As a round type, pre-seed dates back to the very beginning of venture capital. In recent years, however, pre-seed has become the fastest growing round type, responsible for 20%+ of all venture rounds globally. In the below post, we look to understand pre-seed from an empirical perspective.
Stage Expectations
At pre-seed, investors have varying expectations – accelerators commonly invest in companies that do not yet have revenue or product. Other venture investors tend to expect some form of market validation or an early prototype.
Demand validation can often take the form of pre-orders or rigorous customer feedback. The quality and extent of customer feedback often varies considerably, depending on the nature and the type of product.
For hardware companies, pre-orders or contracted revenue is often used for demand validation. In the software category, a small set of engaged freemium users or paying customers is typically a strong indicator for latent demand.
At pre-seed, the bet is primarily on the team, the market opportunity, and some evidence evidence of latent demand. A well-defined prototype coupled with some early evidence of latent demand are often the primary expectations at pre-seed.
Stage Objectives
Most commonly, pre-seed rounds provide capital for founders to build a product and achieve preliminary market traction. These two outcomes typically qualify companies for a seed round, which then provides larger amounts of capital to further develop the product and grow the business.
At pre-seed, founders should have crystal clarity on their objectives for the raise. This should be laid out clearly in the initial deck, often with an advanced level of detail. In some sectors, the objective from the pre-seed round may be different, and may require founders to first develop an understanding of what they need to get to the next round.
Round Size & Valuations
According to Carta, which provides software for cap table management, a vast majority of pre-seed rounds in the US tend to be in the $1-2m range.
As per Angel’s List, which powers the cap table solutions for thousands of startups, pre-seed rounds in the US have been raised at the $5-10m valuation.
The above charts show round size and valuations at an industry level. These vary significantly based on sector, geography and the overall opportunity.
Activity Levels at Pre-seed
Over the past two decades, pre-seed rounds have transitioned from being quite rare to becoming extremely common. In recent years, there have been more pre-seed financings globally than there have been Series A rounds. Pre-seed is now the second most common type of venture round (second only to seed).
Growth in the pre-seed category is driven primarily by fund managers looking to invest in companies at the earliest stages when valuations are the lowest. Historically, venture returns have been highly concentrated at the earliest stages, resulting in incrementally larger numbers of pre-seed rounds with each passing year.
Limited Optionality at Pre-seed
A closer look at the data reveals that pre-seed activity is highly concentrated within a small pool of investors. Specifically, while pre-seed rounds take place in larger numbers than Series A financings, the total number of investors specializing at pre-seed is about one-third that of Series A.
The distinctive element at pre-seed is that there is a small number of investors that specialize at pre-seed. Each of these investors is making a large number of investments each year to spread out the high risk at pre-seed across a broader distribution of companies. This trend is consistent with our understanding that pre-seed investments tend to be experimental in nature (with failure rates typically ranging in the 50-90% of all financings).
The above landscape makes it critical for founders to rely on data, and not on hearsay, to correctly identify investors that specialize at pre-seed.
Investor Types at Pre-seed
Another distinctive element at pre-seed is that accelerators are responsible for >35%+ of all pre-seed rounds globally.
For first-time founders, accelerators also play a crucial role in creating an enabling environment that allows companies to benefit from network effects and embark on a shared learning journey. This is often seen with large accelerators, such as YCombinator and Techstars. The sheer size of such accelerators creates network effects that allow companies to learn from one another and to use the community to secure their early customers.
Sector Overview at Preseed
At pre-seed, most investors tend to be open to a broad spectrum of sectors; however, most investors have a clear concentration in specific areas. This concentration is sometimes due to market forces whereby they receive deal flow from companies in a given sector.
More commonly, however, the concentration of investments in specific sectors is linked to an accelerator’s strategy whereby they are excited about a given opportunity space and are concentrating their capital deployment in that space. The below chart shows the overall distribution of pre-seed activity from 2019-24 across sectors:
Investors to Target
It is fairly common for pre-seed founders to pursue seed-stage investors. Similarly, seed-stage founders also commonly engage with pre-seed investors. A stage mismatch is among the most common reasons for why investment discussions may not result in a positive decision.
At pre-seed, founders need to be laser-focused on investors that have three characteristics:
Summary
Being laser-focused on the right type of investors is the highest leverage activity in a fundraising process. With the right set of “most likely” investors, founders report higher conversion rates at every step of the funnel. Such investors are a lot more likely than others to review online applications, take introduction requests and meet with founders.
