Most of my meetings as a VC end up with founders saying: “ We are raising a $2M-$10M Seed round.”
I am a Seed (and sometimes a Pre-Seed) investor at F2 VC, and yes — these were the sizes of the rounds.
COVID-19 came along and hit some founders on the head, which caused round sizes and valuations to decline, but still, these terms represent 90% of what I come across during my day-to-day activity, and I believe these valuations will be back faster than expected.
If you are lucky as an investor, after hearing the “ask” from the founder, you might even get the founder to disclose the valuation they are aiming for.
It doesn’t matter much because we all know the “ball game” — Founders “sell” 20%-40% of their equity per financing round.
Now, this is nothing new, but in today’s ecosystem, the rounds and valuations have skyrocketed. If you combine this with the trend of founders attempting to raise funds earlier than ever (I’m talking about pre-market validation), we end up with a pretty problematic situation: Founders are trying to raise astronomical amounts with no correlation to their stage while VCs are taking more risk for bigger check sizes.
This is where pre-seed comes into play.
The market today offers a pretty solid framework for Pre-Seed rounds.
Usually, the round will be done using a note such as a CLA or a SAFE (recommended — Adding YC templates), not giving up any immediate equity, while compensating the investors by capping the valuation and/or offering them some kind of discount.
The rounds range between $100k-$1M with the sweet spot somewhere in the middle.
These notes allow angels, micro funds and early-stage VCs to move fast and dramatically decrease the time spent on the due diligence process. VCs see this as an opportunity to get skin in the game and achieve visibility. On the other end, founders win by receive funding without giving up any immediate equity, establishing more partners aligned to help the company succeed, and gaining fast capital that will help them accelerate towards a solid and well-deserved Seed round.
The main milestone at this stage is market validation and mini product-market fit.
Pre-Seed Capital is perfect for building something that doesn’t scale but validates your thesis.
The Pre-Seed will enable founders to bring that important hire or two they can't do without, attend an important conference where they might meet a strategic design partner or buy crucial data for a working demo. However, pre-seed is not enough to scale, forcing founders to hustle and be lean & mean.
As a founder, pre-seed presents the opportunity to validate your promise to all stakeholders (including yourself.) It is beneficial to do this before committing to a larger investment since with a large investment comes far more pressure to stick to your promises, making a pivot seem like a weakness or an indication of low execution skills.
Another advantage pre-seed holds is the ability to hire essential team members. This might sound very simple but for founders, this could be a game-changer.
The flexibility to play with the ESOP vs. Capital balance is important at any stage, but the fact there is capital at such an early point helps mitigate this dilemma.
In addition, at the start of building your company, there is always a position or two you wish you had in order to accelerate your progress- a developer, marketer, a graphic designer. With pre-seed, there is no need to wait for an ambiguous seed round for these hires to occur.
Last but not least - before you, as an early-stage founder, commit to a “mega” financing round, think about the consequences of your actions.
A Seed round is a promise that you will spend the next several years building what you pitched.
Are you up for that? Are you really sure? Wouldn’t you rather spend some time validating before diving into the deep and freezing water?
A good Founder goes all in.
Some will claim the pre-seed path isn’t right for all industries. Cyber, for example, might require a large amount of capital to build the right team and show value with a GA product.
This is partially true. Yet a pre-seed round can accelerate the fine-tuning of the problem, the discovery of the exact gap you were looking for in the market, and give you the confidence to showcase it with no scale.
It is important to remember, Pre-Seed and Seed rounds are commonly raised based on a promise, while the A round will be more dependant on your execution.
The “numbers” tend to play a bigger role in the A round due-diligence process. The implications of raising a Seed round too early and underdelivering the “numbers” will cause a shift in your A round strategy.
And with that, the most common consequences are launching a “bridge” round or- god forbid- a down round.
As VCs we have a wide and diverse portfolio, we can afford to take risks. As a founder, you went all-in on your startup - play it smart!