Are you a founder considering whether to raise pre-seed funding? Have you got many burning questions about what pre-seed funding exactly is and how you can go on your way to raising investment? Here, we discuss what pre-seed funding exactly is, the purpose of pre-seed funding and what you can do to prepare before your raise.
According to a survey by CBInsights, which analysed the reasons for failure among 101 startups through interviews with employees and founders, the main reasons for failure were found to be: a lack of market demand for the products or services offered (42%), and running out of cash (29%).
The main reason why 29% of startups fail is due to a lack of funds, including the founder’s personal resources. Without reaching a sufficient level of success, recovery becomes impossible. This is why pre-seed investment can be critical to saving your start-up.
Thus, the primary benefit of pre-seed funding is the increased likelihood of reaching this success level. Many startups fail due to a lack of funds, and the backing of investors can helps to reduce this risk.
What is pre-seed funding?
Pre-seed funding refers to the early stage of startup financing, where a company raises capital from investors before reaching its first significant milestones, such as launching its product or generating revenue.
Pre-seed funding is the initial stage of investment, preceding seed funding and other rounds. It entails investors providing startups with financing in exchange for ownership, to commence product development. This stage may follow earlier funding phases such as self-funding by the business owner or angel investment.
Pre-seed funding essentially involves financing an idea, as the product is typically not yet developed and the business may only have a prototype.
Thus, it is typically used to support the formation of the company and the development of its concept. In this stage, the company is still at a very early stage of development, and investors are taking a risk by investing in an unproven idea.
The distinction between pre-seed and seed funding:
Pre-seed and seed funding share some similarities, but with several key differences.
Seed funding is typically the first formal round of investment, involving more structured investment and providing more substantial growth after pre-seed funding.Founders tend to receive larger investments through seed funding compared to pre-seed funding. Pre-seed funding typically ranges from £50k to £100k, while seed funding may bring in over £100k+. During the seed funding stage, investors generally expect the company to have established some momentum, while pre-seed funding usually precedes product development.
Over the past decade, Europe has seen a rise in venture capital funding and a more developed ecosystem. As a result, more investment funds have emerged seeking to discover the next big success story. According to Dealroom, pre-seed stage investments in Europe rose dramatically from $385 million in 2012 to $1.3 billion in 2021.
And in 2022, the pre-seed investment space has seen the arrival of several new funds. Cornerstone VC, born from a Black-led angel group, raised a £20 million fund. The UK witnessed the largest ever pre-seed fund with Concept Ventures announcing a £50 million fund. Octopus Ventures also closed its first pre-seed fund worth £10 million. Additionally, many new funds across Europe have set their sights on pre-seed investments.
When is it appropriate to seek pre-seed funding?
We asked this question of All-in-one pet care and insurance app founder, Pavel Gertsberg who secured $450k in a pre-seed funding round earlier this month (February 2023):
He said, to know the right time to raise pre-seed funding is when:
“I believe that there are only two things you need to build a successful company: team and capital. Sometimes you can get away with just one, but this is very rare.
“If you have the right team you can understand your customer’s pain points, come up with solutions and execute them. You then need capital to reach more customers and improve your product. Because capital is one of the two ingredients of “success” it is worth starting building relations with investors before you go to raise money.
“But how do you know when to raise pre-seed? For me, you can raise your pre-seed if you have (1) a founding team that can execute (2) an understanding of customers’ problems (3) some sort of validation of your solution (ideally people paying something). Then you can go and raise VC money.”
At FundingHero, we think businesses can be at various stages before considering pre-seed funding. Some signs that indicate that you may be ready for pre-seed funding include:
- Development of a minimum viable product (MVP) – This refers to an early version of your product that is likely to gain traction. Over time, your product will evolve based on market research and customer feedback, eventually becoming the final product as it gains the attention of investors and consumers.
- A strong founding team – Your founding team should have industry knowledge and expertise, but you can still appeal to investors without extensive experience.
- Product-market fit – If your product resonates with your target market, you are more likely to attract investors who see potential in it. You must be able to demonstrate that your audience likes your product and that there is demand for it.
- On-boarding new customers – You may also consider raising pre-seed funding if you have a small customer base or are starting to attract them. The crucial factor is that you must be able to keep pace with the growing demand from your expanding customer base.
In addition to these key factors, it is important for businesses to have a well-defined plan for how they will use the pre-seed funding to achieve their goals. Having a clear understanding of your market, target audience, and the potential for growth can help you secure the funding you need to get your business off the ground.
What is the purpose of pre-seed funding?
The primary purpose of pre-seed funding is to help startups get their footing and build the foundation of their company. This funding can be used to pay for expenses such as product development, legal fees, office space, and other operational costs. It can also help the company hire its first employees and build its team. With pre-seed funding, startups can also validate their idea, conduct market research, and create a minimum viable product (MVP).
