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Introduction to startup fundraising: Pre-seed vs. seed

three entrepreneurs presenting to two potential investors

Introduction to startup fundraising: Pre-seed vs. seed

Raising your startup's financing is time-consuming, tough, and frequently discouraging. However, if you are successful, you will leave with funds to support your startup's expansion and potential success.

Startups do not just raise a large chunk of money or obtain an early-stage business loan and then become set for life. The frequency with which entrepreneurs return to the market to raise more funds has been rising. Each of these raises is referred to as a "funding stage." Funding stages characterize all business paths. Ultimately, every stage of a company's growth has a separate fundraising phase.

The earliest investment rounds for a startup are pre-seed and seed. The goal is to raise the finances needed to start and promote a project. Indeed, these initial investment rounds are typically held before any cash flow difficulties arise.

In this piece, we will discuss the distinguishing qualities and variations between these two rounds and forms of funding, as well as which you, as an entrepreneur, can and should select depending on your stage. This article will outline the intricacies and show how the pre-seed and seed cycles relate to businesses in their early stages.

 

Pre-seed vs. seed

It is essential to understand the reasoning behind classifying fundraising phases to fully understand the variation between a pre-seed and a seed round. The value, amounts, and equity awarded during a funding round vary depending on the maturity stage of the firm and the sum already invested.

As a result, each fundraising stage is classified based on the normal amount of funding obtained and the purpose of the funding in connection to the firm's maturity.

Fun fact, Silicon Valley is where words like "seed," "pre-seed," "Series A," and "Series B" originated.

What is the pre-seed stage? 

The pre-seed stage is frequently the first level of funding, preceding the seed stage and subsequent phases. During this period, investors offer funds to entrepreneurs in exchange for an equity stake to kickstart product development. Pre-seed funding entails investing in an idea because most items haven't yet been produced, and some startups may only have a prototype.

The initial salaries, as well as the initial machinery or tools required for the developed solution, are covered by the pre-seed fund. It also covers expenses like office rent, internet connection, management fees, etc. It can even assist in developing the business plan for the organization and provide it time to do market research before beginning its commercialization.

Types of pre-seed funding

There are several ways to raise money during the pre-seed stage. The pre-seed round starts with identifying which financing possibilities are available to startups hoping to convert a concept into a sustainable business. Let's look at the most popular ways to get your first round of funding:

  • Family and friends: These are the most common funding sources for pre-seed firms. Most of the entrepreneurs here invest their own money and seek the assistance of their loved ones.
  • Angel investors: Angel investments are often modest early-stage finance rounds provided to firms with creative ideas. These rounds can be anything from $10,000 and $250,000. Angel investors frequently have a long-term outlook and desire to see the firm they invest in prosper.
  • Crowdfunding: This pre-seed funding makes it simple and quick for people and businesses to raise money from various sources. A group of people who contribute a small sum of money will provide the startup with the necessary capital. These are useful tools but mainly rely on your brand's marketing to generate attention.
  • Venture capitalists: One area of expertise for some venture capitalists is making early investments in startups. Be aware that success rates are low and that venture capitalists are frequently the pickiest investors.
  • Incubators: Besides financing, incubators emphasize providing extra business services, including training courses, offices, and connections to active investors.
  • Accelerators: Accelerators concentrate on speedy scaling for ideas with a lot of growth potential. Although some accelerators offer pre-seed capital, they often focus more on expanding firms.

How much equity is given in pre-seed?

The amount of equity a startup should give up in a seed round should depend on a few things, such as how much money it is currently making, how much it will be worth in the future, how much money it needs to raise right now, and so on.

Founders and entrepreneurs often struggle with determining the pre-seed startup valuation and how much they are prepared to give up. There are a few factors to consider when determining how much equity companies should give up at pre-seed rounds and other stages of a company's growth.

It is vital to be well-versed in the firm shares you are willing to give up or are at ease giving up. When founders must quickly obtain capital, offer a firm valuation, and sell a portion of the company's shares to anyone interested in purchasing them, the equity problem becomes relevant. This effort to raise money is being made to ensure that the business has the funding it needs to advance to the following stage of its development.

Knowing how much to give up at the seed round is crucial to prevent the problems of not having complete control over your company's finances as it grows. Pre-seed round investors often include close friends and family or angel investors, and the contributions range from $50,000 to $200,000 for a 5% to 10% equity stake. They give you ample time to construct your MVP (minimum viable product).

How much should I raise for pre-seed funding?

