- By SeedInvest
- April 11, 2022
- 15 minute read
The journey from brilliant idea to thriving business is a long and arduous one. In the past, it often took years to raise the capital needed to get a business off the ground. Modern technology has cut that timeline significantly, and the pandemic lowered barriers to entry even further, with some startups now reaching valuations of $1 billion or more in under three years.
All that frenetic growth comes at great cost, however, and it’s not uncommon for startups to raise multiple funding rounds before an IPO. One of the earliest, and arguably foundational, of these funding rounds is pre-seed funding, which can make or break an early-stage company’s momentum.
This page is dedicated to the topic of pre-seed funding. Here you will find answers to questions such as:
- What is pre-seed funding, and how has it evolved?
- How can you raise a pre-seed round?
- What’s the difference between pre-seed and seed funding?
- When should you raise pre-seed funding?
If you are a startup founder, the following sections will help you decide if or when you should raise a pre-seed funding round and how to go about it.
What Is Pre-Seed Funding?
Pre-seed funding is a type of financing sought by startups during the very early days of their formation. Seasoned entrepreneurs frequently call it the “friends and family” round because, in many instances, friends and family are the sources of pre-seed funding.
Investors generally have high standards for picking a new company or startup and will usually only provide financial backing if the product or service is reasonably mature and has some promise in the market. Since it takes time for startups to generate revenue to attract the eye of investors, close friends and family members often step up to provide those critical early-stage cash infusions in the form of pre-seed funding even prior to revenue generation.
Other sources can be personal funds, or in some cases angel investors, select venture funds, or equity crowdfunding platforms.
Pre-seed funding is the first, "unofficial" funding received by a startup in its embryonic stage. The money raised will help pay for the initial costs of setting up the company, hiring the key team members, and creating a minimum viable product (MVP). Pre-seed funding provides critical early-stage cash infusions needed to stabilize the business and give it a solid start.
The Rise of Pre-Seed Funding
Seed funding has exploded in recent years. According to Crunchbase research, fewer than 3,200 companies received seed funding between 2006 and 2010, but that number increased to over 23,000 between 2016 and 2020.
Unique U.S. Startups that Raised Seed Funding, by 5-year Cohort
According to Wing VC’s 2021 annual funding survey, the average amount of seed funding continues to increase. In 2020, the median round size increased to $4.4M from $3.2M in 4Q 2019 and increased 90 percent from 2015 levels. At the same time, the age of companies using seed funding continues to rise. The median years since founding for seed funding was 1.6 in 2020, up 2.6x since 2010.
Wing’s survey further revealed that 81 percent of companies raising seed funding in 2020 were already generating revenue, which is more than double from 40 percent in 2015. In years past, it was normal for early-stage startups to raise a seed round pre-revenue, but that is now the exception.
Where does that leave early-stage companies that have not yet been able to generate revenue, create scalable processes, or find the perfect market fit? The increase in seed funding size and investor expectations for companies to generate revenue prior to seed funding rounds means that typical seed funding today does not meet the needs of most day 0 startups. Founders of these companies may turn to pre-seed funding sources. For these reasons, pre-seed funding is gaining traction and evolving similarly to seed funding.
Pre-Seed Funding vs. Seed Funding: What’s the Difference?
To understand if you’re a pre-seed stage company or a seed-stage one, you’ll need to know the significant differences between pre-seed funding rounds and seed funding rounds.
What is Seed Funding?
Seed funding is the first institutional round of funding that a startup will go through. Once the startup has met key growth milestones with the money raised through pre-seed funding, it is time to seek seed funding. By this time, the product or service has gained enough traction to attract bigger, accredited investors.
The money raised at this stage will help grow the business, increase its valuation, and prepare it for bigger Series A and B funding rounds. Seed money is most often used for market research and product development, which help the startup find its bearings in the market.
Through extensive research, the company will hone its messaging and zero in on its target demographic in this stage. Seed round funds are also used to further develop or refine the product to ensure maximum viability and traction. This is also the stage where you may hire a larger team to help you achieve this goal.
The funding amount that's usually sought during this round can be anywhere from $1-4 million.
Incubators, angel investors, and venture capital firms are the main sources of money in the seed funding stage. These investors have the wherewithal to accept the risks involved. Keep in mind that these investors will want some equity stake in return for investing.
Key Differences Between Pre-Seed Funding and Seed Funding
Now that you know the basics of seed funding, it is easier to understand how it differs from pre-seed funding. The following table provides a handy summary:
What Target Runway
Once closed, pre-seed funds can keep early-stage companies afloat from a few months to a year.
