Pre Seed Funding for Startups: what is and how does it work?

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Pre-Seed Funding for Startups: what is and how does it work?

Traditionally, pre-seed funding was not considered part of the official funding rounds. However, with more interest from investment companies in the earliest stage of funding, pre-seed funding for startups is now recognised as part of the total funding process. This article discusses what pre-seed funding is, how it works and what to expect in terms of duration and funding goals. We'll also touch on how a venture capital pre-seed firm can assist in the process of securing pre-seed funds.

Pre-Seed Funding Meaning or What exactly is a pre-seed funding round?

A pre-seed funding round is a relatively new concept in the startup investment scene. However, pre-seed funding for startups can greatly accelerate the pace at which a startup is able to develop and build their business model to become an established business.

So, what exactly is the meaning of pre-seed funding? This round is the earliest in the funding round process, taking place before the seed and series A funding stages. Since startups need a significant amount of funds to get operations running, the pre-seed round was introduced to assist startups with its initial formation.

Pre-seed funding, meaning an initial investment you need to get your business development going, is greatly valuable to secure from investors during the early stage funding rounds.

In many cases, investors refer to pre-seed as the “friends and family” round. However, the capital you get from family, friends, donations and personal investments from founders is just not enough to begin

operations. Hence why venture capital firms have become more open to invest during the pre-seed stage.

What Exactly Is The Difference Between Pre-Seed and Seed Funding?

The key difference between pre-seed and seed funding is that pre-seed takes place before the first ‘official’ funding round and in the earliest stages of a company’s life. Traditionally, the seed or series A funding round was the first instance where formal investors or a venture capital firm would invest capital in a startup company. Today, pre-seed venture capital is a more common practice and recognised as an official funding round.

During the pre-seed funding round, the goal for startups is to show that they are fulfilling a market need no other business is able to cater for. Next, in the seed or series A funding round, the goal is to prove product or service market-fit.

To further explain, pre-seed venture capital investments are raised with the purpose to prepare for future fundraising opportunities. Pre-seed takes place at the very start of early stage product development, whereas seed startups in the seed funding round are supposed to have already confirmed their value proposition.

In the case that pre-seed venture capital is invested, the startup should use these funds to set the following in place:

Product: Demonstrate the ability to execute a workable product.

Team: Assemble a credible team who are proven to work together.

Market: Provide indicators of customer demand.

Distribution: Present a growth strategy that includes relevant distribution channels and customer contact points.

Traction: Complete a ‘test launch’ with product/service feedback from early adopters, with customers ready for a beta launch.

During the seed funding stage, the company in question will develop the business model to a workable and scalable operation. Here, the goal is to demonstrate how the support from venture capitalists will result in continued business growth and essentially a return on investment, plus additional profits.

When And How To Raise Pre-Seed Funding

To succeed as an early stage startup, it’s important to know when and how to raise pre-seed funds. Many believe that securing pre-seed venture funds is now the gateway to getting support from venture capital firms during later stage investment rounds as well.

When are startups ready for pre-seed funding?

There is no singular rule for when you can start collecting pre-seed funding or pitch to pre-seed venture capital firms. However, there are some indicator that show when it’s the golden opportunity:

  1. You have a minimum viable product (MVP) that shows early signs of traction
  2. You have the data or proof that shows potential for product-market fit
  3. You have a team with the needed background and experience
  4. You are in the early stage of onboarding relevant customers
  5. Revenue is in the forecast
  6. You are ready to develop the first prototype and need capital to support this

How To Raise Pre-Seed Funding?

When aiming to secure pre-seed venture capital, the most important step is to choose the right investors to approach. Since you are asking for investments in an ‘idea’ that does not yet have much sales data available to base investments on, not all investment firms will be interested in receiving your capital pitch.

Pre-seed venture capital firms are specifically oriented towards investing in early stage companies, so they will be prepared to invest - based on future potential instead of sales figures or revenue. One benefit of landing pre-seed VC funds is that the investment is usually much larger than donations from friends and family, accelerating the process of business development.

Next, know how to attract attention from pre-seed investment firms. There are multiple ways in which you can prove yourself as a worthy investment opportunity, however, the following key attributes will help display your success potential.

What Are The Goals of a Pre-Seed Round?

When a business is in the pre-seed phase, it's still just a concept. The pre-seed stage is there to start developing the business into an actual, operating one. The main goal is to secure capital that can take the concept from being an idea and turning it into something more tangible.