The answer to this mostly depends on the requirements of your company. To give you some insight, the usual pre-seed investment ranges from $50 to $250k globally. Prototyping, concept generation, or general, administrative, and organizational costs, including rent, supplier payments, and working capital, are often covered by the revenues from this stage.

Compared to Seed and Series A funding rounds, pre-seed funding rounds often raise much less money. The easiest technique to figure out how much pre-seed cash you require is to calculate how much you'll need to raise in the next funding round and become profitable.

What is a good pre-seed valuation?

Startups that obtain pre-seed funding typically receive around $250,000. The amount you qualify for may vary based on the investment route. The most crucial guideline to remember is straightforward: Ask potential investors for a reasonable estimate.

You must provide evidence to justify your pre-money valuation (i.e., the amount you are requesting), which means you should only ask for what you require to become profitable or to last until the next financing round. Most businesses want to achieve the next funding milestone, but some exceptional startups swiftly reach profitability.

What is the seed stage?

The first formal round of funding for a startup is the seed funding definition. When the firm has met critical growth milestones with the money received through pre-seed fundraising, it is now time to seek seed capital. By this point, the product or service has attracted enough interest to draw bigger, accredited investors. The funds raised at this point will aid the company's expansion, boost its valuation, and prepare it for larger Series A and B fundraising phases.

This fundraising aims to lay the initial seeds and support the firm's development. It provides funding for market research, hiring, and initial product developments. A startup that receives seed funding has the chance to grow and mature past its very early stages. With these increased resources, the firm will expand its working capital and hire more salespeople, support workers, and other areas.

Types of seed funding

Understanding the various options to raise seed funding will aid in the expansion of your business. Let's look at the most common ways to obtain your startup's first "formal" investment round.

  • Crowdfunding: Crowdfunding sites have recently been a popular source of seed investment. Anyone can support the idea, concept, or product on these platforms because they are typically open.
  • Venture capitalist: High-end investors known as venture capitalists make investments in new ventures after considering various factors, including market conditions, the founder's vision, growth prospects, etc.
  • Incubators: These investors focus on assisting the new companies through training and frequently supply office space and little seed capital. Numerous prestigious academic institutions also offer such services. Incubators often do not request equity stakes from startups.
  • Angel investors: These investors contribute seed capital to a startup in exchange for equity or debt securities.
  • Accelerators: These investors prioritize scaling-up assistance for startups over early-stage innovation funding. Additionally, they offer assistance by offering networking opportunities, mentoring, and various forms of training. Accelerators typically take equity, unlike the majority of incubators.
  • Corporate seed funding: Due to the large corporate investors, this is a very good source of startup capital as startups become more well-known. Large corporations such as Google frequently provide seed funding to quite a few startup companies. These expenditures may benefit new firms as they establish their brand.

In a seed fundraising scenario, numerous prospective investors exist, including entrepreneurs, colleagues, relatives, accelerators, venture capital firms, and more. Three different contract kinds are included in the investment, which is between $100,000 and $5 million. Which are:

  • Equity Financing: Investors invest in exchange for a share of the company's ownership. These investors demand a portion of the company's equity because the seed stage is crucial for gauging a startup's potential.
  • Debt Financing: Investors put their money into the startup as debt that must be repaid with interest after a predetermined period.
  • Convertible Debt: When a startup valuation is not feasible, investors invest utilizing convertible debt, with the option to convert the invested funds into equity later. If not, it must be considered debt and paid back after a certain time.

 Typically, seed funding is provided for six to eighteen months. There is a lot of research, legal work, negotiating, and other things at this time. From here, the firm will either advance in the market or find another way to arrange for the capital.

Tips for raising pre-seed and seed funding

One of the most frequent challenges founders have throughout the planning stages of establishing a firm is obtaining the funding to support early-stage operations. When trying to raise money for your startup, you should follow four key processes. Let's review the fundamental procedures and what you should consider when approaching investors.

Build your pitch deck

Your main resource for obtaining funding is a strong pitch. This is your chance to explain to and convince investors what your enterprise is all about and the problems your product is intended to tackle. An excellent presentation can be made by using a pitch deck template.

