Beginner's Guide to Pre-Seed Funding

Seed funding is a term commonly used by entrepreneurs and business owners. However, pre-seed funding is also an important term that needs proper understanding. If a business owner goes through the standard circumstances, the pre-seed funding stage may come before seed funding. It is not difficult to know that people invest in the idea behind a business.

Learn through the VPS Server platform about pre-seed funding and how it works compared to other funding stages. We will also cover some practical strategies to begin fund-raising.

Understanding Pre-Seed Funding

The first, or, as you can say, the earliest stage of startup funding, comes before the seed funding stage. In this stage, investors provide capital to startups in exchange for equity to develop products.

The pre-seed stage comes after the bootstrapping stage with the personal funds of the business owner or the initial angel investment round from angel investors. Pre-seed funding involves investing in the idea because this is a very initial stage, and the product may not have been developed. Moreover, the business at this stage may be nothing beyond a prototype.

Comparison Between Seed Funding and Pre-seed Funding

Seed funding and pre-seed funding are the stages of the investment round that lay the foundation of a startup. These stages serve distinct purposes in developing a business in the early stage. Pre-seed funding provides initial resources to shape an idea, while seed funding comes into play as the startup progresses, supporting

• Further development

• Scaling,

• Market entry

Here are the key differences between the seed and pre-seed funding round:

Seed Funding

Timing:

Seed funding comes after the pre-seed stage. It is typically sought when the startup has developed a prototype, demonstrated some market potential, and is ready to scale or further develop its product.

Purpose:

Seed funding supports the startup in developing its business model, scaling operations, and entering the market.

It often helps cover expenses related to marketing, hiring key team members, and expanding the customer base.

Investment Size

Seed funding involves more significant amounts of capital as compared to pre-seed funding. This infusion of funds is intended to propel the startup to the next level of growth.

Investor Requirements

Seed funding can involve a mix of angel investors, venture capitalists, and sometimes even institutional investors. Investors at this stage typically expect a more developed business plan, a proof of concept, and a clear growth path.

Business Development

Seed funding supports the startup in moving from the concept stage to a more operational phase. It helps build infrastructure, hire key team members, and expand market reach.

Pre-Seed Funding

Timing

This initial funding stage occurs at the very early stages of a startup's formation. It's the capital sought before the business has a fully developed product or service.

Purpose:

Pre-seed funding aims to help entrepreneurs take their idea from concept to a more tangible form, such as building a prototype or conducting initial market research.

Investment Size

Pre-seed capital amounts are typically more minor compared to seed funding. It provides enough capital to kickstart the initial phases of a startup.

Investor Requirements:

Investors at the pre-seed stage are often angel investors, friends, family, or early startup supporters. They invest based on the entrepreneur's vision and the potential they see in the idea.

Business Development:

Pre-seed funding is focused on proving the concept and validating the business idea. It allows entrepreneurs to refine their vision and prepare for more substantial funding rounds.

Best Time to Raise pre-seed funding

Businesses can be at a few different stages before raising pre-seed funding to build a strong foundation, refine their business model, and demonstrate the viability of their concept. Here are the key stages that entrepreneurs often navigate before seeking pre-seed funding:

Conceptualization:

At this stage, founders conceive of a business idea or identify a market need. They conduct initial research to validate the concept, assess market potential, and understand the target audience.

Market Research:

Entrepreneurs delve deeper into the market to understand competitors, identify potential challenges, and assess the demand for their products or services. Market research involves gathering data on industry trends, customer preferences, and potential obstacles.

Prototype Development:

Founders create a basic version or prototype of their product or service. This stage focuses on turning the idea into something tangible, allowing for early testing and feedback.

Validation and Testing:

Entrepreneurs test their prototypes in the market to gather feedback and validate assumptions. Testing may involve pilot programs, beta launches, or other methods to assess the product's functionality and market acceptance.

Minimal Viable Product (MVP):

The startup develops, at minimum, a viable product with essential features to meet market needs. The MVP allows founders to launch a more refined version of their product, demonstrating its core value proposition.

Early Traction:

Founders aim to generate initial interest and gain early customers or users. This stage involves marketing efforts, customer acquisition strategies, and gathering metrics that showcase user engagement and product adoption.

Market Positioning:

Startups refine their market positioning based on feedback and real-world data. Entrepreneurs identify their unique value proposition, target customer segments, and develop strategies to differentiate themselves in the market.

Business Model Refinement:

Founders fine-tune their business model based on insights gained from testing and early traction. It involves adjusting pricing strategies, revenue models, and distribution channels to optimize the startup's path to profitability.

