Pre-seed funding – Everything you need to know
Any funding initiatives before the seed round, as the name suggests, is the pre-seed funding amount.
Startup fundraising is a specialized skill. This process unfolds in stages and founders are advised to develop a vision for the entire process instead of a myopic view. In this article, we focus on pre-seed funding. We look closely into what constitutes pre-seed funding and try to understand the sources and methods of raising this fund.
The basic stages of external funding for a startup are seed, series A, series B, and series C. These are typically funded by Angels and Venture Capitalists. Any funding initiatives before the seed round, as the name suggests, is the pre-seed funding amount. The Investor patterns vary for this stage as well. Let’s explore more.
What is pre-seed funding?
This is the basic funds required by a startup to take-off. Being the initial amount, it is technically not considered a funding round. Pre-seed funding is designed in a way that a founder has to make arrangements for it to start operations. Most often this happens in the form of personal investments by founders, their close friends, and families. A typical pre-seed fund ranges between $10K and $250K.
The idea behind a pre-seed fund is to gather enough cash to launch the business, organize the initial setup, and take it to the next level of funding. The startup must be attractive enough to the investors in the next stage. It is up to the discretion of the founder to make the pre-seed funding last as long as possible. But to set a good rhythm for the business, 0 to 12 months is a good time to sustain on the pre-seed fund. Any delay beyond this time frame reflects as a sign of unpreparedness at the founder’s end. Some basic features of pre-seed funding are:
- Investments are generally done by founders and their close family and friends
- Funds are extended based on the founder’s credibility, not so much on the business idea
- Investors do not expect quick returns and understand the risk underlying this stage of startup development
- Founders must be accountable to their investors, however personally close they are
- The business must focus on utilizing this fund to get clarity on their value proposition, milestones, and the financial road map ahead
When should I raise pre-seed money for my startup?
The right time to raise pre-seed funding for startups is when the founder is clear about the business idea and ready to set the wheels in motion towards creating a minimum value product or a functional service. The founder must be prepared to go as far as possible to see this to fruition, and when required, re-invent. Specifically, here are some indicators to show the readiness of a startup to raise pre-seed funds.
As mentioned earlier, pre-seed funding for startups is supported by the founder’s network and savings. However, it is prudent to believe that as long as the person has some cash to invest, anyone can be your investor. This assumption can derail all fundraising efforts. Then, how should one proceed?
How to find the right pre-seed investor for my startup?
Finding a compatible pre-seed funding investor is as good as finding a partner for the company. No matter how close they are, the founders must prioritize the possibilities of a good working relationship while choosing these investors. Here are some pointers:
- Experience –The role of an investor is primarily associated with money. However, investors with entrepreneurial experience, especially in the relevant industry, are a bonus. Founders are better suited to look for these traits among their networks. Care must be taken to analyze the strengths and weaknesses of every potential investor. If done right, such partnerships prove beneficial in the long run. The right kind of investor also opens new channels of fundraising opportunities for the startup.
- Commitment – A startup workplace is usually high on energy, yet volatile at times. Not all days are the same. A pre-seed funding investor has to be in sync with these dynamics. They must stay committed to the business idea and keep their faith in the founders through troubling times. Discord between founders and investors, in addition to external issues, can prove catastrophic to the business.
- Involvement – An investor can play the role of a mentor. But their involvement should not interfere with the founder’s vision. Before receiving money, especially from personal contacts, entrepreneurs must talk about this at length. Many a time, misunderstanding about the expected role is normal. Since most of these pre-seed funding investors are not professional, it is natural for them to not understand the extent of their involvement in the business.
- Equity share – It is a known fact that startup fundraising happens in exchange for equity in the company. With every funding round, the company is faced with dilution. This begins with the pre-seed funding stage. On an average 10% equity share is acceptable. Founders must be professional and if need be play an educative role in informing pre-seed funding investors about the equity aspects. However, care must be taken not to succumb to high demands simply owing to ‘personal’ relationships.
Company valuation is the process to determine the present value of a company. It is easier to determine this figure for established companies or publicly traded ones since they have substantial finance data. But for startups, it is quite a challenge as not much data is available in the early stages of operation. Then how do pre-seed funding investors proceed? Also, as a founder how does one know how much to ask for? Let’s explore.
How does an early-stage investor value a startup?
Founders must realize one thing before accounting for investor feedback on company valuation. At the pre-seed stage, a company valuation is only a finance tool required to get through investment calculations. It is not the true value of the business. Neither is it a determiner for future valuations. Pre-seed valuations are at the moment and widely based on the influence of market forces on the present industry. Thus, any form of comparison or benchmarking with competitors will be futile.
Many other factors such as the supply and demand of the target product and recent exits in the industry also affect the valuation of a pre-seed startup. If the industry is performing well, the valuation will be higher. But if the industry is in the slumps, pre-seed funding of any new startup in that particular sector will suffer. As is obvious, this has nothing do with the founder or that of the business idea. This is how external market forces sway pre-seed funding decisions for startups.
Though there are many valuation methods employed to determine pre-seed funding, investor’s instincts matter the most; more so if the investor has industry-specific experience. Their long haul in the business guides their decision-making process and most often they can predict industry trends and the probable exit value. The most common method used to determine pre-seed funding is the comparables method. This gives a sense of how the startup will fare in comparison to similar businesses in the same industry. Once a pre-seed investor figures out the percentage of equity they would own after their investment, dividing these figures will reveal the final exit value.
How much money can I raise in pre-seed funding?
This varies and depends on the scale of a startup’s product/service. The goal of raising pre-seed funding revolves around working on a prototype, validating the value proposition in the market, and achieving proof of concept. This is a good place to begin. Founders must check if the budget sufficiently supports all these activities.
The next aspect to think about is if the total pre-seed funding value will sustain the startup until the next round of funding. The next round is the seed fund, the first external funding round, investors will show interest in only those businesses which come out strong with attractive metrics. It is a known fact that seed funding is a risky investment. However, seasoned investors will look for all opportunities to minimize risks. Thus the pre-seed fund has to be realistic. Not too high to result in unnecessary dilution or not too low to limit the startup’s performance.
Founders must work on polishing the business plan. It should include a thorough account of all the business objectives, resources, and expenses. A timeline should be in place to achieve all of these. Though an average pre-seed funding stage is planned for 12 months, it is advised to account for uncertainties and keep a buffer of 3 additional months. Budgeting must be done in line with this. Investors do not appreciate startups desperate for funds. Neither is funding deals closed overnight. Time is of the essence. Irrespective of the funding value, founders must plan well in advance.
Achieving Milestones for your company
Pre-seed funding is the foundation on which the entire company will be built. Hence, every aspect of this stage has to be planned and executed with precision. How a startup raises and manages a fund in this stage creates a reputation in the industry. It is also a trust-building exercise for the founder. A good reputation among personal contacts builds confidence and goes a long way for the company.
Create Your Company’s Pre- Seed Cap Table on Eqvista
As we see, equity distribution begins right from the pre-seed stage. For startups, this not only involves the founders and investors but early-stage employees as well. Hence founders find themselves managing cap tables early on in their startup operation. This process can be easily simplified.
Eqvista’s pre-seed cap table easily allows you to determine details about the ownership of company shares and dilution of the share price over time. Here is a complete guide to cap tables. To know more, reach us today.
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