Pavel said: “The purpose of raising pre-seed for me is simple. If you know the pain points and have some validation of your solution you need cash to build a more robust MVP, test customer acquisition channels and get key hires in.”
Types of pre-seed funding
There are several types of pre-seed funding, including angel investment, grants, and incubator and accelerator programs. Angel investors are individuals who invest their own money in startups in exchange for equity. Grants are usually provided by government agencies or non-profit organisations and do not need to be repaid. Incubator and accelerator programs provide startups with mentorship, resources, and support in exchange for a percentage of equity.
The best sources for pre-seed funding can vary depending on your business and industry, but some common options include:
- Friends and family – Your personal network may be a good starting point for raising initial capital.
- Angel investors – Angel investors are individuals who provide seed money in exchange for equity in a startup. They may have industry knowledge and connections that can benefit your business.
- Incubators and accelerators – Incubators and accelerators offer support and resources to startups, including mentorship and networking opportunities. Some also provide seed funding to companies that meet certain criteria.
- Crowdfunding – Crowdfunding platforms, such as Kickstarter or Indiegogo, can help you raise money from a large number of people through online campaigns.
- Grants – Some government organisations and non-profits offer grants to startups in specific industries or with unique technologies.
- Venture Capital firms – Some venture capital firms invest in pre-seed stage startups, but these can be competitive and selective.
It’s important to carefully consider the terms and conditions of any investment and to seek the advice of a legal professional. Additionally, be prepared to share equity in exchange for capital and be transparent about your company’s vision, goals, and progress.
How should founders prepare for pre-seed funding?
If you are a startup founder looking for pre-seed funding, here are some steps you can follow:
Develop a Strong Pitch:
Before seeking funding, you need to have a clear and concise pitch that explains your business concept and why it is unique and valuable. Your pitch should also outline your business plan, including your target market, revenue model, and growth projections.
Build Your Network:
Networking is key to securing pre-seed funding. Attend industry events and conferences, join startup groups and online communities, and connect with other entrepreneurs and investors. This will help you build relationships and gain exposure for your startup.
Create a Compelling Deck:
In addition to your pitch, you should also create a compelling deck that showcases your business concept and provides more details about your product, market, and team. Your deck should be visually appealing and easy to understand, with clear and concise information.
Identify Potential Investors:
Research potential investors who are interested in your industry and have a history of investing in startups at the pre-seed stage. You can find potential investors through online databases, such as AngelList, Gust, and CB Insights. FundingHero also has an investor database available on our “Raise Plan”. Check it out here.
Prepare Your Financials:
Before approaching investors, you should have a solid understanding of your financials, including your current expenses, revenue projections, and funding needs. This will help you demonstrate the potential of your business and the potential return on investment for investors.
Make a Personal Connection:
When seeking pre-seed funding, it’s important to make a personal connection with potential investors. This can be done by reaching out to them through email or LinkedIn, or by meeting with them in person. Be sure to be authentic and genuine in your interactions, and be clear about why you believe your startup is a good investment opportunity.
Be Prepared to Negotiate:
When securing pre-seed funding, it’s important to be prepared to negotiate with investors. This may include discussing the terms of the investment, such as the amount of equity you are willing to give up, the valuation of your company, and the timeline for reaching your milestones.
If you’re wondering how a founder who successfully raised pre-seed funding prepared for the round, then you’ll want to pay attention to Pavel’s advice here:
“To prepare for pre-seed or any funding round, I suggest founders build relations first. Identify the top 100 founders in your industry and try to network with them (cold email/LinkedIn). They are the best people to introduce you to investors. Then identify the top 100 C-Level employees in large companies in your industry – they can be perfect angel investors.”
Pre-seed funding as a crucial step to validate ideas
In conclusion, pre-seed funding is a crucial step for startups to validate their ideas and build the foundation of their companies. By following these steps and working with the right investors, startups can secure the funding they need to grow and succeed.
Pre-seed funding is a critical step for startups to build the foundation of their companies and bring their ideas to life. This funding allows startups to pay for expenses such as product development, legal fees, office space, and other operational costs, as well as validate their ideas, conduct market research, and create a minimum viable product.
To secure pre-seed funding, startup founders should develop a strong pitch, build their network, create a compelling deck, identify potential investors, prepare their financials, make a personal connection, and be prepared to negotiate. It’s important to work with the right investors who understand the risks and potential rewards of investing in startups at this early stage.
Overall, pre-seed funding is an important investment that can help startups succeed and reach their full potential. By following these steps and working with the right investors, startups can secure the funding they need to grow and succeed. If you are a founder looking to be in the 1% who successfully raise external funds, join FundingHero – The platform where founders learn to fundraise!
