Do you have an idea for a startup, but no product, traction, or even a working prototype? That's OK! You could still get up to $500,000 from a new wave of investment firms — "pre-seed investors" — who are happy to fund your future business endeavor.
What is “Pre-Seed” Investing?
"Pre-seed" investing is an alternative to raising a traditional friends and family round of financing, or collecting multiple checks from strategic angel investors to get a a startup idea off the ground. These rounds, which are typically $50,000 to $500,000, go to founders in exchange for a piece of their companies (5% to 10%) right at the idea stage, before there's been any proof of concept.
Really, pre-seed investing isn't anything new. A few years ago, these rounds were simply known as seed or angel rounds, lead by early stage investors like SV Angel, Lerer Ventures, or Thrive Capital. Startup accelerator programs like TechStars and Y Combinator also use a similar model.
Now many of those firms have gone on to raise much larger funds, and writing relatively small checks won't yield the returns their funds needed to please their investors (limited partners). In addition, funding rounds have gotten more crowded, often pushing founders to raise millions of dollars before their businesses are ready for the capital.
Why Raise Capital?
The reason for raising funds at any stage is to be able to take the company to the next ‘phase’ of its evolution. Most startups would go through the following phases in their journey:
Concept stage - i.e. when the idea is not yet developed into a product or service, but the founders may have done a fair bit of thinking on the concept and understanding the business dynamics surrounding that idea. This is the stage where the business case is being evaluated and assumptions are made and validated – hopefully by understanding the market and speaking to customers, etc.
Prototype development stage – when the concept – either a product or service – is ready for testing with a limited audience – the startup may have a few initial employees.
Early-stage – when the product or service has started gaining some traction – there are a few early customers/consumers, the product and processes are being refined and fine-tuned and the building blocks for growth are being built – a small team is getting formed
Growth stage – when the startup has started getting more customers, processes are getting developed, an organization structure is getting into place and the company is in an expansion mode – this is probably the time when most companies would start getting profitable
Utilizing Pre-Seed Money
Pre-seed money would typically be raised at concept stage, and should ideally last a little beyond the prototype stage. In most cases, pre-seed stage money is used for the things that will prepare the company to attract seed capital from angel investors or from early-stage VCs i.e.
Understanding the business case by validating assumptions
In building the prototype or the first version of the product – what is called the MVP or Minimum Viable Product which will allow you to test your assumptions in the market i.e. check if your customers find the value proposition meaningful, if they feel that this product / service does fulfill their needs, etc.
At the pre-seed funding stage, a startup should keep capital expenses very low – i.e. rent ACs, furniture, etc. rather than buying. Operating expenses should also be kept low – take lower salaries, work out of a shared office, multi-task, etc.
This is also in your interest because the valuations are likely be very low at this stage, and hence the lower the amount you raise, the lesser your equity dilution at this stage.