For many startups, the need for funding begins even before they have a fully developed product or service to bring to market. In fact, a founder may have nothing more than a great idea, yet still need capital to take it to the next level. The question is, where can they get it?
That’s where pre-seed funding comes in. While you may have heard of seed funding, the first official round of funding for a startup, pre-seed funding comes into play even earlier in the game. It’s capital from investors who are willing to gamble on not much more than a viable idea for a new business.
While pre-seed investment can be difficult to get, it can fast-track your startup’s growth. Read on to learn how pre-seed funding works, who offers it, and how to secure a pre-seed investment.
Key Points
• Pre-seed funding is the first stage of capital raised by startups, often used to transform an idea into a workable prototype or product concept.
• Pre-seed rounds are usually smaller, ranging from $10,000 to $250,000, while seed funding amounts are larger, typically between $250,000 and $2 million.
• Pre-seed funds are used to build the foundation of the business, such as product development or market research.
• Pre-seed investments carry significant risk for investors, as businesses are in their infancy with little to no market validation or revenue.
• Pre-seed funding often comes from personal savings, family, friends, or angel investors. You can also turn to small business grants and loans for pre-seed funding.
What Is Pre-Seed Funding?
Pre-seed funding is an early funding round in which investors provide a startup with capital to develop its product in return for equity in the company.
Pre-seed funding comes before the “official” rounds of funding, which include seed funding, followed by Series A, B, and C stage funding. Generally, this type of investment is made when a venture is still in the proof-of-concept stage and provides founders with enough capital to get off the ground.
How Does Pre-Seed Funding Work?
Like other types of startup funding, pre-seed funding involves receiving a certain amount of working capital in exchange for equity in your business. As your startup grows, that equity will (hopefully) become more valuable, and investors can cash in when your business gets purchased or goes public.
Why Is Pre-Seed Funding Important
Pre-seed funding for startups is important because it’s that idea, that seed, that needs to be taken care of and nurtured in order to become a full-fledged, blooming business.
Without money for research and development or employees who can turn that idea into reality, your startup may never actually get off the ground. Pre-seed funding provides the resources needed to establish the foundation of your business. Later rounds of financing can help you build on that foundation.
Recommended: 10 Business Growth Strategies
Pre-Seed vs. Seed Funding
There are similarities between pre-seed and seed funding, since all funding rounds tend to overlap slightly. For example, both pre-seed and seed funding are used to cover early expenses, like hiring and research and development, for a new product offering.
However, there are some key differences. For one, pre-seed funding isn’t generally considered an official round of funding, whereas seed funding is. Pre-seed funding also tends to be smaller than seed funding.
Another key difference: With pre-seed funding, investors don’t expect your startup to have done much yet. With seed funding, on the other hand, investors often require that the company has already developed their product and has somewhat of a customer base.
Finally, pre-seed funding is riskier to investors than seed funding, since it’s possible that product may never even make it to market.
What Is Pre-Seed Funding Used For?
You can use pre-seed funds for anything that helps you get your idea off the ground. That includes researching the market to understand who your audience is, hiring staff, renting office space, developing a prototype, manufacturing that prototype into something scalable, and marketing your product or service to those first few customers.
How Soon Does It Make Sense to Look for Pre-Seed Funding?
Even though pre-seed funding is for the earliest stage of a start-up, you don’t want to go to investors empty-handed. A good time to research pre-seed funding is when:
• You know the niche your product fills. If you’ve done your homework, you know the market your product is designed for and can use this early-stage funding to dive deeper into how you can tailor the product to fill a need in the marketplace.
• You have a rough prototype of your product. It doesn’t have to be fully developed yet, as pre-seed funding will help work out the kinks.
• You already have some interest. Have you started showing your product to customers? Early positive feedback is a good sign that a startup has high growth potential.
• You have a revenue model. You may not yet be earning revenue, but you have a plan and clearcut path to making money.
Types of Pre-Seed Funding
Pre-seed funding can come from a variety of sources. These include:
Venture Capital
Venture capital is a form of financing provided by investors to startups and early-stage companies with high growth potential. In exchange for funding, venture capitalists receive equity or ownership stakes in the business.
Friends and Family
Who better to support your endeavor than the people who know you best? You may be able to get pre-seed funding from friends and family. Just be careful to keep it a business transaction and create a loan or investment agreement that stipulates repayment or equity share.
Angel Investors
Angel investors tend to provide smaller amounts of capital than venture capitalists, which can make them particularly well-suited to pre-seed funding. Plus, many have niche specialties that could align with your business’ industry or focus.
