As a founder or early-stage investor, you have probably heard the term pre-seed being tossed around. But what constitutes an official round before the seed stage and why is the pre-seed so important now? In this article, we will delve into what exactly the pre-seed stage is, the top VC firms, accelerators, and angels for this stage, and finally some resources for founders looking to raise capital for this stage.
So what qualifies a company and/or round to be considered ‘pre-seed?’ According to Crunchbase: “A Pre-Seed round is a pre-institutional seed round that either has no institutional investors or is a very low amount, often below $150k.” It is the round after the ‘angel’ round and before the ‘seed’ stage. In reality, most define pre-seed to be after a friends/family/angels round, and before ‘seed’ of course, with a company typically having achieved an MVP (minimum viable product) but yet to establish firm market validation or product-market fit (all the better if they have though). Some other common characteristics:
- ARR between $50-250K
- Pre-money cap is less than $5M
- Round size less than $1.5M
- Prior capital raised is <$500K
Of course, there is no one size fits all for pre-seed. It is more about how early a founder wants/needs to raise capital and the risk that investors are willing to take.
What can explain the growth of the pre-seed stage though over the past 5 years or so? Really it has to do with investors being able to receive such a high multiple on their initial investment when a company is successful. VC returns are not a normal distribution, but rather a power-law distribution.
Why is this important? This is important for investors to understand as they search for the rare winners in this fat-tail, but also founders. If founders can better understand how investors look for and evaluate companies based on this distribution, they can better position themselves to raise VC money and hopefully build a successful business. In looking to understand why the concept of the fat-tail matters so much to VCs, this article writes about how most investments return very little or lose money, some return a multiple on initial investment, but it is the very small handful of “hyper performers” that return an outcome well outside what could be expected in a normal distribution. These few start-ups more than compensate for a fund’s losses, while also generating most of a portfolio’s returns. The last point explains the idea of ‘fat tails’ – as the tails have more bulk, the probability of extreme events is higher compared to the normal. While these ‘hyper performers’ are rare, the lower valuations for these companies at the pre-seed level present an exceptional opportunity for investors if they are able to identify these companies at a higher rate than average.
Besides the power-law distribution to help explain the growth of the pre-seed round, NextView believes that there are two main factors that have contributed to the rise of pre-seed rounds: “the frothy late-stage financing market, coupled with both the scaling-up of some of the early winners in the institutional seed ecosystem and the scaling-down of some larger funds that retrenched after the financial crisis.” The fact that the late-stage financing market for tech companies has been typically over-funded with valuations/multiples that seem completely ludicrous over the past 10 years has incentivized investors to invest earlier, as they recognize this same trend. If a company is able to make it to a Series C, the pre-seed investors will have already have a 10-100X multiple in unrealized gains that will soon grow further with the frothy late-stage markets and the hopes of an IPO or acquisition. Finally, some of the first early-stage investors and VC firms have realized the returns on their first and second wave of winners and have been able to grow considerably with more institutional investors flooding in to generate alpha.
Let’s take a closer look at some of these top pre-seed VC firms and some of the criteria that they look for in companies, founders, and some resources to contact them and reach out if you feel you fit their thesis. Here are 5 of the top VC firms that focus almost exclusively on the pre-seed round:
- Afore Capital: Backs product-centric founders at the pre-seed stage exclusively. The investment team brings 16 years of founding product experience (Android and Twitter) and 7 years of institutional investing experience (Founder Collective and Foundation Capital). Their sweet spot is the ~$1M pre-seed round, where they can lead the round as an institutional investor alongside high value angels. The firm has made 4 investments so far this year, including most recently Flatfile, a leader in data onboarding. Their SaaS solutions enable bulk data transfer between businesses; no data science required. Afore invests across all industries, but has a preference for SaaS & Supply Chain Tech.
- Founder Collective: Created by a group of former founders who have each started a technology company. They see themselves as a peer-to-peer investing firm who aligns themselves with each founder/company that they back. The firm has made 11 investments to this point in 2020 and makes a majority of investments in software & internet. Most recently, Founder Collective invested in Front of the Pack which delivers dog supplements.
- Lightspeed Venture Partners: Lightspeed Venture Partners is a venture capital firm that engages in consumer, enterprise, technology, and cleantech markets. The firm was founded in 2000 and is based in Menlo Park, California with additional offices in Beijing, China; Shanghai, China; New Delhi, India; and Herzliya Pituach, Israel. Lightspeed has made 62 investments so far this year with the most recent being ShareChat which is a social networking and regional content platform for India.
- Ludlow Ventures: Ludlow was founded in 2010 and is based in Detroit, MI. They see themselves as a different firm, one without ego that funds the dreams of entrepreneurs and startups, becoming close friends with all of the teams they invest in. Ludlow Ventures has made 8 investments so far this year, with the most recent being Welcome, which offers management and compensation data platforms for HR and recruiting teams.
- Initialized Capital: One of the most well-known pre-seed & seed VC firms in the world, Initialized Capital is led by Garry Tan and formerly Alexis Ohanian. Initialized has 6 investing partners and over $770M under management over five core funds since its founding in 2012. The firm focuses on investing in high-potential software startups with small teams that include great engineers, designers and product founders. Initialized has invested in 27 companies so far this year, most recently investing in Silo, a wholesale food marketplace that enables customers to buy and sell produce, protein, dairy, and shelf-stable food quickly.
The table above provides some more information on these VC firms including a tier ranking, website, contact info, number of investments, and some notable winners from their portfolio.
Obviously, there are many more VC firms that invest in the pre-seed stage, but the ones highlighted are heavily focused here and have a strong track-record. This list provides a look at over 750 seed stage funds and could prove extremely useful in your search for your first round of VC funding. Next we will take a look at the role that accelerators take at this stage and some of the top ones.
