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Avoid the Seed-Funding Surge Trap With These 8 Tips

Avoid the Seed-Funding Surge Trap With These 8 Tips
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"Finding startup funding is easy."

Of course, anyone who has ever been involved with a startup knows that this is not something you would typically hear from founders. Finding credible investors with the resources to invest -- and convincing them to commit -- continues to be a time- and resource-consuming challenge for all startups.

Related: 4 Options for Raising Capital From Friends, Investors or Even the Feds

Times are changing, however, and so is the funding environment for startups.

While most startups will be self-funded by its founders or the founder's immediate family and friends, some seek and accept third party "seed funding," an investment at the very early stages of a company.

Seed investing is risky, and most seed investors understand that seven of 10 startup investments will ultimately fail. They also understand, however, that it only takes one massive startup success to make you rich.

Therefore, seed investors understand that they need to have "skin in the game" to find successes and, maybe more important, to avoid the pitfall of "FOMO," or "fear of missing out" on the next big startup success.

So as more seed investors take more risks, early-stage seed funding becomes more prevalent, plentiful and easier to find.

This readily available and growing pool of seed funding is great news for startups, especially since many startups know and understand how important it is to get to market quickly. Ironically, this development has also created serious problems for startups.

By taking on early seed funding, startup founders will be committing to an early valuation, revenue and customer benchmarks, and tight time frames for delivering results. If a startup rushes into early seed funding too soon, it can cause serious challenges when raising subsequent rounds of funding, such as a series A. These rounds are often more significant and complex, so failing to meet early benchmarks sends a strong negative message to successive investors.

Josh Kopelman, a seasoned entrepreneur, investor and founding partner at First Round, an investment firm that focuses on "helping seed stage companies become the next big thing," discussed recently the "series A crunch," or the later round fundraising challenges that the current surge in seed funding is creating for startups.

The primary problem, according to Kopelman, is that while the availability of seed funding has increased considerably over the past five years, the availability of series A funding has not changed. Therefore, because you have four times the number of startup companies finding and accepting early-seed funding, you also have four times the number of startup companies competing for series A funding later. If series A funding opportunities have not changed, then it is increasingly more competitive and difficult to find later rounds of funding.

Related: 12 Tips for Finding Seed Funding, Starting With a Close Look at Your Pocket

So while it may be easier to find seed funding, startups need to be diligent when considering and preparing to do so, or else find themselves in a sticky situation later when they really need funding to meet future growth goals.

Kopelman goes on to make a few recommendations for startup founders as they consider early-stage seed investments.

1. Startups should not be fooled by the “seed series surge.” Even if you have success finding seed investment, believing that securing future rounds of funding will be just as easy is a painfully false assumption.

2. Startups should not rush into selecting seed-round investors. Be patient and choose only the investors who have the experience, resources and willingness to help in future rounds of fundraising.

3. Startups need to know and be very familiar with key inflection points of the business, or the points when the business is ready for its next developmental step. Not only is demonstrating awareness of this important, so too is understanding when you have hit them and properly communicating these successes to investors.

4. Startups should make certain that they raise enough seed funding to provide a comfortable runway to successfully meet benchmarks and collect enough data to show success before considering subsequent series A funding.

5. Startups need to be monitoring and able to speak to key financial figures, including burn rate and customer acquisition cost, as well as any other compelling data sought by prospective investors.

6. If pursuing series A funding, startups need to be rational about the amount to raise. It is always easier to start with a low target and increase the round if needed. Starting high and scaling back, most likely because you are unable to raise the initial goal, sends a negative message to other investors. Allow the market bid up your startup.

7. Only start the process of seeking series A funding after your startup has successfully met major milestones. If you start too early and are turned down by venture capital firms, it sends a strong and negative message to other VCs. As Kopelman points out, “It's almost impossible for a startup to get a second fresh look.”

8. Startups should always be planning and looking to the future. Do not get distracted by the time-, energy- and resource-consuming funding cycle. Stay focused on growing the business, achieving successes and leading your team.

Related: 6 Questions to Determine If a Potential Investor Is the Right Investor