What is Pre-Seed Funding?

Launching a startup requires one thing: capital. Without capital, the chances are a startup will fail before it ever gets a product to market. There are several funding stages, and much of the terminology can confuse first-time founders.

Chances are you’ve heard of seed funding, but what is pre-seed funding? Entrepreneurs consider pre-seed funding to be the earliest form of funding. It’s a gamble on a big idea, and in many cases, pre-seed capital is funding only an idea and nothing more.

So, if you’re starting a business and you need capital, here’s everything you need to know about securing a pre-seed investment.

 

What is pre-seed funding?

Pre-seed, or “family and friends” funding, is the initial step toward getting enough capital to develop a product. Since pre-seed money is the earliest part of the fundraising journey, few startups manage to secure capital at this stage.

Most entrepreneurs in this situation have yet to get a product to market and may not have anything more than a prototype, which makes it difficult to convince pre-seed investors to bet their hard-earned money on an idea that hasn’t been fully completed yet.

In most cases, pre-seed capital  comes in the form of convertible security. It begins as a loan, and when certain growth conditions are met, the loan turns into a certain amount of equity.

Naturally, every deal is different and will depend on several variables.

 

Pre-seed vs. seed funding: What’s the difference?

Like all funding rounds, the pre-seed round definition has some overlap with seed funding. Both share the fact that founders are asking for money for a product that has yet to prove its potential within the market.

Pre-seed investment always comes before seed funding. The easiest way to tell the difference is that pre-seed fundraising is an investment in an idea. In other words, it’s an investment in a product that has yet to find its market. In contrast, investors seek seed funding for a product that already exists and typically has some form of a customer base.

Because pre-seed funding involves betting on an idea, it is typically more challenging to secure. To investors, providing capital at the pre-seed stage is a much more significant risk as that product may never even make it to market.

 

The importance of pre-seed funding for startups

So you may be wondering: If pre-seed funding is so difficult to secure, why should I take the time to ask for it in the first place?

Startups need to proliferate to reach profitability. Without the appropriate funds, most startups begin at an immediate disadvantage when competing with established brands. Pre-seed funding for startups is especially important because most of the money will go toward constructing the company’s foundation.

Full product development is a massive consideration at this stage. Taking a prototype and manufacturing it into something scalable is the priority.

Hiring new staff members, finding an office space, and marketing to those first few customers are all reasons you need to look for pre-seed capital for your business. Without this capital, you will find it extremely difficult to survive.

Of course, some industries may not require pre-seed money at all. Pre-seed is best suited to industries with high startup costs. For example, tech companies building hardware will need more funding than a software company looking to build an app.

Fundraising for startups, in general, is a challenge. Pre-seed investment is even more difficult to secure because you have little to back up your claims. The process will be long, arduous and complex, but securing the support of pre-seed investors has the potential to supercharge a business’s growth.

Now that you know how crucial pre-seed funding is, what are the different avenues available for startups in this scenario?

 

Types of pre-seed funding

Several methods exist for securing capital during the pre-seed stage. The pre-seed round begins by determining which financing options exist for startups looking to turn an idea into a viable business.

Let’s examine the most popular options for securing your first round of capital:

• Family and Friends – By far the most popular funding option for pre-seed startups. Most founders invest personal wealth and ask family and friends to get involved.
• Venture Capitalists – Certain venture capitalists specialize in jumping into startups at the earliest stages of their development. Take note, venture capitalists are often the pickiest investors, and success rates are low.
• Angel Investors – Wealthy individuals investing in startups. Pre-seed angel investors often look for big risks and invest an average of $100,000 in startups during the pre-seed phase.
• Crowdfunding – Over 500 crowdfunding platforms exist. Individuals from around the world donate small amounts to fund an idea. These are effective tools, but they rely heavily on marketing your brand to stimulate interest.
• Incubators – Incubators focus not just on capital but on providing other business services, such as training courses, office space and access to active investors.
• Accelerators – Accelerators concentrate on fast scaling for the ideas with high growth potential. They tend to focus more on already growing startups, but some accelerators offer pre-seed capital.

