Pre-seed funds have exploded in popularity. We’ll list out some of the most active and best pre-seed funds below.
But, first, what is pre-seed funding and how is it different than a seed round?
Pre-seed funding is a round of investment in a very early-stage company designed to help the founders 1) form a company, 2) get operations going and 3) achieve the milestones they need to hit to raise a seed round. Pre-seed rounds often leave “room” in the cap table for one or more subsequent seed financings.
Of course, like any round of financing, actually raising the capital is easier the more traction or proof points the startup has.
Certain funds are specialized in this stage of investing. Does your startup need one when you first start raising outside capital?
In a nutshell, pre-seed funding is just enough money, given to a startup, to prove out their initial idea. Around five to ten years ago all the venture capital funds started going upmarket. Traditional series A players, such as the famous Sand Hill Road funds, wanted to wait a little bit longer and make sure the company was doing well before they gave them money. The upside to this was, once they saw the growth, they would give them more money.
This helped thepre-seed funding emerge by creating an opportunity for investment at the earliest stage possible – the very first check into a company. Some very smart fund managers saw this opportunity and decided to pursue it, branding the earliest stage of funding as “pre-seed”. And it’s been super successful.
There are a lot of really good pre-seed funds right now. We are seeing pre-seed funds raise $50 million when they used to be around $10 million, which shows they are really growing. This is great news for founders, since pre-seed is there toget your startup going and help you build something that can then prove out your idea.
Some people call this stage “product market fit”, but we would say it’s not even product market fit. It is more like “minimum viable product.” Examples include things like:
Pre-seed funding is for really early stage startup founders, and it’s really for the “non-famous,” “non-repeat” founders. Founders with an established track record, like those who’ve done an IPO or have been successful before, are probably going to go straight to seed, possibly even series A, and immediately raise a big chunk of capital.
Venture capital firms, angel investors, and everyone else loves to back founders that have done it before. Even founders that may not have previously been successful can sometimes have an easier time raising money than first time founders. They can talk about all of the things they have learned, and they know how to talk to investors, run board meetings and, essentially, build something.
Usually pre-seed money is for a novel idea, often from a young founder, who other later-stage investors at series A, or even C, don’t want to take a chance on. We love this asset class here at Kruze because you are giving the truest form of entrepreneurs their first start. We really appreciate and respect the funds that do this.
One thing to remember is that these very early funding rounds will probably be one of your startup’s most dilutive rounds as an entrepreneur. The reason for this is your startup valuation will be very low. Your goal here should be to take as little money as possible that will still let you prove out your idea.
We often see pre-seed rounds being between $500,000 - $1 million, with the valuation around the $5 million mark. This means you are still selling 10-20% of your startup. However, while a million dollars is a lot of dilution, pre-seed funding is for founders who really need that infusion of cash. The beautiful thing about taking that money, although you suffer dilution, is it means you are in business. If you build something awesome then you are going to be able to find follow-on money.
There are three basics goal that a founder wants to achieve with this type of funding:
That means pre-seed funds are the pipeline for seed and series A funds. Seed and series A funds are constantly talking to pre-seed funds to figure out who the best companies are in that pre-seed position. When they find a pre-seed fund with a successful company they become incentivized to help the startup raise money too.
There’s a huge amount of value in that introduction. It’s really helpful to gain someone who is experienced, who is in your corner, and who can give you guidance.
There are a couple of other types of key players at the pre-seed stage:
Angel investors have been around forever. They go back to the dentists and doctors in Silicon Valley, somewhere between the 1950s and 1970s, who had a lot of cash and decided to put money into startups and Silicon Valley was born.
This means there are plenty of people out there that will want to write smaller checks in front or behind the pre-seed funds. This is another value that pre-seed funding brings: Angels will write you a term sheet, put their name on it, and price the deal. Once you get that signed term sheet, it becomes considerably easier to fill in the round. There is huge value in having a lead investor, even at the pre-seed stage. That helps you find other angels, like high-net-worth individuals, successful entrepreneurs, or people you know or have worked with before.
Another path you can take are incubators, like Y Combinator. Incubators provide a lot of value, including:
This will lead to you doing demo days and presenting to investors. It is another really good way to raise a pre-seed.
We often see companies raise a pre-seed simultaneously with joining an incubator. Instead of just going to the incubator and getting $200,000, they will raise between $500,000 and $1 million. This means the company can build a little bit faster and make a little bit more progress while they’re part of the incubator.
So our advice to founders who haven’t been successful at raising funds at seed or series A is that if you’re offered a check from a pre-seed fund, bite the bullet, take the dilution, and get into business. At that point you control your own future. You can really reap the benefits of pre-seed funding to get your startup off the ground.