Accelerators/incubators are unique in the start-up ecosystem in the sense that they are more hands-on than a VC firm, but only for a selected duration of time. Almost all focus on the earliest of stages, and therefore if you are a pre-seed company should be a perfect fit for any accelerator. These incubators/accelerators will typically take a minority stake in a company and in return provide support in the form of: formalizing your goals/vision, market sizing, product development, branding, finance/accounting, legal, fundraising and introductions to angels and VCs, team building, sales strategy, communication/presentation skills, and other training programs and aid. Each accelerator really differs in their approach and the nature of their aid in the process but there have been countless successful startups to come out of accelerators and it’s fantastic for first time founders. There is also the venture studio which is like an accelerator where companies are incubated inside of the studio and you have multiple people working on multiple companies at a time. The successful ideas are spun out of the studio. With this information at hand, let’s take a look at some of the top accelerators, incubators, and venture studios:
- Techstars: Techstars is known as one of the top accelerators around the world, with incubator/accelerator programs throughout the globe, serving different niches and founders from all different backgrounds. From their website: “Applications open six times a year, and stay open typically for 12 weeks…” Their programs range from varying industry focuses such as the ‘Farm to Fork’ to ‘Allied Space’ to ‘Air Force’ among others. Some cities include Banagalor, Chicago, Boston, New York, Singapore, Amsterdam, Berlin, among many others. They have backed some amazing start-ups and their programs offer mentorship, access to investors, an extensive community, and help local areas really develop the best set of entrepreneurs and companies and spur economic growth.
- 500 Startups: 500 Startups calls themselves the “most active global venture capital firm of 2019.” They have invested in over 2500 startups and in over 75 countries. Like Techstars, they are international and very renowned. Their success in investing is in parallel with Techstars as well and their focus also ranges from niches to more general city accelerator programs. They help founders navigate regulatory and legal issues, provide them with access to hundreds of VCs and their global network of investors, entrepreneurs, and advisors to ensure that the companies that go through their program are set up to succeed from Day One.
- Y Combinator: YC is probably the most well-known accelerator program and is utterly dominant. Founded in 2005 by Paul Graham, YC has created an incredibly competitive program in which teams essentially compete with each other over a 3-month period and continually refine their pitches for the most important day that lies at the end: Demo Day. YC’s Demo Day and program has seen the likes of AirBnB, Stripe, DoorDash, DropBox, Coinbase, and countless other unicorns. Their start-ups have raised over $100B and they have invested in over 2,000 companies. For all of their help, they invest $125k for 7% equity stake and invest in the best of their graduating classes through their YC Continuity Fund.
- Acceleprise: Acceleprise is a top-notch accelerator that focuses on B2B SaaS companies that was founded in 2012 in Washington DC by Sean Glass, Allen Gannett, and Collin Gutman. They believed that there was a lack of resources for early-stage enterprise technology companies at the time. Acceleprise takes a different approach than the accelerators listed above, as they focus on smaller cohorts and devote more time, energy and attention to these select few. They have invested in over 150+ early stage SaaS companies and use their own experiences, network, and expertise to help their founders.
- Betaworks: Betaworks is a product-focused seed stage incubator, VC, and studio that incubates companies, invests, and creates their own businesses. They are based out of SF and NYC and focus primarily on new consumer behaviors and trends powered by frontier technologies. They have backed more than 150 companies that include Giphy, Anchor, Gimlet Media, Product Hunt, Medium, Kickstarter, and Tumblr. They have two main incubators: Betaworks Camp & Lab. Betaworks Camp focuses on start-ups building frontier technologies while Betaworks Lab focuses on entrepreneurs, academics and investors who have a passion for fixing the internet. Betaworks is certainly less well-known than the others on this list, yet their unique model has produced and invested in some truly extraordinary companies and their high rate of success here should be noted.
The table above again provides some more detailed information on these incubators including their average check size, application link, and some notable companies they have invested in. Again, there are thousands of accelerators and incubators across the globe and this website does a fantastic job of breaking down over 500 of them.
What are some key things investors are looking for at this stage? Because traction is so limited, many qualitative factors must be considered. Five of the most important are:
- Founding team (prior experience, expertise in the industry, passion for the problem, charismatic and/or technical)
- Total Addressable Market (how big is the market for the problem that this company is solving?)
- Business Model (how does the company plan to make money and what will the revenue streams be?)
- Business Development / Go-To Market Strategy (how does the company plan to acquire customers and increase retention rates?)
- Competition / MOAT (what are the barriers to entry and what do the competitors in this space look like? How is this company different and better?)
The risk at the pre-seed level is the highest in an asset class that is already known to be the riskiest. Hence, investors are looking for exceptional returns on these early stage bets and the 99% percentile in the categories listed above. VC is a numbers game and investors see thousands of deals a year and pass on almost every single one (so don’t take it personally if you’re business is passed on by a VC).
In conclusion, we have learned that Pre-Seed can generally be defined as a pre-institutional seed round with prior capital raised often below $150k” It is the round after the ‘angel’ round and before the ‘seed’ stage. Companies have generally yet to establish firm market validation or product-market fit but some sort of minimum viable product (MVP).
Hopefully this article was useful in providing some insight into what exactly pre-seed means, why it is rising, and some of the top VC firms and accelerators at this stage. If you are a first-time founder or just want to learn more about the VC space, I highly recommend listening to the first 10 episodes of the first-ever VC podcast called The Full Ratchet. Nick Moran helps to break down the blackbox of VC and give founders a better idea of the funding process and what investors are generally looking for at this stage. The episodes can be found here.
If you have any questions, comments or useful tips about pre-seed investing and the process of raising capital or any interesting start-ups please feel free to comment below!!
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