Entrepreneurs are often surprised at the limited options available for pre-seed money, but it’s likely because most traditional financial organizations will not invest in an idea. They want to invest in a viable business, which is why they don’t become available until founders start looking into seed funding.

 

When should you start raising pre-seed funding?

Every business owner knows the importance of “right place, right time.” You need to know that your startup is ready to seek out funding. Remember, investors meet thousands of founders every year. Not coming fully prepared will lead to immediate rejection.

To succeed in raising money, you not only need to convince an investor, but you also need to be more convincing than other startups.

Here are some of the signs that you could be ready to start meeting pre-seed investors:

• Product/Market Fit – You have already confirmed that your product fits into a chosen market. Founders will have already done their research but likely have yet to test it with a finished product.
• Building a Team – Need to make some hires to bring in the right expertise? This is a sign that pre-seed investment is a necessity.
• Prototype – Few investors will take an idea alone seriously. At a minimum, you should have a prototype displaying a product’s primary features. Pre-seed startups are not required to have a fully developed product.
• Early Interest – Have you started showing your product to customers? Early positive feedback is a good sign that a startup has high growth potential.
• Revenue Modeling – Entrepreneurs should focus on building a revenue model that is ambitious yet realistic. Investors want to know how you are going to make them a profit.

Just because investors looking at a pre-seed valuation are entering the fray at the earliest possible stage doesn’t mean they will invest in just an idea. Although your business might not be as developed as a startup exploring seed funding, it doesn’t mean you have to show up empty-handed. Be ready with any facts and figures you have.

 

How much pre-seed funding should you ask for?

Amounts raised during a pre-seed round tend to be much lower than investments in seed and Series A funding phases. On average, startups that secure pre-seed capital receive approximately $500,000. You may be eligible for more or less depending on the investment avenue.

The most important rule to remember here is simple: Ask for a realistic number from investors. You need to justify the amount you are asking for, meaning you should only ask for what you need to reach profitability or survive until the subsequent funding round.

Most companies are simply looking to reach the next funding milestone, but some extraordinary startups reach profitability exceptionally quickly.

While it might be tempting to ask for an astronomical figure, keep in mind that the more you ask for, the better your startup will need to perform. Experienced investors will analyze your proposal to conclude whether what you’re asking for is realistic, so stay conservative.

So, how do you calculate how much you’ll need?

Provide a rough analysis of your monthly costs. What’s the lowest possible number your startup could operate with? Figure out how many months it will take to either reach profitability or progress to the next funding stage.

 

How to get pre-seed funding

Securing pre-seed funding has much in common with obtaining seed funding. The difference is that you need to work harder to convince an investor that an untested product can make an impact. Remember, unlike a seed company, you’ve yet to find out whether your idea has any market traction.

Let’s run through the primary steps and what you need to focus on when approaching pre-seed investors.

 

Step 1: Build your pitch deck

You still need a pitch deck to begin raising capital even at this early stage. Pitch decks tell investors everything they need to know about your startup, the product, the market and your financial projections for the near- and long-term.

Most investors will create two pitch decks. One will accompany in-person presentations, with another designed for email use.

A pre-seed pitch deck will tell investors about the product and the problem it solves. It should include information about you, the founder, and your business’ story. Some investors will provide capital to startups simply because they found the founder and their vision so compelling.

Regarding market research, while you cannot prove existing traction at this point, you can still conduct market research. Focus groups are instrumental at this stage for demonstrating customer interest in the absence of a market track record.

Make sure you include pie charts and graphs as part of your pitch deck to hit home your findings and demonstrate that you have a viable proposition with staying power.

The perfect pitch deck will have between 10 and 12 slides, with each slide focusing on a single key concept. Try not to overload your slides with information. Keep it short, sweet and simple. If you need more space, however, make sure your pitch deck doesn’t have more than 15 slides.