It turns out that pre-seed funds are filling a really important niche in the market. These firms actually help increase the velocity of the earliest stages of venture capital. Greasing the wheels of Silicon Valley, in a way.
The first thing that pre-seed funds do is they set the terms and actually price a deal at the really early stage. This is incredibly valuable, because angel investors feel so much more comfortable coming into the deal and following a named institutional pre-seed fund.
And so, one of the core services a pre-seed fund is doing is just giving you a term sheet that sets the terms of the deal (such as the security type SAFE vs convert vs preferred, valuation, etc.). You can use them as the anchor investor, and use those terms to fill out the rest of the round. This is probably the most valuable thing they do.
The next thing that one of these funds will do, is that they get you thinking like a VC-backed company. It’s a huge shift from being bootstrapped or just a super scrappy, three ladies in a garage type of startup. When you take professional money, you have to start professionalizing in a way that helps the company and that helps you be prepared for your next round of financing. Professional financials, real board meetings, producing KPIs and metrics… These investors really helps you make that shift. And they do it kind of in a lower stakes environment than trying to do that after you’ve taken a 20 million dollar round and learning on the fly.
Another benefit is with recruiting. A well-known pre-seed fund can recruiting so much easier for you, because you have some incredible logos. Then you can put on your website that people recognize. And when employees are taking a job at your company, they’re really betting their capital, like their time. They’re going to be working for you and spending a lot of time on your company. And so, knowing that some bigger players, some institutional players are funding you really makes recruiting a lot easier.
It’s the same thing with customers, which is the next benefit of taking an investment from a pre-seed investor. Small customers probably don’t really care who the backers are. But, when they’re signing a multi hundred thousand dollar or a multimillion dollar deal with your startup, it really helps to have some institutional VCs that they can reference, that are on your website, and that they have confidence that will help get the company funded. If they’re signing up to use your service, they don’t want it to go away in six months because you ran out of money. This helps make your sales process easier.
Another huge benefit is that seed and Series A funds follow the best pre-seed investors like crazy. Leading seed and Series A investors want to see the deals that come out of the good pre-seed investors’ portfolios. The next stage of investors are going to trust the general partners of the pre-seed fund. Their reputations and contacts will make the next round of financing so much easier.
And the final big value-add from pre-seed funds is their LP-base. Now, LPs are investors in the funds. The investors in the pre-seed fund tend to invest in a lot of other kinds of funds including seed and Series A funds. It’s very common for positive word of mouth to start circulating on a company that they have seen in great updates to the LPs or even better at the Annual Investor Update Meeting. If you get to present to the LPs that’s really really valuable. You’ll have positive buzz. The LPs will probably mention your company to the Series A funds that they invest in. Again, valuable introductions. And, we’ve noticed a trend where the partners of traditional VC funds
These are some of the big benefits you get out of raising from a quality pre-seed fund.
Why should you consider having pre-seed investors invest in your startup?
And who are the best pre-seed funds?
We are labeling these “venture capital funds” since they function as VC funds - a partnership raises capital from outside investors (“LPs”), and typically charges those investors the same rates that VCs charge their LPs. This list of pre-seed funds is based on the investors we see actively investing in the clients that we service.
Every industry will have specific milestones on when professional pre-seed funds are ready to make an investment. And other important variables may make it easier for a younger company to raise pre-seed funding - such as an experienced team, pre-existing/strong relationships with funding sources, hot hot markets, etc. However, there are a few KPIs that we can broadly generalize to that help founders know that pre-seed funding from professional investors may be an option:
We’ve written extensively about what goes into a VC pitch deck - the concept is the same for founders raising pre-seed funds.
Check our our pitch deck piece to get more detail and more ideas on what you can include.
Did you just raise funding? Congrats! Now you have professional investors who expect professional financial statements. Check out our low-cost, high-quality bookkeeping service pricing for funded startups.
By definition, a company pitching for pre-seed funding is very early-stage. So what does an investor look for in a startup to determine if investing is a good idea?
An interview with a well known pre-seed investor, Charles Hudson discusses what he looks for. Answering the question “what do you look for - what is it that gets your attention,” he said:
“It’s a really interesting question. The only thing that I can focus on is that person’s articulation of the idea. And what is it that they’ve understood or learned about the problem that they are trying to solve that feels novel, special or unique… for me it’s can the person tell me a really good story about the market opportunity that they are going after and why they are uniquely suited for going after it. And a lot of times… we have people who are mid-level manager or director level at a startup and have build a tool internally or saw some problem repeatedly in their own company and decided that they want to go solve that for a bigger audience. Other times we have people who are maybe employee 1,000 at a company that’s gone on to be really successful… and they’ve learned a ton about some aspect of the business that they want to solve. And my view is that the people I meet who can tell me a good story and get me excited can do the same for customers, investors and employees… and $500k to one million can solve one of the big, unopened questions about the business.”