Incubators
Incubators are programs that offer coaching and assistance to startups, including feedback on product development and connections to influential people in the entrepreneurial community. Some also include pre-seed funding, while others will assist you in raising funding from angel investors or venture capitalists.
Accelerators
Accelerators are just like incubators except that, rather than focus on helping a startup launch, they typically help already-established startups grow. However, if you have experience launching other startups, you may be able to find funding assistance through an accelerator program.
5 Tips for Getting Pre-Seed Funding
The steps for getting pre-seed funding are similar to those for seed funding. The difference is that it can be harder to convince an investor to fund an untested product or idea. Here are some ways to increase your chances of success.
1. Formulate a Business Plan
You may be chomping at the bit to find the money, but you’ll first need to establish a solid foundation to attract the right investors. That starts with your business plan. This document will get ideas to paper on who your audience is, the problem your product solves, and how you’ll market it to customers.
Your business plan should also include your revenue model and startup costs so investors know you’ve done your due diligence and will use your pre-seed funding judiciously.
2. Come Up With Your Pitch
Your business plan will help you develop a pitch deck, which is a slide presentation that tells investors everything they need to know about your startup, the product, the market, and your financial projections. Here are some ideas on what to include in your pitch:
• The need your business idea fills
• Your target market
• What makes your product/service unique
• Your revenue model
• Revenue projections for five years
• How you’ll market to customers
• Budget for pre-seed funding
• Information about you, the founder, and your business’ story
It’s a good idea to keep your pitch short and sweet. Stick to the highlights and be ready to elaborate as you answer questions.
3. Find Potential Investors
You may want to start by using your business connections to find investors who are interested in early-stage startups. Incubator platforms can also help you access investors specializing in pre-seed capital. As you research investors, be sure to dig into their track record on working with pre-seed startups, how much funding they typically give, and their experience in your industry.
4. Present Your Pitch
Most investors will require an in-person presentation before committing to your company. Once you secure that coveted pitch meeting, it’s a good idea to practice until you can confidently give your pitch from memory. Anticipate the questions that investors will ask, paying particular attention to numbers.
5. Negotiate
You may not get the offer you wanted right off the bat from an interested investor, so be ready to negotiate. Decide how much equity you are willing to give up in exchange for capital in advance so you don’t make a bad decision in the heat of the moment. Also, be sure to get any deal you make in writing, especially if an investor is committing their time and resources.
Alternatives to Pre-Seed Funding
The types of investors listed above aren’t your only options for getting the capital you need for your startup. Here are a few alternatives.
Small Business Loans
There are many different types of small business loans. While traditional banks will typically only lend to businesses that have been established for two years or more, alternative online lenders tend to be more flexible.
You may be able to get a small business loan, such as a short-term loan, startup business lines of credit, invoice factoring, or equipment financing, from an alternative lender with only a short length of business history. You’ll likely receive smaller amounts and pay higher interest rates than more established businesses, however.
Recommended: How to Apply for Small Business Loans
Crowdfunding
There are hundreds of crowdfunding sites, where anyone (not just professional investors) can contribute toward a new business project, product, or service. While it can take time and effort to create a compelling campaign, you typically don’t have to give up equity with crowdfunding. Instead, you may need to provide a token of appreciation to donors or investors, like early access to your product or a t-shirt with your startup’s logo on it.
Startup Loans
Startup business loans may not have the strict criteria for time in business that other business loans do, and you may be able to secure funds before you’ve even launched.
The U.S. Small Business Administration (SBA), for example, offers a microloan program for small businesses looking to start or expand. Microloans are also available outside of the SBA program through nonprofit and for-profit lenders. Often, these lenders focus on giving opportunities to minority business owners and startups in underserved communities.
Recommended: Applying for a Microloan for Your Startup
The Takeaway
Pre-seed funding is a critical first step for many startups, providing the financial support needed to turn innovative ideas into viable products or services. Funds can come from family and friends, crowdfunding, angel investors, venture capital, and small business loans.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
How are seed and pre-seed funding different?
Pre-seed funding helps a startup initially get off the ground. It comes in early, when the founder may have nothing more than a viable idea. Seed funding, on the other hand, is typically for a product that already exists and has some form of customer base.
How much money can you typically expect from pre-seed funding?
Pre-seed funding amounts typically range from $10,000 to $250,000, depending on the needs of the business and the investor.
How much equity should you give away in pre-seed?
The amount of equity you give away in pre-seed funding will depend on your industry and the amount of investment you’re receiving. Often, startups give away 5% to 10% of the equity in their company during a pre-seed round.
Photo credit: iStock/Pekic
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