Pre-seed vs Seed Pt 1: Pre-seed

One of the most common questions I get as an early-stage investor that I can’t really answer, is “how do you define pre-seed and seed stage companies?” The truth is, whether you peg to dollar amount, company size, or execution stage, the answers will still look wildly different across industries, venture firms, geographies, and founder profiles. Early funding can look like anything from a $10k “pre-seed” so a college student can take a semester off to work on starting a business, or a $100m check for a “seed round” to hire a couple hundred people. Ultimately, the question of pre-seed vs. seed is just one of semantics, but it can have a huge impact on expectations from investors and early customers. The outcome of your early fundraises depends a lot on how people understand you, what you’re working on, and what your goals are, so knowing how to navigate these decisions is extremely important.

Some quick history:

Appetite for risk, and along with it high risk capital, has become steadily more abundant over the last fifty years. If you needed money to start a business in the 1960s, it’s likely your only option was debt funding (i.e. money you have to pay back with interest), and it was virtually impossible to borrow more money than you had on hand (i.e. if you had one thousand dollars in the bank, you could get a loan for up to one thousand dollars). As the venture ecosystem has matured, it’s become easier to find investors who will bet on the future value of early company with no hard guarantee on getting a return on their investment. This has meant companies are able to raise larger rounds with less actual progress on the company.

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It’s useful to have some intuition for how the average seed round size grows over time. First you must understand that no great company idea is unique. A tendency of inexperienced founders is to be very secretive about what they are working on. There may be times when this makes sense, but your advantage in building a successful company is almost never being the first one to think of an idea. Even if you truly are the first person to come up with something, if you have a successful launch a dozen new companies will spring up to compete with you, and they will have a much clearer roadmap on how to get to early product. With that in mind, your main advantage is execution. When two competitive companies are started at the same time, you want to be the company with the biggest unfair advantage. That can mean excellent founders, strong connections, or unique IP. Or it can also mean having a bigger war chest to compete with. As you can imagine, with investors trying to be in the best companies, this can lead to growing size of seed rounds. What is actually best for your company, however, might be more complicated, and often a smaller earlier round is most valuable, or the only thing accessible to you given your background or the industry you are working in. Even ten years ago, pre-seed investments were fairly rare. Now with the average seed round size 2-3x that of what it was a decade ago, there is room for a round of smaller institutional funding at the earliest stages of a company.

Pre-Seed Funding: The Team Stage

People often refer to pre-seed as “the idea phase”, but fundamentally, pre-seed investing is about betting on a team. There are a few reasons for this:

  1. Companies pivot. Sometimes in the early days of working on an idea, founders realize there is a much better business to be built, or the macro environment changes and their original business might no longer make sense. Even when investors are not super excited about an early idea, if they believe strongly enough in the team, they can invest at a pre-seed round with some confidence that they will eventually land on a great business idea.
  2. Investors don’t want to miss their chance. By the time an early company has worked through the initial ideation phase, it may become much more obvious how exciting the investment opportunity is, meaning it becomes a much more competitive round for investors. When pre-seed investors see an early outlier team, they often want to take the bet as early as possible to get ahead of other investors hanging around the hoop.
  3. Ideating can be expensive. Early capital can be the difference between starting a generational company and not. Apple, Amazon, and Google all started with small very early venture investments of a few $100k that let the founders work on their passion projects without having to worry about getting a job. If future founders have to support themselves financially by working at another company, it’s time away from building their own company. A pre-seed check is often not just about buying equity in a company, but actively catalyzing that company’s formation.

How big is a pre-seed?

Typically between $100k and $1 million with a post-money company valuation of $5-10 million. $100k to $1 million is obviously a huge range, so it’s important to know how much to ask for in a fundraise. You need to figure how much money you need to live and build enough of a business that you can make it to the next fundraise at seed stage. You don’t necessarily need clearly defined milestones at pre-seed, but having an idea of what you’d like to accomplish will give you a sense of how much to raise. If you are working on pure software and don’t need to hire anybody, raising $100k may be plenty to pay for your food, rent, wifi, and everything else you need to live so you can focus on building the company. If you’re building something that requires real capital expenditure or a larger team, raising closer to $1m might give you the flexibility to make some key early hires and pay bills necessary for making the early product.

Pre-seed funding is usually done on a “safe note”, which is a financing vehicle invented by YCombinator to enable equity investments in very early companies before they can issue shares. This can be confusing, so let me what through an example of the most common type of safe: I invest $1 million at a ten cap (”10 cap” means “valuation cap of $10 million”), then when you raise a priced round (i.e. a round that issues shares), you’ll owe me equity equal either to my investment relative to the existing valuation, or relative to the cap, whichever is larger.

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This is the simplest type of safe note, but there are a variety of permutations you can read about on the YC website.

When to seek pre-seed funding

Pre-seed funding is typically the earliest institutional funding round. “Institutional funding” just means the money comes from a venture capital firm rather than an individual. It may be the first check into the company, or it may bridge the gap between a friends & family round and a seed round. If you are in college and don’t have rich parents, you might be wondering where “friends & family” funding actually comes from. Often this can come from early angels and mentors, and there is a ton of strategy on how to find these that I’ll cover in another post, but the important thing to note is that it’s not a prerequisite to seeking pre-seed funding. The short answer for when to seek pre-seed funding is just whenever you feel fully committed to building a company. The amount you need to have “built” before going out to raise will depend a lot on your background. The profile of pre-seed founder can be broken down into four categories, which I’ll order by how much work you need to do on the company before raising money.

