Before getting into the details of pre-seed funding, I will try to outline my understanding of what the different rounds of funding mean. Series A usually refers to the first round of funding involving institutional VC investors (unlike Angel investors, Incubators/Accelerators and Friends & Family). So, what the emergence of pre-seed means is the following:
- Startups are raising more rounds of funding before approaching the institutional VCs
- The ticket sizes of VC investments are on the rise (as outlined in the Chicago Ventures example below)
What is Pre-Seed?
The trend was first written about by Manu Kumar at K9 Ventures in April 2014. In it, he noted:
Seed is not the first round of financing any more. In fact after noticing this trend last year, I have transitioned to calling most of my initial investments “pre-seed” rounds, where the company raises close to $500K, before raising a full seed round. The Seed round is larger — closer to and sometimes upwards of $2M. The Series A is now the fourth round of funding for a company — the first is usually friends and family, or an incubator (~$50K), then pre-seed (~$500K), then seed (~$2M), then Series A (~$6M-$15M).
And the trend is building. Last month, Notation Capital raised an $8M seed fund, noting amongst other observations that “There are so few real VCs willing to invest in pre-growth. They all want to invest in the growth chart.” And yesterday, Charles Hudson, a Partner at SoftTechVC (one of the original MicroVCs) left his post to form his own pre-seed fund, citing a desire to get his hands dirtier at even earlier stage with entrepreneurs.
High level – the venture landscape has changed and “early stage” or “seed” or “microVC firms” are not going to be the proper source of funding for most entrepreneurs.
Let us examine the evolution of Chicago Ventures as a fund. Chicago Ventures was born in December 2011 (let’s call it 2012) amidst the boom in MicroVC funds, of which there are now more than 200. Many of these funds will fail, but others are building strong networks, brands, and track records. It is quite evident that they moved further upstream in the investment stack.
They are not the only ones. I’d imagine many iterative MicroVCs have experienced similar shifts. A deepening risk aversion is a natural consequence of the current ecosystem dynamics: incrementally more startups, increasingly verticalized target markets, and growing non-institutional early stage capital. Venture Capital is a game of missing information and the current setup provides even very early stage investors with a greater information advantage than ever before: and for them, there’s simply no option but to take it. The even better news for MicroVCs is that with a few exceptions, the market is so oversaturated with startups, that even by waiting an additional 9-18 months, their entry valuation (albeit often higher) is still low enough to make fund economics work.
What this means is that many of the outlets that used to provide $250k checks to early stage entrepreneurs no longer exist.
Entrepreneurs need a new option: a firm whose model is based on high variance investments in exchange for increased ownership and lower valuations. These are the new Super Angels. Funds such as K9 Ventures,Boldstart, Ludlow, and Brooklyn Bridge Ventures are great examples of quality firms filling this gap. Their models are predicated on having the conviction to place bets before larger investors step in.
In my opinion, entrepreneurs reading this at the 2-6 employee stage, with a product only a couple of months old or still in MVP mode, should be approaching these firms first and avoid wasting time with traditional seed VCs. The pre-seed firms are working hard to build strong upstream syndicate networks and if they believe a larger institution could be an appropriate partner, will make the recommendation accordingly.
Empathetic support and experience are the roles pre-seed funds can fill. It isn’t charity – these firms should be appropriately compensated for their risk and infrastructure. But it’s hard to build healthy, balanced entrepreneurs and startups if there aren’t healthy, balanced institutions supporting them.