Include your long-term projections as part of your pitch deck. Too many entrepreneurs only talk about the here and now, but investors are searching for companies that will become industry mainstays 10 years from now.

Think ahead and be ambitious without being unrealistic. Getting it right demonstrates that you’re a serious founder with a serious idea. If you’re not sure where to start, refer to these pitch deck examples. 

 

Step 2: Make an investor list

Not every investor will provide funding for pre-seed startups. Start by leveraging your business connections to find investors interested in startups at this stage in their journeys.

There are plenty of incubator and accelerator platforms that include access to investors specializing in pre-seed capital. Your list should be set in order of priority in the same way as a sales-lead funnel. Research investors using the following primary characteristics:

• Type – What type of investor are you searching for? Some startups need capital, whereas others also need expertise and connections.
• Experience – Dig into an investor’s track record in dealing with pre-seed startups. Pre-seed experience is very different from seed experience.
• Funding – Decide which investors match the amount of funding you need. Some investors specialize in large investment amounts, whereas others only provide small amounts of capital.
• Expertise – How much experience does an investor have within your industry? Investors need to understand your business if they’re taking a more active role in growing and scaling your startup.
• Integration – The working relationship you have with an investor can influence how successful the relationship is. Look into an investor’s track record and see what sort of impact they’ve had on other pre-seed startups.

What matters at this stage is that the investor has experience in dealing with pre-seed ventures specifically. Go beyond the funding alone and focus on what they’ve done for other startups during this challenging growth period.

 

Step 3: Present to investors

Most investors will require an in-person presentation before committing to your company. Presenting your business comes with the territory, and it’s certainly the most nerve-wracking part of the process.

Presentations are an opportunity to show off the real you. Startup success hinges on the founder, so you need to show yourself as confident yet humble. Arrogance and overconfidence are major red flags to pre-seed investors. 

Here are some great tips for nailing your pre-seed pitch:

• Keep your presentation simple. Try not to go off on a tangent or allow it to run for more than a few minutes. Trim it down as much as you possibly can. Remember, investors are busy people and the last thing you want to do is waste their time.
• Interact genuinely. People invest in people, and people want to be heard. Show that you’re listening to their points and addressing their concerns. An investor is not a bank. They are someone you will work closely with for several years.
• Know who your investor is. Find out as much about them and the businesses they’ve invested in in the past. What triggers them, and what do they want to know about?
• Be ambitious yet realistic. It’s okay to dream big, but investors want to know that your feet are firmly on the ground. Don’t exaggerate or pull numbers out of thin air.
• Show off your charisma and demonstrate your passion. Startups are powered by both things. Simply tell your story and share your passion, and investors are sure to respond. 

Make sure that you practice your pitch at home with a family member or friend. You should know your pitch by heart by the time you start meeting investors in person.

 

Step 4: Negotiate for success

Negotiation is the last major hurdle you have to overcome to secure capital for your pre-seed startup. Avoid taking the first offer and haggle over any equity stake or proposed investment amount. While it’s easy to get excited about an offer, take a breath and give serious thought to the offer on the table.

Make sure you get any deal in writing, especially if an investor is committing their time and resources. Never accept vague pledges, as this could lead to disputes and misunderstandings further down the line.

Finally, don’t be afraid to walk away if the deal is unsuitable for your business. No deal is always better than a bad deal in the long run.

 

Find investors for your startup with Crunchbase

When it comes to how to find investors for a startup, pre-seed funding is one of the most important stages. Unfortunately, the pre-seed round is especially tricky because the chances are you only have a minimally viable product and no market experience as of yet. The hard truth is that you will need to work harder to find investors willing to commit to your startup at this stage, but it will be worth it. Securing your finances early gives you a significant advantage over startups, and you can make it happen by pairing with the right investor. 

Track down pre-seed investors who are ready to invest in you and your startup idea. Crunchbase can help you find the best investors for your startup: sign up for a free Crunchbase trial.

• Tags:
• Entrepreneurs

• Originally published March 17, 2022