What Is Pre-Seed?

28th February, 2016 No Comments Startups , Venture Capital

I was talking with a group of accomplished technologists this week – academics, former entrepreneurs – discussing the fundraising strategy for a company that has raised some angel funding.  At one point, there was discussion of a “Series A” financing in the near-term future of the company.  The company was not ready for a Series A financing the current fundraising environment; it quickly became clear that we needed to define our terms; to talk about the characteristics of Series A (and other early-stage) rounds in today’s startup ecosystem.

As has been the case since the dawn of the venture capital industry, a typical high-growth technology startup will raise capital episodically, in multiple “rounds” of financing.  The labels for those rounds, and their participants, have changed over time.  Today, a typical progression of rounds looks like this:

  1. Founders, Friends and Family:  The very first round of financing.  The investors comprise the founding team and the people they know.  The investors are betting on the team and their idea.  Generally, the company raises <$100,000 at this point.  This capital is used to develop a very rough pretotype or prototype of the product which is used to gauge initial customer interest in the product.
  2. Pre-Seed:  The first round of financing that involves “arms-length” investors; angels or pre-seed venture capital funds who invest in the company based on the results of any pretotype or prototype testing and the backgrounds of the founders.  The company will usually raise <$1 million in this financing; perhaps as little as $100,000.  The money is used to build a first version of the company’s product and to test its value hypothesis.
  3. Seed:  Once a company has a working, early version of its product and some initial, enthusiastic customers, it is ready to raise a seed round.  The investors may be “professional” angels (those that spend most of their time investing in startups) and/or seed-stage venture capital firms.  A seed financing will typically involve $1-3 million in new capital which the company will use to further develop its product, develop its growth hypothesis, and show early traction.
  4. Series A:  Over the last few years, the Series A financing has become perhaps the most difficult for many companies to raise.  Investors at this stage – professional venture capital firms – are looking for evidence of clear customer traction in the form of significant, growing revenue and/or consumer engagement.  Many investors expect companies to have achieved specific milestones:  $1 million in annual recurring revenue (ARR), a certain number of users (often 100,000+) for consumer businesses, and/or a certain level of growth are typical examples.  The expectation at this stage is that the company has largely worked out its marketing strategy and that it will use the capital from the Series A financing to bulletproof its product and to dramatically expand its customer base.  A healthy Series A round will involve $3-8 million in fresh capital.
  5. Series B and beyond:  The Series B and later financings are growth funding rounds for performing companies.  Investors at this point look for a company with a track record of significant growth (usually 100% or more year-over-year), a strong handle on its marketing mix and cost of customer acquisition, source(s) of competitive differentiation, and credible exit options.  A company at this point should be able to articulate -based on historical data – how much revenue it can generate for each dollar it invests in customer acquisition.  Series B financings often involve $8 million or more in new funding.

For those entrepreneurs and investors who have been in the startup world for more than the last few years but who have not raised early capital lately, the above progression may look odd.  The Pre-Seed financing is a relatively new phenomenon; until recently, this round didn’t exist.  I submit that the requirements for new rounds of funding haven’t changed much since 2007 or 2008, but the labels have changed as seed funds got bigger and the cost of proving product-market fit have generally decreased.  Today’s seed round, in other words, is yesterday’s Series A (and a Series A today looks much like a Series B circa 2006).

Finally, the path above sounds very linear, but few startups follow such a straight line.  Many companies, for example, pursue “extension” rounds between the Seed and Series A fundings, or between A and B – additional capital from existing (or occasionally new) investors at terms that are similar or identical to those of the last round.  These financings are provided to enable a company to hit the milestones necessary to get to the next round or to an exit.

So if your company doesn’t fit neatly along the progression above, you are probably in the majority.

This post is a product of my experience at CoVenture (where we generally first invest at the Pre-Seed stage) and, previously, Gotham Ventures.  For more on pre-seed financings and how early-stage funding has changed, checkout this great post by Rob Go at NextView.

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