It’s a great interview with a leading investor at this stage - listen here.
The average amount of capital raised in a pre-seed round is typically $100,000 to $1,000,000 - although CrunchBase reports pre-seed capital raises of up to $7.3 million in the first three months of 2021.
Most of our clients who raise this type of capital raise under $2,000,000, with this round of financing being a bridge until they can raise a larger seed round. And seed rounds have became quite large in 2021; we saw a number of seed rounds raising $10 million or more in capital. This has moderated somewhat in 2022, but there are still companies raising $5M+ seed rounds, usually off the backs of $2M+ pre-seed rounds.
Most of these capital raises are $100k to $1M in size, but the “correct” amount of capital to raise in a pre-seed round depends on how much capital the startup needs to achieve the milestones to successfully raise a seed funding round. An MVP, revenue traction, strong customer logos, proof of concept from a scientific perspective - these are all good milestones to shoot for with the pre-seed round.
We see most startups selling 10% to 20% of their equity in a priced round. However, many startups - especially ones with second-time founders - negotiate a SAFE or convertible note round with around a 30% discount. These rounds, if done with a convertible security, often have a more aggressive discount rate since company is usually closer to ‘slideware’ than an actual operating business.
The first step in how to get pre-seed funding is to get in contact with possible investors. Meeting pre-seed investors can be daunting, especially if you are looking for pre-revenue investors. We’ve worked with hundreds of founders who have successfully found very early-stage investors. Here are some of the strategies that they’ve used:
See some other tips on how to raise angel funding here.
Sometimes a founder will find the right lead investor for their seed or pre-seed round right away. Other times, getting funding commitments is a long battle that involves conversations with multiple groups over a long period of time.
There are two common strategies to get investors to commit, sign and wire seed and pre-seed funding (seed extension funding as well!). Founders use these strategies when they are raising a convertible security, like a SAFE or Convertible Note; these strategies are not usually used when raising a ‘priced’ round with Preferred Stock. The two strategies are: Progressive Caps or a Soft Commits.
With a progressive cap strategy, the founder sets a series of progressively higher valuation caps on their SAFE/Convert. The first investors to sign and wire their investment get the lowest cap, until all that security is taken. Then the next investors get the subsequent caps.
For example, the founder will state that they are raising $500k at a $4M cap, then $500k at a $5m cap, then $500k at a $6M cap. As each amount is filled, investors coming in get the higher cap, until the round is closed. This creates a sense of urgency through scarcity, meaning that investors are more likely move so that they get the more desirable tranche. The biggest issue with this fundraising strategy, especially in a difficult funding environment, is that investors may be afraid to be part of the first commitment, since the subsequent dollars may not arrive. this leaves them as an investors in a pre-seed company that failed to fill out it’s round and that may not have enough capital to achieve the goals it needs to hit to raise a seed round!
For a Soft Commit strategy, the founder gets investors to provide “soft commits,”, i.e. asking the investors how much they want to invest at a reasonable cap/valuation. Then the founder meets with many investors to pencil in the round. In an ideal scenario, the founder finds an investor near the end of the process who sets the pricing/cap. Then the founder has to go and tell all of the committed investors what the terms are, and get them to sign and wire. This strategy can be slower/take longer to get funding into the company. However, in a tough funding environment, it can be a higher probability method of raising a round, to the extent that your startup remains attractive and that investors who soft committed were serious.
If you are successful raising pre-seed funding, it’s time to set up the infrastructure for your startup’s finances.
You’ll need a place to keep the cash that you’ve raised, an accounting system to keep track of your finances, a payroll system to pay you and your first employees, a corporate card (not a personal one!) to pay expenses, and more. Here are the steps you need to take after you’ve raised pre-seed funding:
The authors of this post have collectively invested in 80+ startups, many at the pre-seed and seed rounds. They have invested in SAFEs, Converts, price rounds; have been on cap tables of SaaS companies, crypto startups, cleantech companies, marketplaces, and more.
Things You Should Do After Closing a Seed Round
Posted on Sat, 17 December 2022
Seed rounds are usually the first material amount of institutional investor money put into a company. So it’s important for startup founders to take the right steps once you have successfully raised that funding.
The Kruze team works closely with many leading pre-seed investors. We also convince many of them to sit down with us for podcast interviews - listen to them now!
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