Team Building:

As the startup evolves, founders may expand their team to include critical roles necessary for growth. They recruit key team members, advisors, and specialists to strengthen the startup's capabilities.

Financial Planning:

Founders create detailed financial projections and budgets to understand the funding needed for scaling.

Financial planning involves estimating costs, projecting revenue, and determining the startup's capital requirements for the next phase.

Preparation For Pre-seed Funding

You must be ready for pre-seed funding if your business has the following:

Minimum Viable Product (MVP):

A minimum viable product is an early stage of a product offered by a company. With time, products will be developed and improved based on customer feedback and market research. The product will then grab the attention of investors and consumers with additional features and better quality.

Proficient Founding Team

The founding team of a particular product should have enough knowledge and expertise in that specific industry. It will help them develop a perfect product to appeal to the initial investors, even with more experience.

Target Market Competent Product

Consider your product is a good fit for the distinct target market. In that case, you will be more likely to clutch the concentration of potential investors. To achieve attention, you must confirm that the user has received your product and that there is plentiful demand for it in the market.

Grabbing the Attention of New Consumers

A startup may want to raise pre-seed funding if they already have a small number of consumers or plan to attract them. Businesses need to meet the increasing demand with the rise in customer base.

Getting Started with Pre-seed Funding

After completing the steps for pre-seed funding qualification, you can start the actual funding process. While starting the process, you will need to consider the following points:

Take the Right Decision

Pre-seed finding is not always the right step to take for every startup. It is more likely suitable for companies in their early stages. Before starting up, consider all the valuable considerations and what suits the business. If you have an ideal working prototype and a winning idea, your business can have it as a key to success. You can grow more by raising more funds through a seed funding round. Using suitable and relevant tools will take your business to the next level.

Get a Compelling Pitch Deck

In the beginning, businesses usually do not have actual products at this time. Through this pitch, investors will know what they are investing in and all the other details about the product. The details include product details, financial predictions, target market, and customers.

However, you can create multiple pitch decks depending on the business's mission. For instance, you can create one pitch to present your idea to the investors and another for email pitches.

Choose Investors Wisely

Now, it is the time to choose an angel investor for raising funds respective to your pitch deck. You can also search for later-stage investors who might have invested in the same business. But the case may be different every time.

A business owner may find interested investors in his network, making looking at potential networking opportunities compulsory. However, it is safe to check the history of investments made by the potential investor. Partnering with the right investor, you will benefit from pre-seed funding with beneficial guidance for the growth of your business.

Negotiation of a contract

The final step a business owner needs to take is negotiating a contract. Once the deal is done with pre-seed investors before the pre-seed round, you should ensure that every agreement is in writing to avoid any hassle in the earliest stages.

On the other hand, if the investor backs out or starts any dispute, your business might suffer. However, before the startup process, ensure that your target is correct. If unsatisfied with the contract, you carry all the ownership to turn it down. It will help you reserve your business in the long term for more suitable deals and market approaches.

Risks and Challenges in the Pre-seed Funding Stage

When venturing into the complex landscape of pre-seed funding, engaging advisors becomes imperative for startups seeking to secure early-stage capital. These advisors play a crucial role in navigating the intricacies of the fund-raising process, ensuring compliance with legal requirements, and optimizing financial strategies.

Legal Advisors in Pre-Seed Funding

Legal advisors might be a challenge to the success of a business. A proper decision can take your business to another level of success. Still, at the same time, you can face challenges from a wrong decision. Following are some key considerations a business owner needs to take care of:

Compliance and Structure:

Legal advisors guide startups through the complexities of compliance, helping businesses structure their pre-seed investments that align with regulatory frameworks. It involves determining the appropriate legal structure for the company and ensuring adherence to relevant laws.

Contract Drafting and Review

Legal experts assist in drafting and reviewing contracts related to pre-seed investments. It includes term sheets, shareholder agreements, and any other legal documents crucial for defining the terms and conditions of the investment.

Intellectual Property Protection

Legal advisors play a significant role in safeguarding the startup's intellectual property. They ensure proper documentation and protection matters are in place, minimizing the risk of disputes and enhancing the valuation of startups.

Due Diligence

During the pre-seed stage, the legal advisor team conducts thorough due diligence to identify and address any legal issues that might affect the investment. This proactive approach helps mitigate risks and enhances the startup's attractiveness to potential investors.

Financial Advisors in Pre-Seed Funding:

There are many challenges an early-stage startup can face during a pre-seed round in terms of financial assistance. Covering these risks will make investing easier for potential pre-seed investors. Below are a few risks and challenges to cater to most pre-seed rounds:

Financial Projections and Modeling

Financial advisors assist pre-seed startups in developing comprehensive economic models and projections. It involves forecasting the startup's potential financial performance and providing prospective investors with a clear picture of expected returns.