Think about adding these to your pitch, but remember that simplicity and conciseness are crucial. To raise money, founders need to be prepared for in-depth inquiries regarding each of these subjects as they look for extra funding:

  • How your goods or services are distinctive
  • Your business model
  • Plans to engage customers
  • The target market demographics you're aiming for
  • How do you intend to increase revenue
  • The number of funds needed and how the proceeds will be used

Make an investor list

Analyze the investors or organizations you're evaluating, or look for investors with a track record of investing in enterprises comparable to yours. These investors are knowledgeable about your business and more eager to help you lead your firm through its early phases of development. Evaluate potential investors using type, funding, experience, integration, and expertise traits.

Engage your audience

Before investing in your startup, most investors will want to see a live presentation. Presenting your company is the tensest step in the process. Presentations are a chance to display your true self. As the founder of a startup, you must project both confidence and humility. Overconfidence and arrogance are big caution signs for pre-seed investors.

Here are some great tips when engaging investors;

  • Don't complicate your presentation: Avoid straying off topic or letting it drag on for more than a few minutes. As much as you can, trim it back. Keep in mind that investors are busy individuals, so wasting their time is the last thing you should do.
  • Engage in honest conversation: People want to be heard, and people want to be invested in. Demonstrate that you are paying attention to their issues and concerns. An investor is not a financial institution. They are someone you will be working with for a long time.
  • Be ambitious while remaining realistic: Having high dreams is fine, but investors want to know that you're grounded. Don't make up stats or overstate the situation.

Manage your milestones

Setting reasonable milestones demonstrates to investors your candor regarding timelines, financial objectives, and growth projections. Your firm should be further along than the ideation phase to run a successful fundraising campaign. You would already have found co-founders in an ideal world, worked out a thorough product description, and investigated market fit. You will already know your target market's demographics and how your offering meets their wants.

The following are some typical benchmarks that could show you're prepared for pre-seed funding:

  • Having a prototype or minimum viable product (MVP)
  • Displaying some traction, including early adopters and feedback indicating product demand.
  • Having a compelling business model

Your objectives should be tailored to your product and enterprise. Show off your charisma and your enthusiasm. Both propel startups. Simply telling your story and sharing your enthusiasm will elicit a response from investors.

How do I determine the value of my startup?

The value of a startup indicates how much it is worth at any particular time. The product or service's stage of development, market proof of concept, the CEO and their team, valuations of competitors or startups with a similar business model, already-existing strategic alliances and clients, and sales all play a role in the valuation. Financial analysts can employ a variety of startup valuation techniques. Below, we'll go over a few well-liked techniques for appraising an early-stage startup.

Cost-to-duplicate approach

The Cost-to-Duplicate Approach entails accounting for all fees and costs related to the startup and its product creation, including the acquisition of its physical assets. The fair market value of the startup is calculated by factoring in all of these costs to get the total value of the startup.

Market multiple approaches

One of the most often used techniques for valuing startups is the Market Multiple Approach. The multiple market approach functions similarly to other multiples. The company in issue is compared to recent market acquisitions of like kind, and a base multiple is established based on the worth of those recent acquisitions. The base market multiple is then used to determine the startup's value.

Discounted cash flow approach

The discounted cash flow approach (DCF) Method is primarily concerned with forecasting the startup's future cash flow trends. The future cash flow value is then evaluated using a rate of return on investment, or "discount rate," as a basis. Since startups are still in their early stages and investing in them carries a significant risk, a large discount rate is typically used.

Future valuation multiple approaches

The Future Valuation Multiple Approach is primarily concerned with determining investors' expected return on investment in the next five to 10 years. The company is valued based on several estimates made for the aforementioned reason, including sales projections over five years, growth projections, cost and expenditure projections, etc.

How gini can help

Raising capital is the biggest problem facing asset-light companies that don't fit the traditional financier's profile.

Our partner, Pershing Ventures, uses the same models provided to gini customers to understand a client's financial projections and drivers, allowing them to provide bespoke investment solutions that accelerate growth. Click here to learn more.

FAQs

What is pre-seed stage funding?

A pre-seed funding round is the first meaningful cash injection a firm will receive, aside from money saved, loans from family and friends, or money from a prior exit in the instance of a serial founder.

What is seed-stage funding?

Seed funding is the initial official early-stage funding round that businesses receive before moving on to the following rounds: series A, B, C, and so on. Investors contribute funds to your firm in exchange for equity in the company.

How much do I need for pre-seed funding? 

A pre-seed round typically raises $150,000, but it can be as little as $50,000 or as much as $250,000.

How much do I need for seed funding? 

A seed round typically raises $2.2 million, but it can be as little as $100,000 or as much as $5 million.

Cash Flow Forecasting Xero
Ray Wyand, CEO of gini
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