  1. The Industry Expert

    This is someone who has very strong work experience in a specific industry and wants to start a company directly related to that. Because this person intimately understands the market they are working in and has a demonstrated track record of being a successful businessperson, they can raise money with very little upfront work. For example, imagine a founder who has spent the last five years as a supply chain manager at PepsiCo and now is thinking of building a startup that provides software for beverage production. As long as this person can show that: 1) they are an outlier operator, and 2) there is a real market opportunity in beverage production, they can likely raise pre-seed funding under the assumption that insofar as any company can be built in this space, they are the perfect person to do so.

    Materials/Process: A few conversations, colleague references, maybe a written memo.

  2. The Academic

    This is a founder who is finishing or dropping out of school (could be undergrad or grad program) to build a company related to their field of study. This usually has to be a company built around differentiated intellectual property, i.e. most people could not build the core technology of the company because they lack the subject matter expertise. (For what it’s worth, most startups are not built around a technical moat like this, so it only makes sense for highly technical companies.) Researcher-founders have the technical advantage both of their knowledge base, and their ability to recruit high quality researchers to work at the company as it scales. Imagine a PhD candidate who researches battery technology starting a battery company. They need to show that they are: 1) an outlier technical talent, and 2) commercial. Referring to a founder as “commercial” is VC-speak for “does this person want to figure out how to make money”. At the end of the day, the purpose of a business is to make money, which is not always aligned with the purpose or goals of a university lab. To bet on a researcher starting a company, you have to believe not only that they can build the technology, but that they can use that technology to build a great business. Because of this, it is incumbent on a researcher raising money to show why the thing they want to build has the potential to make a lot of money. It doesn’t need to be a full business plan. In the battery example it could just be to show that currently we spend X dollars a year on some type of battery that is interchangeable with a new battery type that is cheaper to produce.

    Materials/Process: A few conversations, classmate/professor/lab references, written memo, maybe a pitch deck.

  3. The Genius

    This is the rarest of the four founder archetypes, but I’m including it because it’s becoming more common and there have been some recent high profile examples of this. The Genius Founder is someone who has demonstrated intellectual excellence in an area not directly related to the company they want to start. The canonical example is a competition math or coding champion starting any kind of software company. Although the knowledge base required for getting a gold medal at the International Math Olympiad might not have much to do with starting a tech company, investors are willing to bet that this person is so smart, that whatever they set their mind to they will be able to succeed at. There is high variance in how much preparation is needed for a pre-seed raise for this founder archetype depending on founder background and investor preferences, but typically these founders have to come in with a fairly specific idea of what they want to work on. They often don’t need to demonstrate any existing expertise in the field, because investors will bet that once they really start working they will soon become a top domain expert.

    Materials/Process: A few conversations, strong resume, pitch deck.

  4. The Dilettante

    “Dilettante” is essentially a fancy word for someone who dabbles in an area of interest. As a founder archetype, this is just The Genius but without all the accolades. The good news is you don’t need to be an IOI medalist or a Jane Street quant to raise a pre-seed for a company in an industry you’ve never worked in or studied. The bad news is you’ll have to do a lot of work up front before fundraising. While this might mean building an early version of your product, the more important upfront work is actually just research. You’ll have to prove your ability to become highly educated on a particular topic and develop an airtight business case for why you should start a company in that area. This means becoming an expert in the existing competitive landscape, the technology you want to work with, and the customers you plan to serve. The flavor of this pitch is “I’ve spent the last six weeks doing nothing but read about underwater data center technology, and here is why I can create a billion dollar business building them.” This may sound challenging, and it is, but remember that most great founders win because they are more passionate and willing to work hard, not because of background knowledge or experience they had before starting a company.

    Materials/Process: A few conversations, extensive memo, pitch deck, formal pitch.

In addition to knowing how much planning you have to do before raising a pre-seed, there is also a question of how much product to build before raising a pre-seed. This actually depends much more on the type of company than it does on the founder. All companies fall on a spectrum of how capital-intensive it is to produce an early product. On one end of the spectrum are simple web applications that can be built by a single person on a laptop, with the only potential cost being the price of the domain and hosting service. On the other end are things like rocket ships, autonomous vehicles, brain implants, drug discovery, and AI models that require billions of dollars and sometimes thousands of people to create the product. In the context of a pre-seed, investors often want to see that you’ve made as much progress as possible with the resources available. So if you want to create a sneaker marketplace, you should probably figure out how to build a simple version of the marketplace website, which you could likely do in a weekend. If you want to build 3D-printed rocket ships, however, no one is expecting you to open a factory before meeting investors. Instead, the work is much more about planning and building relationships. A good framework here is building as much product as you can without spending more than you are willing to lose in poker. After that, focus on research, planning, and customer discovery.

Where does pre-seed funding come from?

Pre-seed funding, a critical early stage of startup funding, can come from a variety of sources. Understanding these sources can greatly impact the success of a startup.

Go forth and raise!

Securing pre-seed funding can be a crucial step in the life of a startup. Although getting funded when you’ve barely started building anything can seem impossible, with a clear understanding of where and how to seek funding there is always a path to early capital. Knowing what investors’ expectations are and how to standout is essential to getting the outcome you want, so when in doubt, remember it’s always better to over prepare and over build. And if you think you’re already too far along for a pre-seed, checkout Part 2 of this guide to learn about raising a seed round.