UPDATED: Pre-seed funding provides the initial capital needed to start your prospective business. Broadly speaking, if you are pre-revenue and pre-product, you are a “pre-seed” business.
According to Seedlegals, UK startups raise between £50,000 to £250,000 in their first pre-seed round.
Because if you turning to investors you have to offer something-for-something, entrepreneurs will give away between 10-20 per cent of equity.
This means you will have to work out a “pre-money valuation” so you can calculate how much your equity is worth.
What can pre-seed funding be used for?
- Renting premises such as office or warehouse space
- Conduct market research
- Building prototypes and minimum viable product (MVP)
- Employ early-stage staff
- Securing intellectual property rights such as patents
- Create a business website
- Establish social media presence
Where does pre-seed funding come from?
Because venture capital firms usually only offer later-stage seed funding, most pre-seed funding comes from:
This is of course the purest form of equity; it’s your own cash and yours to lose, so you are backing yourself and your vision.
Friends and family
Raising investment from friends and family is the next step. However, relationships can sour if the investment goes south, and everybody loses their investment. Conversely, I know of one family who invested at pre-seed stage in a start-up which has become a wildly successful household brand and who know argue over inherits a deceased family member’s now very valuable share.
Angel investors can sometimes be founders who’ve already exited from a business in your sector and who can become mentors. And there are plenty of angel investors out there. Just over 2,000 companies raised £175m through the tax-efficient Seed Enterprise Investment Scheme (SEIS) in 2020-21 with 64 per cent of businesses raising more than £50,000 and 39 per cent receiving investments of over £100,000.
According to the British Business Bank’s 2020 angel market report, the number one factor angel investors look at is the quality of the founding team. In fact, 91 per cent of angel investors think the skills and experience of the founding team is of the highest importance.
A start-up incubator is a company that offers founders that have yet to develop a full product and business model literally with room to grow.
An incubator can offer founders:
- Physical space
- Pre-seed funding in exchange for equity
- Founder community
One of the attractions of crowdfunding is that it gives you immediate market research. You see if your idea has traction through whether individual investors want to back you… For this reason, crowdfunding is ideally suited for consumer-facing businesses, rather than B2B.
The median round size for crowdfunding deals in 2021 was £487,000.
More than 2,000 British companies have secured equity crowdfunding since 2011. Between them, the UK’s two biggest crowdfunding platforms, Crowdcube and Seedrs, raised £324m between them in 2021 for over 500 funding deals. However, only 39 per cent of this went to seed-stage startups.
When to launch a funding round
Many founders start looking for pre-seed investors before they even launch their businesses, and — especially if they don’t have much of their own money to fall back on — raise a pre-seed round within six months of incorporating the company.
Be warned though, raising a pre-seed round can take anywhere from less than a week to six months.
What is the difference between pre-seed and seed funding?
Pre-seed funding is the earliest stage of start-up funding; it helps entrepreneurs explore their business concept from conducting initial market research through to establishing prototypes or a minimum viable product.
Seed funding is the next step after a company has developed a viable product or service but needs to spend money on marketing to gain customer traction and validation. It can also be used to hire more staff members.
Again, according to Seedlegals, UK startups raise on average between £500,000 and £1.5m in their seed round.
Overall, founders should start thinking about their seed round as soon as they’ve finished with their pre-seed — what milestones you want to hit, how much money you’d want, whether you look for new investors or stick with your existing ones. Most start-ups raise a seed round about a year after their pre-seed.
Venture capital pre-seed
Some venture capital firms do offer pre-seed funding, but this is rare.
Funds that offer pre-seed funding include Playfair Capital and Concept Ventures, which are focused on this stage, but the likes of Ascension, Seedcamp and Haatch will all lead rounds, while others including Portfolio Ventures, Ventures Together, Firedrop and Plug and Play will all join in pre-seed rounds.
Another avenue to explore are regional and sector-specific funds, such as Techstart in Scotland and Northern Ireland, Creator Fund for university spinouts, Insurtech Gateway for insurance, and Cornerstone for diverse founders.
Last year, Concept Ventures launched a £50m pre-seed fund writing cheques from £100,000 to £600,000. On average, Concept Ventures invests £500,000 at pre-seed stage, leading rounds of between £1m-£1.5m. It sees its mission as filling that pre-seed funding hole for ambitious founders. For example, it recently invested £500,000 in a round for AI-driven text-to-speech generator Eleven Labs, which ended up raising £7m, enabling it move straight to Series A.
Fellow VC Octopus Ventures has suggested that start-ups looking to raise pre-seed funding need to go for at least €500,000 – anything less might struggle to attract professional investors.
Reece Chowdhry, managing partner of Concept Ventures, says: “Not every business is designed for pre-seed funding options. We expect one or two of our companies to do exceptionally well and become a billion-dollar company. That’s why tech-focused businesses are very attractive to venture capitalists, because it’s just a question of scaling the customer base. Venture capital looks for high-growth scalable businesses, start-ups which can become multi-billion businesses.”
Henrik Wetter Sanchez, a partner with Playfair, says that pre-seed venture capital looks for both a founder-market fit and a problem-solution fit.
Says Wetter Sanchez: “You don’t need revenue to prove this, you need to demonstrate you intimately understand the market you’re working in, your future customers’ burning painpoints and have initial positive feedback on the solution you’re proposing.”
Remember, in exchange for your pre-seed round, VC investors will want to take equity, anything between 10 per cent and 20 per cent.
Concept Ventures launches UK’s largest pre-seed fund – The £50m fund will back over 60 start-ups over four years, writing cheques of up to £600,000
How early can a founder approach a VC for pre-seed funding?
Says Chowdhry: “No founder is too early. Typically, we do like to see something, such as a pitch deck; showing us your vision of the world is very important. But more important is the strength of the team and how aligned people are to that vision. Our whole approach to investing is very people centric.”
Convertible loan notes
Convertible loan notes are a common financial tool for VC and angel fundraising rounds, particularly at early stages. Investors agree to give money to a business in the form of a loan, but instead of being repaid in cash, the debt is converted into shares at a later stage — generally when the start-up raises a seed round, or after a pre-determined maturity date.
Who else offers pre-seed funding?
Government-backed Start Up Loans offers new businesses up to £25,000 for new business ventures. However, the average start-up loan is £7,200. Loans have a fixed interest rate of 6 per cent and is repayable over 1-5 years. The British Business Bank-administered scheme has supported over 90,000 business ideas with more than £800m worth of loans.