Valuation Strategies:

Determining the valuation of the early-stage startup is a critical aspect of pre-seed funding. Financial advisors apply various valuation methods to establish a fair and attractive valuation, maximizing the startup's appeal to pre-seed investors.

Funding Strategy:

Financial advisors work with startups to develop a funding strategy that aligns with their growth objectives. They assist in determining the optimal amount of pre-seed investment required and the allocation of funds for critical activities such as product development and market entry.

Investor Relations:

Financial advisors help startups build and maintain strong relationships with potential investors. It includes crafting compelling financial narratives and presentations articulating the startup's financial health and growth potential.

Transition to Seed Round:

Look at how the transition to the seed round is a challenge for an investor.

Seamless Transition Planning

Legal and financial advisors are vital in planning a seamless transition from pre-seed to seed funding. They ensure the startup's legal and economic structures are scalable and conducive to attracting more significant investments in the subsequent rounds.

Investor Communication:

Advisors assist startups in effectively communicating their financial performance and milestones achieved during the pre-seed stage. This transparency is crucial for retaining and attracting new investors in the seed round.

Compliance Continuity:

As the startup progresses to the seed round, legal advisors ensure the continuity of compliance with evolving regulatory requirements. This includes updating legal documentation and addressing any new legal considerations that may arise.

Advantages and Disadvantages of Pre-seed Funding

Advantages of Pre-Seed Funding:

Early Validation: Pre-seed funding provides startups the financial support to validate their business idea. This validation can be crucial for attracting later-stage investors and gaining confidence from potential customers.

Product Development: Funds at the pre-seed stage allow entrepreneurs to invest in product development. Refining the product or service, addressing initial challenges, and creating a more market-ready offering is essential.

Team Building: Pre-seed funding enables founders to build a skilled and dedicated team. Hiring key personnel early on is critical for scaling the business and tackling various operational aspects.

Market Research: With pre-seed funding, startups can conduct comprehensive market research to understand customer needs, identify competitors, and refine their market positioning. This information is vital for shaping the product strategy.

Milestone Achievement: Meeting certain milestones, such as a working prototype or initial user acquisition, becomes feasible with pre-seed funding. Achieving these milestones enhances the startup's attractiveness to future investors.

Attracting Later Funding: Successful pre-seed rounds can make a startup more appealing to seed and venture capital investors. It demonstrates the business's potential and the capability of the founding team to execute the plan.

Disadvantages of Pre-Seed Funding:

Dilution of Ownership: Accepting pre-seed funding means giving up some equity to investors. This early dilution can impact the founders' ownership stake in the company, potentially reducing their control over strategic decisions.

Limited Capital: Pre-seed funding amounts are typically smaller than later funding rounds. This limitation may hinder the startup's ability to execute a comprehensive marketing strategy, expand rapidly, or address unforeseen challenges.

High Risk: Pre-seed investors often take a significant risk by investing in unproven concepts or early-stage startups. The failure rate is high at this stage, and investors may lose their entire investment if the startup fails to succeed.

Pressure to Perform: The infusion of pre-seed capital often comes with expectations for rapid progress. Startups may need more time to meet milestones and show tangible results to attract follow-on funding, potentially leading to shortcuts or compromises.

Limited Professional Guidance: At the pre-seed stage, startups may not benefit from the extensive mentorship and guidance that can come with later-stage funding. This lack of experienced support can be a disadvantage, especially for first-time entrepreneurs.

Uncertain Valuation: Determining the valuation of a pre-revenue startup takes time and effort. Disagreements on valuation between founders and investors can lead to complications in the funding process and affect the dynamics of future fund-raising efforts.

Common Misconceptions

There are many misconceptions a person can face. Clearing these misconceptions is crucial for entrepreneurs seeking pre-seed funding, as it helps form realistic expectations, make informed decisions, and better navigate the complexities of the startup landscape.

Pre-Seeding Equals Instant Success:

Some entrepreneurs believe that securing pre-seed funding guarantees instant success. However, pre-seeding is just the beginning, and startups must continue to navigate challenges and execute their business plans effectively.

Pre-seeding is Only for Tech Startups:

While technology startups often seek pre-seed funding, it's not exclusive to the tech industry. Pre-seeding is applicable across various sectors, including healthcare, finance, and consumer goods.

All Startups Need Pre-Seed Funding:

Not every startup requires pre-seed funding. Some businesses can bootstrap or generate revenue from the outset. Pre-seeding is particularly relevant for ventures needing capital for product development, market validation, and team expansion.

