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Pre-seed funding: A comprehensive introduction

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Pre-seed funding: A comprehensive introduction

Pre-seed funding is usually the first round of funding that any startup will go through. The purpose of the pre-seed round is to make sure that the startup has enough runway to develop its vision in one manner or the other.

It is often easy for startup founders and employees to understand how the standard funding rounds work (Series A, B, etc.). However, they may have trouble differentiating between seed and pre-seed rounds. Many startups even wonder if they need a pre-seed funding round in the first place.

Here, we discuss the pre-seed round in detail, compare it with other early-stage investment methods, and answer the most common questions regarding the pre-seed stage.

What is pre-seed funding?

Pre-seed funding is often the first round of funding entrepreneurs, and startup owners receive. We often say that not all startups need to undergo a pre-seed phase.

Usually, a pre-seed round takes place when a startup does not have a product or a service that it can offer. However, a prototype or an idea is present, along with a clear vision of how to take it to market. Simply put, there is a clear unmet need in the market that the startup can fill.

The goal of a pre-seed funding round is usually to provide the company with enough resources to create a minimum viable product (MVP). An MVP is a functional product in its most basic form, and companies can then test and improve it through iterative development.

What can you use the pre-seed funds for?

Even though we have discussed that pre-seed funds are used toward building an MVP, here are a few specific pre-seed startup expenses that are usually covered by a pre-seed fund:

  • Resources (computers, servers, materials, etc.)
  • Salaries
  • Office space
  • Legal and administrative expenses
  • Market research (e.g., focus groups)

Chances are that your team will be pretty small at this stage. As such, most of the expenses mentioned above will be quite minimal. You will be spending most of the capital raised on the startup idea and bringing it to fruition in its most basic form.

It is vital for you as a business owner to make sure you have a plan on where the pre-seed funds will be spent. Most startups that run out of pre-seed money without having an MVP have trouble raising more.

Typically, the goal of pre-seed startups is to have enough funds on hand for six months of runway. This is more than enough time to build an MVP. However, this time may vary depending on the industry.

The best thing you can do is to let your investorsknow during the early stages of negotiations how long it will take for you to build an MVP. This helps avoid any misunderstandings later on.

What is the difference between seed and pre-seed funding

Both of these funding rounds are perhaps the most important for the company. All subsequent rounds, such as Series A and Series B, depending on the startup's performance during these two phases.

Here are the five most significant differences between seed and pre-seed rounds.

Timing

Pre-seed funding is the earliest possible stage when a startup may receive cash. At this point, the startup may have little more than a pitch deck to show to potential investors. Investors usually look at the market research, the team, and the business model to see if they want to invest.

The seed round occurs once the company already has an MVP. At this point, the goal is to see if there is a product-market fit. This means that the startup will use venture capital funds to see if it can penetrate the market and generate revenue.

Funding amount

Pre-seed investments are typically much smaller compared to their late-stage counterparts. Pre-seed capital is rarely more than $150,000. However, there are exceptions to this rule, and there have been pre-seed funding rounds in the millions.

Seed rounds, on the other hand, can be as high as the needs of the startup. How much capital is raised by the company depends on the potential market size, the amount of money required to achieve a product-market fit, and how long before the startup can be profitable.

Many startups have raised massive seed-stage investments. A perfect example is the cryptocurrency-focused startup Trust Machines. Trust Machines raised $150,000,000 in the first quarter of 2022 and was the most significant seed round of the quarter.

Runway

As stated earlier, pre-seed rounds have an average runway of 6 months.

On the other hand, seed rounds usually provide a startup with a runway of over a year. The company's objective during the seed stage is much more complex than just building an MVP.

Difficulty in raising money

Pre-seed fundraising is a lot more complicated. This is because there is nothing for the pre-seed investor to bank on apart from the prototype and the pitch deck. As such, the investor is taking on a lot more risk than they would if they were to invest during the seed stage.

Although raising a seed funding round is no picnic, it is a piece of cake compared to the difficulties faced at the earliest stages of the startup.

Customer interest

One last difference between the two funding stages is customer interest. Pre-seed startups have no interest in their target market.

Companies at the seed stage, on the other hand, usually have some form of interest in their MVP. Some startups may even have early customers to show to potential investors.

Who usually takes part in pre-seed funding rounds?

If you are in an early-stage startup and have researched, you will know who to reach out to for a seed round. Everyone from angel investors to venture capital firms is on the cards. 

That said, a few types of investors (e.g., institutional investors) almost always come in at a later date. Institutional investors are usually much more risk-averse than their VC counterparts and, thus, tend to avoid the pre-seed round.

However, pre-seed rounds are much more nuanced, and you probably don't know all the places you can contact to raise pre-seed funding. Here are what most successful pre-seed startups do at this stage:

Angel investors

Angel investors should be your primary target if you want to acquire pre-seed funding for your startup. An angel investor is an individual that provides capital for a startup to grow.

