In recent years, entrepreneurs have been able to find funding earlier in the startup process. It was not long ago that pre-seed funding was a rarity indeed. Even when a startup founder was able to secure it, it was usually a “friends and family” arrangement, with a parent or sibling chipping in to help kick things along, as much as a favor as anything else.
Now, however, with the rate in which startups can gather steam, and great ideas can turn into unicorns, there are more early-stage VCs with money to invest at the pre-seed phase. This is a big opportunity for the entrepreneur! Suddenly it’s possible to have a great idea and not need to have accumulated personal wealth to fund the initial push. Now, more entrepreneurs can chase their dreams, knowing that, with the right startup idea, team and pitch, they can find the money to kickstart things, get that MVP created, and then approach further funding rounds with confidence.
One great recent example of a company effectively leveraging pre-seed funding is German startup, tl;dv. tl;dv specializes in recording meetings held over Zoom and other platforms, and then providing automated meeting highlights to make it easier for those that missed the meeting to catch up. The company raised €350,000 in pre-seed funding after being founded in 2020. In June, it closed out its first round of seed funding, raising €4.3 million, having been able to deploy the pre-seed funding to launch and scale rapidly, with 200,000 users already on the books.
So, what exactly is pre-seed funding?
Pre-seed funding, as the name suggests, is an investment round that is secured pre-product market fit and pre-revenue. It comes right at the start of the startup’s life, when the founders are being fueled by great ideas and plenty of coffee, but have yet to start to make inroads in developing the product.
There are many great ideas that fail to materialize simply because the entrepreneur is not able to find the money for it. Without pre-seed funding, they’re going to need to draw on their own financial resources, and having the greatest idea in the world doesn’t mean much if you’re not able to risk a few hundred thousand dollars to get going.
Pre-seed funding is solving that problem and results in the startup space becoming much more egalitarian. Now, suddenly, the focus is on ideas and the people behind them, rather than who has access to money.
… And how do startups use pre-seed funding?
Pre-seed funding is typically a small investment, and the founders need to make that money stretch a long way. The typical approach that early stage VC investors take is to invest in multiple startups with a smaller investment in each, rather than later stage investors that tend to invest heavily in a relatively small number of companies.
Therefore, founders that have a compelling startup idea could expect to raise anything from $150K to $1M in the pre-seed funding stage.
That money needs to be stretched in many different directions. Some of the most common uses of pre-seed funding include:
1) Setting up the infrastructure
It costs money to set everything up. This includes creating a legal business entity, purchasing the right equipment, tech stack, office space (if required), initial sales materials, and other necessary operational expenditures to make.
2) Designing your initial product
Before you can have an MVP, you’ve got to go through the design process. This can be a costly enterprise for a startup, as it’s essentially an R&D exercise, but it’s critical to get right, as it will form the foundation of the MVP and beyond.
3) Developing the MVP
Building an MVP will always cost money, but without the MVP it’s going to be tricky to land and grow customers. Furthermore, while pre-seed investors might not need to see an MVP, for future funding rounds it’s going to be important, as the MVP demonstrates your ability to execute.
4) Achieving early milestones
Other critical milestones for a startup include on-boarding the first customers and starting to generate revenue. This generally involves some marketing expenditure.
What is the difference between pre-seed funding, seed funding and later funding rounds?
It’s useful to understand how each round of funding fits in with the growth of a startup because, as a founder, that subsequently helps you to tailor your pitch to the relevant investors. The more you understand what they’re looking for, and why they might be interested in investing in your startup, the stronger your pitch will be for their investment:
Why raise pre-seed funding?
A common question that founders will ask themselves is whether they should even pursue pre-seed funding. The short answer is twofold:
Fast-track your startup journey
Firstly, it can help you accelerate the startup journey in those early stages where having cash is such a critical concern.
Entrepreneur literature will often talk about an “escape velocity”. It’s a metaphor borrowed from rocket physics whereby, at the early stages, a startup needs to accelerate quickly to “break free” of gravity and achieve spaceflight. If the speed is too slow, the effort ultimately stalls, and the longer it takes to get going, the lower the chances.
This is the fundamental reason why a third (29 percent) of startups fail because they run out of money, including the founder’s personal reserves. They haven’t achieved escape velocity, and once things have stalled too far, it’s impossible to recover.