Your target runway can vary based on your company stage, expenses, and funding plans. Generally speaking, you want enough runway to manage your business through a milestone that increases your odds of successfully closing your next funding round. Milestones can be in the areas of product development, revenue, regulatory approvals, or other milestones appropriate in the startup’s industry.
Mimi Ghosh of J.P. Morgan offers this advice:
“Think about how much capital you really need in order to accomplish your next milestone. But also have the flexibility on the tail end of that plan in order to focus on your next fundraise—because fundraising really distracts from a management team’s attention.”
To figure out your ideal runway, here are some best practices:
- Map out what you need to accomplish for a successful launch, and what tasks you will need to complete to get there.
- Determine how much it will cost to perform those tasks and how much time and money you will dedicate to each one – allowing a reasonable cushion for unanticipated bumps in the road.
- Based on your calculations, set realistic expectations for your pre-seed funding and be transparent about any obstacles in your way.
Equity Associated with Pre-Seed Funding Rounds
Typically, founders looking for pre-seed funding from outside sources can expect equity costs associated with it to be between 10 and 15 percent.
In the seed funding stage, on the other hand, founders can expect equity costs that may be as high as 15 to 25 percent on average. It is not unusual for angel investors to expect 30 percent equity during the seed stage, and VC firms may expect to take between 25 and 50 percent equity.
Size of Funding and Objectives
The main objective of the pre-seed funding round is to raise enough funds to get the firm up and running. Early hires, office space and infrastructure, registration, and other setup costs are covered by the money raised in this round.
Depending on the type of business and scope, pre-seed rounds can be as small as $10,000. For more ambitious startups, up to $1 million is a realistic target, albeit at the higher end of the scale.
Creating a minimum viable product–a product with enough features to attract early adopters and validate a product idea– is one of the objectives of pre-seed funding. While you don’t need an MVP to attract pre-seed funding, it is often a necessary component to attract angel investors and VCs during seed funding.
In the later stage, it is not unusual for founding teams to seek amounts above $2 million to fuel market growth and product development. You need a viable revenue model or well-developed product to attract Series A funding, and the money raised through seed funding can be used for this purpose.
The median seed deal averages between $2 and $4 million, though a vast variance has been seen in recent times. According to one report, in 2020, seed fundings ranged from $700,000 to $22 million.
Why Would a Startup Need Pre-Seed Funding?
Pre-seed funding helps day 0 companies to grow from a great idea into a fully functioning business. Founders may use the capital raised in pre–seed funding to:
- Demonstrate their ability to develop a workable product.
- Assemble a team that can work together to execute against the company plan.
- Research and provide evidence of potential customer demand for the product.
- Begin to build a business model that includes a distribution plan and identified customer contact points.
- Complete a test launch to demonstrate a level of traction in the market with input and feedback from early adopters of the product.
In this early stage of business development, founders may be leaving their current job to give their full attention to their new business venture. They are hiring teams to help them execute on their vision and getting the infrastructure in place to build a MVP.
Pre-seed funding can help cover operating costs, hiring talented staff, and gaining access to IT hardware and cloud services. Some of the critical positions for the company may be filled at this stage, although it will likely be in later stages that the C-suite is fully staffed.
For many startups, the bulk of pre-seed funds is used for product development. Until a startup has created an MVP and demonstrated some traction, further funding rounds may remain out of reach.
What Do Pre-Seed Investors Expect?
Investors in pre-seed funding rounds may expect a return on their investment, although they are aware of the risky nature of the investment. Expectations vary, depending on what type of investors contribute to pre-seed funding. For example, friends and family that invest in an early-stage startup may accept less in the way of ROI than angel investors or those who invest through equity crowdfunding.
In many cases, the money that founders can obtain from friends and family is simply not enough to cover the costs associated with getting a business off the ground. Realistically, the better bet for gathering the capital needed to adequately fund this early stage is to attract investors beyond a founder’s immediate network, with the understanding that these investors will expect a return on their investment.
The closer a startup is to having an MVP, an experienced team, and some early signs of traction and revenue potential, the better its chances of attracting external investors.
One of the biggest draws to investing in pre-seed is the potential for much greater gains, however that also comes with additional risks. Investors might also be drawn to the possibility of gaining pro rata rights during the pre-seed round. Pro rata gives the pre-seed investor the right to maintain their initial level of ownership percentage during later financing rounds.
How Much Money Can You Raise with Pre-Seed Funding?
Pre-seed funding rounds should provide enough money to start and sustain a business for up to 12 months, or until it is in a position to attract seed funding. This is not a hard and fast limit – some companies wait longer than a year to raise their seed, while others raise again in just a few months.