Although different investors, regions, market sectors and business models all have distinctive math that goes into calculating the sum of capital to raise, there are some benchmarks to take into consideration when planning your holistic funding goals. For example, in the pre-seed round, capital is likely used to:

  • Develop products or services
  • Assemble a team
  • Conduct further research into the market you’re entering or to prove customer demand
  • Start contacting key distributors or set-up key distribution channels
  • Conduct AB testing with feedback from relevant customers

The holistic goal to achieve will influence the benchmarks and objectives during the pre-seed round. In many cases, this round determines the goals for the following seed round, based on how much capital was raised or investments gained.

In many cases, the main goal is to raise enough capital to help the startup get to their next fundable milestone. Therefore, it is greatly important to showcase the future opportunities your business holds during the pre-seed stage - to create early and later stage traction.

Pre-seed venture capital is hence invested in startups to support them in evolving the business to a point where their continuous growth is viable and achievable throughout the duration of funding rounds to follow.

How Much Pre-Seed Funding to Raise?

Depending on the industry and the unique sector the startup is entering, there’s already significant differences in the amount of funding the business will need. The amount of funds to raise further depends on what the startups aim to achieve with the pre-seed capital.

The startup's capacity and ability of management will, to an extent, influence the total sum of capital to raise. This being said, there's some factors to take into account before being over ambitious at this stage of funding:

  • If a great sum of capital is raised during this stage, the investment terms will automatically rise and more diligence from founders and management will be needed. Investors will also likely be more involved in business decisions to make sure funds are not misused.
  • Raising more capital than needed during the pre-seed round means that the company valuation goes up. This can put a strain on startups, as the expectations need to be kept up during the following investment rounds.
  • Raising excess funds could result in disturbing the startup’s planned operations. If acceleration takes place too fast, some systems may fail due to a lack of time for preparation.

Proactive planning is key in determining a realistic pre-seed goal, keeping the present and future milestones in mind.

It's noteworthy that the nature of the company greatly determines the initial costs of setting up the business. However, based on average statistics, between a period of 12 and 18 months, the pre-seed capital raised can be between €50K and €1.7M, depending on the intended business model the startup is aiming to develop. In exceptional cases, this amount can be much higher.

Selecting The Proper Pre-Seed Investor

Pre-seed investors can either be individuals investing their own funds or pre-seed investment firms investing on behalf of others.

What are pre-seed investors?

Over the course of the last five years, pre-seed venture firms have gained more prominence during early stage investment rounds. This is due to a gap between what founders need and what the market is able to offer, in terms of pre-seed investment.

Traditionally, pre-seed investors have been friends and family, the founders themselves or capital came from angel donors. However, pre-seed VC funds have started to integrate more into the very start of investment rounds.

Essentially, pre-seed investors or pre-seed firms, make investments in the startup founders and not entirely in the business idea or product/service itself. This is due to the business not having a great amount of sales statistics or performance data for investors to go on yet. This is why trust and transparency plays a great role in selecting who to make investment agreements with.

Selecting the right pre-seed investor

The first step is to define your goals and to determine what type of investors will best compliment your growth strategy. There are many types of pre-seed investors who could benefit the development of your business, among which pre-seed firms, specialising in venture capital:

Pre-seed venture capital firms: These funds represent multiple limited partner investors. Pre-seed VC funds can offer larger investments during the pre-seed stage, but also have a longer decision-making process as multiple investment factors need to be taken into consideration by multiple parties involved.

The most important factor to consider when choosing investors is the alignment of visions and agreeing on the same goals. A clear understanding between the startups and investors or the investment firm should be set, this way a healthy business relationship and trustworthiness is established.

How long should pre-seed funding last?

Practically, a pre-seed investment round lasts 12 months, with an advised buffer of three months. This sets the total duration at 18 months. It's always a smart idea to factor in an additional three months to shelter against unforeseen circumstances and uncertainties.

This timeframe is recommended as it sets realistic expectations to meet. It can be the case that startups need more time to fulfil their pre-seed funding goals, however, extensions beyond 18 months are usually due to over ambitious milestones that were set.

Depending on the goals and agreements with investors, startups can comfortably complete the pre-seed round within 18 months. Should the funding round be extended, some reflection should be done to determine if the set milestones and goals are achievable or if they are overambitious.

Conclusion

Hopefully this article helped you to gain a better understanding about what pre-seed is and how it works. The key to having a successful pre-seed round is to set realistic goals and to have a clear understanding of the milestones to achieve. This way, a healthy and trustworthy relationship is established between investors and the company in question. With a greater interest in early stage investment among pre-seed venture capital firms, startups have a greater opportunity to receive the investments needed to accelerate business developments. Management team should keep in mind that excess capital gain during the pre-seed round can be difficult to manage, in terms of realistically scaling the business in accordance with capacity.

Manageable expectations and a clear timeframe will help to stay on track with pre-seed expectations.

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