Pre-Seeding is Only for Revenue-Generating Ventures:

Pre-seed funding is not limited to startups with a proven revenue stream. Investors often support promising ideas and early-stage concepts, understanding that profitability may take time.

Investors Only Look at the Product Idea:

While a compelling product idea is crucial, investors in pre-seeding also evaluate the founding team's capability, market understanding, and execution strategy. A well-rounded pitch is essential for attracting pre-seed investment.

Pre-Seeding is a One-Time Effort:

Entrepreneurs might think that once they secure pre-seed funding, they won't need to seek further investment. However, successful startups often progress through multiple funding rounds to fuel growth and expansion.

Pre-Seeding Guarantees Full Control for Founders:

Accepting pre-seed funding involves giving up a portion of equity, which can result in some loss of control. Founders must balance securing financial support and retaining a significant stake in their company.

Pre-Seeding is Only About the Money:

While funding is significant, pre-seed investors often bring valuable expertise, mentorship, and networking opportunities. Startups should consider these additional benefits beyond the financial infusion.

Pre-seeding is Only for Startups with a Finished Product:

Investors in pre-seeding understand that startups are in the early stages of development. While having a prototype or MVP can be beneficial, a well-defined vision and plan are often sufficient for attracting pre-seed funding.

Success is Immediate Post Pre-Seeding:

Achieving success post pre-seeding takes time. Startups may face challenges, pivots, and iterations before realizing substantial growth. Founders should set realistic expectations and be prepared for a journey of continuous refinement.

Types of Investors Involved in Pre-seed Investments

Angel Investors:

• Profile: Individual investors who provide personal funds to startups.

• Involvement: Apart from capital, angel investors often offer mentorship, industry connections, and valuable strategic advice.

Venture Capital Firms (Micro-VCs):

• Profile: Small venture capital firms specializing in early-stage funding.

• Involvement: Micro-VCs typically invest more significant amounts than angel investors and may actively participate in shaping the startup's direction.

Seed-Stage Venture Capitalists:

• Profile: Traditional venture capital firms entering the seed stage.

• Involvement: These firms bring institutional support, broader networks, and the potential for follow-on funding in later rounds.

Corporate Investors:

• Profile: Large corporations investing in early-stage startups.

• Involvement: Corporate investors often seek strategic partnerships, potential acquisitions, or access to innovative technologies aligned with their business interests.

Crowdfunding Platforms:

• Profile: Online platforms allow many individuals to contribute small amounts of capital.

• Involvement: Crowdfunding involves a diverse pool of backers who may not play an active role beyond financial support.

Expectations and Contributions of Investors:

Financial Support:

• Expectations: Investors provide the necessary capital for the startup's initial development.

• Contributions: The financial infusion allows startups to hire key personnel, develop prototypes, conduct market research, and cover other early-stage expenses.

Expertise and Mentorship:

• Expectations: Investors often expect to share their industry knowledge and experience.

• Contributions: Mentorship from seasoned investors can guide founders in decision-making, strategy development, and navigating challenges.

Networking Opportunities:

• Expectations: Investors anticipate facilitating valuable connections for the startup.

• Contributions: Introductions to industry leaders, potential clients, and other investors can significantly impact the startup's growth and success.

Due Diligence and Strategic Guidance:

• Expectations: Investors expect startups to have a solid business plan and execution strategy.

• Contributions: Investors conduct due diligence to ensure the viability of the business. They may also provide strategic guidance to refine the startup's direction.

Follow-on Funding Possibilities:

• Expectations: Investors often assess the potential for future growth and scalability.

• Contributions: Successful pre-seed funding increases the likelihood of follow-on investments, allowing the startup to reach subsequent milestones.

Risk Management:

• Expectations: Investors acknowledge the inherent risks in early-stage investments.

• Contributions: While accepting the risk, investors may work closely with startups to mitigate challenges, offering support during periods of uncertainty.

Alignment with Exit Strategies:

• Expectations: Investors seek alignment with the startup's exit strategy through acquisition or IPO.

• Contributions: The investor's involvement may extend to advising on exit strategies and positioning the startup for success.

Conclusion

There are many stages involved when it comes to investment. Seed funding and pre-seed funding are two initial stages and are the most important. Connecting with the right investors and advisors will take your business to the next step of success. You must adequately understand pre-seed funding and how and where to invest it to achieve it.

The author

Bilal Mohammed

Bilal Mohammed is a SOC analyst and cybersecurity expert who is passionate about making the internet safer. He has expertise in penetration testing, networking, network security, web development, and security operations center (SOC) services. In his spare time, he looks for security and design vulnerabilities to protect against attacks from hackers.

More from Bilal Mohammed