This amount could range from low five-figures to well into seven-figures, depending on the product, team, and market. Valuation is a decent yardstick for a realistic calculation of how much pre-seed funding founders can expect to raise.
If a firm has a valuation of $5 million, a realistic target for seed funding would be $500,000 (assuming a maximum 10% equity stake for investors). However, keep in mind that accurate valuations can be tricky to pin down in the earlier stages of a startup.
When Should You Raise Pre-Seed Funding?
Operating capital can be in short supply during the early days of a startup, so any time in the first 12-18 months of a company’s life is the right time for pre-seed funding. There are many different scenarios in which a startup may need some pre-seed funding.
- For Early Operating Costs
If the company hasn’t launched an MVP yet and needs additional funds for day-to-day operations, it is a good time to consider pre-seed funding. While extremely useful, an MVP or clearly identified revenue streams are not mandatory for firms to secure funding in this round.
- For Early Hires
Talented staff is essential for the success of any business. This need is amplified at the early stages of a startup, where you need a core group of domain experts to get a viable product ready in the quickest possible time. Firms need deep pockets to hire the best workers or freelancers.
- Other Unanticipated Challenges
The business environment is highly unpredictable. External factors such as new regulations can suddenly increase the operating costs of startups. In such situations, a pre-seed round might be necessary, especially if the startup has yet to achieve the critical mass needed for a seed round.
How Can You Get Pre-Seed Funding?
No matter which path you take to attract investors, you need a compelling pitch to secure pre-seed funding.
The following ingredients can significantly improve your chances of securing pre-seed funding:
- Committed and qualified founders
- A minimum viable product
- Metrics that demonstrate viability and traction
The last factor is usually the clincher in a pre-seed funding round. It’s best to have something to show the potential for your product in the market. A product or commercial progress that shows customer interest and engagement could be a good starting point. Key performance indicators to consider are factors such as average order size, retention rate, user growth, conversion rates, and so on.
A brilliant idea or pitch deck alone is not enough. You need to be able to demonstrate some traction, perhaps through partnerships, customers, reviews from early adopters of your product, a strong product walkthrough to present to potential investors, etc.
Finding investors is the next step. Beyond your circle of friends and family, other excellent places to find investors include:
- Incubators: Help founders refine their business ideas and begin to build their company
- Accelerators: Provide early-stage companies that have an MVP with mentorship, education, and promotion resources
- Pitch events: Events in which a group of startup founders pitch to a selected audience
- Personal pitches: Meetings arranged between founders and individual investors to present pitch decks
- Angel investors: High-net-worth individuals who provide funding, typically in exchange for an equity stake in the startup
- Equity crowdfunding platforms: Online crowdfunding platforms that facilitate the raising of capital from many investors who each receive equity ownership in the startup proportional to their investment
SeedInvest: Equity Crowdfunding at Its Best
As the need for pre-seed funding has increased, equity crowdfunding platforms have become a popular avenue for early-stage founders to raise the funds they need. However, not all equity crowdfunding platforms are created equal.
Founders should look for a platform that takes vetting investment opportunities and security seriously. SeedInvest is a known and trusted platform for early-stage startups and entrepreneurs looking to raise pre-seed funding in a safe, secure environment.
SeedInvest provides retail investors with access to highly vetted startup investment opportunities. Investing entities SeedInvest serves include non-accredited individuals, angel investors, family offices, venture capital firms and funds, and institutional investors.
Prior to being listed on the SeedInvest platform, startups go through an extensive vetting and due diligence process. SeedInvest is highly selective, with less than 2% of startups that apply being accepted.
Generally speaking, companies that are ultimately listed on the platform have an MVP or prototype, at least two full-time employees (excluding founders), a compelling business model, and some amount of traction. SeedInvest generally works with companies that have raised at least a small round before and are now looking to raise at least $500,000.
For more information about how SeedInvest works, please refer to the FAQs here.
Even if your company is in its earliest stages, you are encouraged to apply and join the SeedInvest founder ecosystem. Many successful raises on SeedInvest have originated from companies that have applied more than once to the program.
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- SeedInvest's due diligence process is no guarantee of success or future results. All investors should carefully review each investment opportunity and cancel their subscription within the allotted time-frame if they do not feel comfortable making any specific investment based on their own DD. Learn more about due diligence on the SeedInvest Blog and our vetting process in our FAQs.
- Past performance is no guarantee of future results. In addition, SeedInvest's due diligence process is no guarantee of success or future results. All investors should carefully review each investment opportunity and cancel their subscription within the allotted time-frame if they do not feel comfortable making any specific investment based on their own DD. Learn more about due diligence on the SeedInvest Blog and our vetting process in our FAQs.
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