Pre-seed funding’s most significant value is that it gives you the best chance of achieving that escape velocity. What “stalls” so many startups is that they run out of money, so the VC backing helps to minimize this risk.
Gain critical support
The second big benefit is that with the right investor, you can gain a critical support network, providing mentoring, networking, and other resources that can make all the difference early on. Select VCs invest in many startups, and have a lot of best practice wisdom that they will be more than willing to share with their current investments.
The best sources of pre-seed funding
Alongside your co-founders, you’ll likely put some of your own money into the venture. By being an investor and putting “skin in the game,” you’re giving yourself that additional incentive to drive the startup towards success.
Beyond that, there are external sources of funding that you can approach. These are people that, just like the venture capitalists that you’ll be talking to down the line, will not have day-to-day involvement in the business. They’ll make an investment, monitor how your business performs and potentially provide guidance, but are ultimately there to make a return from their investment.
Family and Friends:
Pre-seed funding is often called the “family and friends” funding stage for a reason. Often, founders will have at least one family member that has some money available and will be willing to make an investment if they believe that you’re onto something.
Now, with that said, approaching people that you have a personal relationship with for a business investment can be very risky. This is not a case of them lending you a bit of cash to buy a suit, or even forwarding you the money for a car or home deposit. This is an investment, and there is the potential for broken bonds if they end up thinking that you’ve misused their money or are ultimately unable to give them a return on the investment.
For this reason, you should only engage with people in the family that you know understand business and, ideally, have some experience in investment themselves. Even then, you need to be aware that this is playing with fire and, while pre-seed investment might be called the “friends and family” round, it’s probably better to tap those bonds as an absolute last resort.
Aside from the family and friends angle, the angel investor is the most likely source of pre-seed money for entrepreneurs. Angel investors are usually independently wealthy individuals that have an appetite for risk. They understand that most of the businesses they back will fail to result in returns, but they accept that risk, knowing that getting on the back of a unicorn right at the start is enormously lucrative.
However, angel investors are still effectively “amateur” investors. They might have invested in a number of companies and even had some impressive wins, and will probably have a rigorous vetting process, but ultimately they’re investing their money, on their terms, and there won’t be the same support structures as finding a VC to invest in the business (see below).
Pre-Seed VC Firms:
There aren’t all that many VC firms that will entertain pre-seed stage companies, but this number is growing, and with it the opportunity to engage with them.
Gaining the support of a VC is the “holy grail” at the pre-seed stage. You’ll need to work harder and longer to get the funding over the line, as the vetting process will be professional and rigorous, but the benefits make that process well worthwhile.
It’s not only that you’ll generally be given a larger investment into the startup than other pre-seed options, but you’ll also gain access to networking and mentoring opportunities, as your VC partners provide knowledge transfer to maximize the opportunities for your startup.
This is the deepest and most involved pre-seed investment opportunity for founders. For those looking for a partner that invests in their success, rather than just a source of some cash, VC’s are an optimal route.
Antler is a good example of this, however, goes one step further in offering day zero investing. This means Antler will provide the typical ‘later-stage’ support more traditional VCs offer, however opening this up to founders who are pre-team or even pre-idea.
This is a relatively new way for pre-seed companies to raise revenue, but the idea is appealing. With crowdfunding, you present your idea to the public and if it’s a good one, the consumer will effectively “pre-purchase” your product, giving you the cash that you need upfront to develop it.
Crowdfunding tends to work better with consumer products than B2B, as you’ll need hundreds, if not thousands of “backers” to raise the money that you’ll need. But it also then becomes your first group of customers, and the feedback and advocacy of that group can be an enormous benefit through the design and eventual launch of the product.
How to prepare for a pre-seed round?
The growth in VCs and other investment opportunities at the pre-seed stage has meant that entrepreneurs have an almost unprecedented opportunity to convert their brilliant idea into a viable startup business. With the right tools and knowledge supporting the financial investment, a founder can launch their startup idea with true confidence.
To raise pre-seed investment, however, there are some critical steps founders need to follow in order maximize their chances of success. Continue reading our exclusive playbook, where we share our battle-tested approach to launching a startup and securing your first round of funds.