Pre-seed investments are not that costly in the grand scheme of things. Angel investors are usually of high net worth and want to spend some of that worth on high-risk ventures. As such, pre-seed angel investors can expose themselves to high-reward situations without spending a lot of cash by actively investing during the pre-seed stage.

Almost any angel investor's track record will show more failed pre-seed investments than successful ones. However, that is to be expected. Angel investors diversify their holdings, and they only need a few ventures to succeed and be profitable. The most successful angel investors have made billions from only a handful of companies.

Pre-seed venture capital firms

After angel investors, you can also raise money through pre-seed venture capitalists.

For the most part, VC firms only invest during an official round when the company has something tangible to show. That said, pre-seed VC firms are becoming more and more common daily.

The advantage of having venture capitalists on your side is that an experienced team will support you every step of the way. VC firms provide everything from cash injections to intellectual property advice, networking, and mentorship.

The best part about a VC firm is that they will probably participate in your seed round if you manage to meet their expectations.

Friends and family

Unfortunately (and understandably), it is pretty hard to get pre-seed funding. You may need to resort to your friends and family to get the capital required.

There is no point in explaining how this works, as each individual situation may be unique. Certain family members may ask for an equity stake through a proper contract, while others might be willing to provide you with a loan. Just know that many more startups began using money from family and friends than you may believe.

Startup accelerators

A startup accelerator exists to provide companies with the funds and resources to achieve explosive growth.

The resources come in the form of connections, mentorship, and help with expansion. It is important to remember that most startup accelerators usually focus on companies in the seed stage and beyond. However, a few also focus on companies in the pre-seed stage.

You should only consider startup accelerators once you have considered all the options. This is because getting into a startup accelerator is extremely tough at such an early stage.

Founders

Many founders put some or all of their own money into their startups. This is not an ideal option, but it can be a hassle-free way to kickstart your company if you or any other founders have saved money.

It is also possible for founders to take out personal loans to fund their companies. However, we recommend being extremely cautious with this approach, as personal loans carry a high-interest rate and could lead you to large amounts of debt if the startup fails.

Crowdfunding

Crowdfunding is the last way through which you can raise pre-seed funding. 

However, you need to ensure that the product or service you are developing is enticing enough for the general public to make them invest in your idea.

On top of that, you will need to incentivize the public and thoroughly explain how the raised money will be used. For example, you may have to give the patrons the product for free when it is ready and even add certain other perks to sweeten the pot. This is known as reward-based crowdfunding.

The best part about crowdfunding your startup is that your equity stake will not be diluted, at the very least, until the seed funding stage.

How to increase your chances of raising pre-seed funding

Even though there are multiple funding rounds after it, raising pre-seed money is perhaps the most difficult point in your startup's life regarding raising capital.

This is often because novice startups have no idea where to meet new potential investors. If you are struggling with meeting people who could provide you with funding, look at our guide on finding and meeting with investors.

With nothing to show in terms of product, most pre-seed rounds are based on the idea and the market research involved. Here are a few steps that you can take to increase your chances of acquiring pre-seed investment.

Create the best pitch deck possible

Pitch decks are an important way of communicating your idea's unqiue value to seed investors. A pitch deck should contain everything your startup aims to do, how it aims to do it and the expected outcomes.

A pitch deck does not need to cover every detail about your business. However, it needs to clearly identify the problem and state how your company will solve it.

Forbes has an essential but still comprehensive guide on the fundamental ethos that goes into every pitch deck. It should serve as a good starting point for most pitch decks. Alternatively, you can hire someone else to create a pitch deck.

Provide as much market research as you can

When startups begin looking for pre-seed capital, they have very little to show to investors. As such, they should delve into their target market as much as possible.

By the time you begin meeting pre-seed investors, you should be an expert on all things related to your market. Pre-seed investors are quite experienced in their craft and know how to ask the right questions even if the market itself is unfamiliar territory to them.

Demonstrate your expertise

It is essential for the success of your pre-seed round for you to show that you and your team are capable of achieving the end goal. Any previous experience that the core team has in the field should be made clear to investors. This can either be a part of your pitch deck, or you can mention it when speaking to a potential investor.

It is best to have someone on your team who is experienced in business operations. Aside from this, your Chief Technical Officer should have a complete grasp of the technical side of things and should be able to show their prowess.

Preparation is everything!

Pre-seed investors rarely invest in startups that do not know what they are doing. Even if you have the tech figured out, you need to make sure that you are aware of what you are looking for when trying to acquire pre-seed capital.

First, you should make a list of all the investors that you can reach out to. This includes all angel investors, startup accelerators, and VC funds that might be interested in what you have to offer. After this, you can begin reaching out to each of them individually.

The most basic question that you need to ask yourself is: "How much equity am I willing to give up?". In order to do this, you need to know how to value your business. 

Luckily, we have a guide on how to value pre-revenue startups. This should help you get a rough estimate of how much your startup is currently worth. Of course, pre-seed investors usually have a different idea of how much a company is worth compared to the business owners. As such, you may have to negotiate a little bit.

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Ray Wyand, CEO of gini
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