More funding rounds have surfaced as the venture capital scene expands and develops. Around 2020, pre-seed funding showed up to meet the needs of founders looking for an initial push to get their ambitious ideas going. Today, pre-seed funding, or “family and friends,” is a chance for investors to take in promising ideas from dedicated founders to kickstart their vision. Let’s look at how early startups can go the pre-seed route and get successfully funded.
What Is Pre-Seed Funding?
Pre-seed funding is the capital startups require to turn their prototype into an authentic product before establishing a customer base or product-market fit (PMF). This stage is all about selling a great idea to investors.
The primary goal of pre-seed fundraising is getting the company fit and ready for seed-stage fundraising, which is more intensive and demands a company show its full potential. So, a successful pre-seed round will fast-track founders’ goals and help them set up shop solidly.
Turning an idea into a minimum viable product (MVP) is most important when receiving pre-seed funding. This way, startups can acquire a customer base, garner traction, and move on to the seed stage with a strong claim.
Let’s take the giant ride-hailing app Uber and its $200,000 pre-seed round in 2008 as an example of a pre-seed round’s impact on a startup. Their pre-seed pitch deck shows us that, even though they didn’t know the true impact their app would have on the world, they had the market analysis down pat.
For example, they forecasted smartphones would take off through their expected growth at the time and the hardships of the monopoly-style taxi cab industry. After raising enough to develop and mature the app with the evolution of smartphones, Uber closed a seed-stage round of $1.3 million in 2010.
Investors in this early round aren’t conventional pension funds or financial institutions. Here’s a list of players who typically participate in pre-seed rounds:
- Family and friends: Also known as bootstrapping. Most times, this will be a pre-seed round’s saving grace. Founders will get their loved ones and acquaintances to pitch in and help their idea grow.
- Venture Capitalists: This is a group of investors who see great potential in a startup and buy a stake, help it grow, and, ideally, get it through the process of exiting with an Initial Public Offering (IPO).
- Angel investors: Usually solo investors who use their own wealth to fund a promising company, with investments ranging from $15,000 to $250,000. Their control over the startup’s operations is minimal.
- Incubators: These organizations provide services for startups to grow and are a bridge to connect with investors. They also offer mentorship, office space, and training courses.
- Accelerators: Much like an incubator, accelerators help startups grow, but at a much faster pace, and take a chunk of equity between 5% to 10%. Accelerator residencies usually last three months and focus on high-growth companies, offering services to improve their business and exposing them to investors.
- Crowdfunding: This is the financing of the people. Crowdfunding helps startups get funded without losing equity. Founders take to online crowdfunding platforms like Kickstarter and Indiegogo for individuals around the world to donate to their idea. This funding option works best if startups know how to market a product from the get-go and grow its online buzz.
How Does Pre-Seed Funding Work?
Early startups’ needs might not be as big as a more advanced funding stage, but founders still need to get their ducks in a row — from knowing how much funding they require and pitching to defining valuations and agreement terms.
To understand the funding needs of an early stage startup, founders must think about how much money it will consume monthly and then secure at least the next 12 months. Ideally, they should secure funding to hold the fort for 24 months, which gives them enough time to gain traction and money to increase the valuation for the next round.
Some Terms To Keep in Mind
Before starting the funding process, it’s good to be familiar with terms that might get thrown around a lot. Here are a few:
- MVP: A prototype of the finished product, which investors will enjoy seeing in order to fund a startup. This shows a company’s promise and allows for better market research to refine its product.
- Equity: This alludes to the startup’s ownership amounts. When getting funded, startups will give away a portion of their equity, meaning an investor owns part of the company.
- Convertible notes: When a startup is too young to have a valuation, convertible notes allow them to get financed with the promise of future equity instead of acquiring debt. They usually have fixed interest rates and a maturity date, giving these banks or investors preferred stock or priority over other future shareholders.
- Simple Agreement for Future Equity (SAFE): The SAFE is similar to a convertible note but accrues no interest. They’re usually triggered by events like company acquisition or future investment, which alter the startup’s valuation.
How To Raise Pre-Seed Funding
While other rounds declined in deal count, pre-seed funding deals grew 8% in 2022. Here are three tips to help young companies secure capital.
1. Building a Business Plan
This will give investors the peace of mind that founders know exactly what they’re doing and how they’re making it happen. Thus, it must be realistic and achievable, including business goals, strategies to get there, and financial projections.
Here, remember the three P’s for business plans: people (who’s on the team doing what), proposition (how unique the product is versus competitors), and purpose (what inspired founders to start the company and why others should invest in it).
2. Crafting a Compelling Pitch
A pitch can make you or break you. So, it’s imperative to use a pitch deck as a visual aid that enhances a presentation rather than bore investors. This is why the number of slides should range from 10 to 12. For example, TechCrunch did a pitch deck teardown for a successful $1.2 million pre-seed round with valuable best practices.
Graphs, maps, and charts are good tools to gather lots of data and make it digestible — but avoid visual clutter.
Founders can also frame their founder’s story and vision through compelling storytelling, which helps investors resonate with them. They’ll often invest in an idea solely if they connect personally with a founder’s story.
3. Identifying Potential Investors
Remember that it’s not the equity firms or investment banks that will fund a tech startup. So, curating a list with the right names will save founders time and get them straight to potential investors.
Knowing a startup’s needs before listing investors will help filter this list. If founders need CapEx, there are more experienced investors than others in this area. Others might better guide the company around the industry and make connections.
Risks and Challenges in Pre-Seed Funding
Investors place a lot of trust in early startups and expect returns within a specific time range, making new founders feel like they’re carrying bricks on their shoulders. A way to avoid this is by communicating directly and earnestly, voicing concerns, such as production delays or unexpected emergencies, and delivering constant updates about the state of the product, research, and sales. Thorough market research and truthful financial projections also reduce overpromising to investors, mitigating a mismatch in expectations.
Another considerable risk for founders is equity dilution. This is why founders should strive to maximize company valuation while reducing or maintaining company equity. Dilution also affects decision-making within the startup if investors don’t see eye-to-eye with founders, which can be avoided by working with investors founders truly connect with.
Pre-seed funding takes a lot of preparation and effort from founders, but if done well, the returns can yield maximized benefits. It’s founders with passion and drive for their idea that will put their money where their mouth is and make the most of their pre-seed funds.
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