, he says.

Timing of the fund raise is crucial

Punit Soni, founder and CEO of Suki, a start-up that uses machine learning and voice tech to build AI-powered digital assistants for doctors, says the timing of the fund raise is crucial. “The best time to raise money is when you think you are willing to invest your own money. A good check I put on things is: ‘Would you put half your net worth into this idea?’. If so, then it’s time to go raise since you have the conviction.”

The key thing to remember, once you have raised, is that this is not your money. Use it wisely. “It’s there to get you from point A to point B, that’s all. This is not a reward, not an exit, and definitely not compensation,” says Soni. The role of seed investment in most start-ups is to get you to a series A round. Typically, Series A rounds come with some amount of product market fit. So, the focus of seed investment should be to experiment iteratively till you can guarantee you have a product that solves the problem you set to work on, says Soni, who was earlier the chief product officer at Flipkart.

The job of a CEO is to never run out of money. So, the seed funding process should start six months or so before you need the cash. “Under pressure, fund raising is even worse,” says Rohin of LightSpeed AI, who raised $600,000 in his seed round and $55,000 as pre-seed. The start-up is into deep-tech photonics that build next generation processors for data centres and edge computing.

Get to know financial agreements better and have a cashflow plan

Familiarity with financial agreements is crucial. “Do not get harmed by agreements,” says Gupta of CoinDCX, which has raised $110 million in funding.

It’s important to plan the cash flow in advance and anticipate future funding requirements. A good financial plan is a must. Have it ready, even before you reach out to the investor. In the early stages of the conversation, a pie chart of higher-level requirements would suffice, says Rohin. Do not forget to budget for legal costs (to prepare definitive agreements based on term sheets etc). Accounting, compliance and due diligence costs are often charged from the funding you raise.

Managing the cash flow is very important. Have a dedicated person to take care of finances. There are virtual services too that help you with monthly accounting and MIS preparation. As Rohin says, most founders either underestimate or overestimate the costs. Getting to the right ball park figure is essential.

Know how much you need to raise, then prioritise your spending

Prioritising the spends is important. Framtid’s Fai Kok is clear that your team is your biggest asset. “If I have to stick my neck out, I would say a big chunk of the funding needs to go into hiring the right people.”

Remember, it’s not quantity but the quality that matters and hiring great people can cost a lot. So, hire great people that genuinely care for your vision and the problem that you are looking to solve, says Fai Kok.

How much should one raise is also a pertinent question. Even in today’s frothy market,

do not raise more than you need to, says Suki’s Soni. You are giving away equity unnecessarily at the most expensive point in your company’s history. Your equity will never be cheaper than this.

Focus your resources on MDP – Minimum Delightful Product, says Soni. Run many, small iterative experiments till you build the product that will make users happy. When you have this covered, it’s time to scale. That’s the time to raise the next round. Or most probably, the round will come to you.