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.

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Stage Expectations:

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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.

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Revenue - Non-existent or minimal (less than $50K ARR)

Product - Pre-product but with a prototype

Market Validation - A few paying customers or some other form of demand validation

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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. 

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Stage Objectives:

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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.

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Round Size & Valuations:

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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.

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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.

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The above charts show round size and valuations at an industry level. These vary significantly based on sector, geography and the overall opportunity.

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Activity Levels at Pre-seed:

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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.

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Limited Optionality at Pre-seed:

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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).

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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.

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Investor Types at Preseed:

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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.

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Sector Overview at Preseed:

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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:

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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:

• Made a large percentage of their investments at pre-seed (>20% of portfolio)
• Have high investment velocity (>10 per year)
• Prior investment activity in the user’s sector

Summary:

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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.

Instead of relying on hearsay, founders across the board are now taking an empirical approach to raising their next round. At Metal, we are seeing customers use our platform in novel ways to discover the “most likely” partners for their company and round construct.

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Before pursuing an investor, founders need to run a “qualifying process” to ensure that the prospective partner is a strong fit. A rigorous process to identify, research and qualify investors is the highest leverage activity within fundraising, one that improves conversion rates.

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The below post focuses exclusively on identifying the “most likely” investors, and does not cover the qualifying process. In the identification process, there are six core principles at play.

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Focusing on “Stage Specialists” vs “Stage Tourists”

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Founders often confuse pre-seed and seed investors as one and the same. The common perception is that these are just stage names that do not carry much significance. In reality, investors have vastly different expectations at preseed versus at seed, and most investors that specialize at seed do not specialize at pre-seed. Readers that are looking to understand investor expectations at each stage can read more here.

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First Round tends to invest early, but they are really seed-stage investors, and not pre-seed partners. Since they specialize at the seed stage, they are “seed specialists” and “pre-seed tourists”.

By definition, stage specialists are investors that specialize in a given stage. Stage tourists are ones that invest in that stage opportunistically in outlier or unique opportunities.

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The first challenge for founders is to identify a set of “stage specialists” for their specific stage. This is easily achievable by filtering investors based on the percentage of investments that they have made in a given stage. The key thing is to not settle for ambiguous tags applied to investors in the absence of any underlying data.

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‍Distinguishing Between “Sector Familiarity” and “Sector Concentration”

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For venture investments, the landscape varies substantially from one sector to another. Some sectors have very strong and ongoing venture activity (I.e. B2B Software) while others have fewer investments in total (I.e. Industrials or Robotics).

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For any given sector, there are two types of investors – 

1. Investors that are familiar with the sector
2. Investors that are concentrating investments within the sector

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Investors that fall in the (1) category can be identified using a simple filter that identifies all investors that have made a minimum number of investments in a given sector. Investors that fall in the (2) category can be identified by filtering for investors that have made a minimum percentage of investments in a given sector.

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Investors that are familiar with a given sector are those that have previously invested in that space and are familiar with it. Investors that are concentrating in a given sector typically have a strong thesis for that opportunity space and may sometimes be stronger partners.

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As an example, Khosla Ventures is a well-known VC firm that has been concentrating investments in the healthcare sector. To date, they have made 27% of all investments within healthcare. Within healthcare, about half of all investments are in two specific sub-sectors: Drug Discovery (24%) and Therapeutics (29%).

It is fairly likely that Khosla has a clear and strong thesis in these sub-sectors, which may sometimes make them a particularly strong partner for healthcare companies building in these spaces.

Finally, at the pre-seed stage, most investors tend to be sector agnostic. This is primarily due to the investment model of venture investors at the pre-seed stage.

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Finding Geographically Relevant Investors

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Most users are either overly restrictive by focusing on only those investors that are based in their specific country, or are too liberal and end up pursuing investors that don’t focus on their geography. 

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• For founders in countries that have a highly developed venture ecosystem (I.e. US), the right approach is to identify investors that have made a healthy percentage of their investments in North America. This typically includes a large number of investors across Europe and Asia that love investing in US companies.

• In developing countries, a recommended approach is to identify investors that have previously invested in similar geographies. As an example, founders building in Egypt may want to identify investors that have made at least “3” investments in a cohort of similar geographies (I.e. Indonesia, Bangladesh, Pakistan, Egypt, etc.).

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The key thing is to identify investors that are “geographically relevant” based on their prior investments. This is typically different from taking an overly restrictive approach whereby users are focusing only on those investors that are based in their country or region.

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Tuning Into the Right Fund Size

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Founders raising large rounds need to target a small set of VCs that have large fund sizes. For such founders, the options are fairly limited (as there is a very limited number of VCs with a fund size of $500m+). On the contrary, founders looking to add a small amount of capital ($<1m) to an existing round need to target micro VCs that write $100-300K follow-on checks.

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The general rule of thumb is that most investors maintain a check size that is roughly 1-2% of the total fund size. As an example, investors with a fund size of $100M will typically write checks in the $100-200K range.

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Depending on the round dynamics, founders can focus on investors that have a fund size that meets their round requirements. A fund size mismatch is often a primary reason for why investors are unable to lead or participate in rounds.

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Zooming In on “Active” Investors

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Similar to startups, venture funds tend to have a fluid nature. At any given point in time, only 10% of all venture funds are actively deploying capital. Founders, therefore, need to filter for and focus on investment firms that have made at least “1” investment in the past 3 or 6 months.

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It is extremely common for founders to learn after a few calls that the fund is “barely active”, making only one or two investments each year. For funds that are operating in a “barely active” mode, the overall risk appetite is unique. Such funds will have behaviors that are a lot less predictable than ones that are actively and consistently deploying capital.

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Focusing on Lead Candidates at Round Kickoff

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Early on in the process of raising a round, founders need to first identify an “anchor” investor to lead the round. While most funds lead occasionally, there is a fairly limited pool of investors that frequently lead rounds, and that do not wait for a lead to come in before committing to invest. 

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When starting a round, founders need to focus on investors that have a history of leading. This is easiest to identify by looking at the percentage of investments that a given investor has historically led.

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Final Thoughts

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In summary, the six core principles defined above help build a clear criteria for the sort of round that founders want to raise. Based on the round requirements, founders then need to run a rigorous process to identify the right set of “most likely” investors. By targeting their efforts on the right set of investors, founders can significantly increase conversion rates at every step of the fundraising funnel.

A small subset of all VC firms tend to specialize in sectors. Such firms typically follow a clearly defined thesis on trends that will lead to growth in a given sector. In the early 2010s, one such trend was technology-driven marketplaces – this created many sector-focused VCs that specialized in marketplaces.

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1. Sector Specialists as Domain Experts

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Founders often report having high-context conversations with sector-focused VCs. These firms are often deeply knowledgeable about a given space and have the ability to bring domain expertise to investment discussions. 

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In a given fundraising process, founders should add at least a few sector-focused VCs that truly understand their sector. This is best achieved by pulling together a list of VC firms that have made 20%+ of their portfolio investments in your specific sector.

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In some sectors (such as biotechnology), specialist investors are more important than in others. In most sectors, founders can have high-context conversations to sharpen their thinking by engaging with investors that truly and deeply understand their sector.

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2. Geo Specialists in Developing Countries

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Similar to sector VCs, geo specialists tend to bring deep expertise around a given geography. For founders in developing countries, such VCs have already overcome the biggest obstacle of being open to investing in their specific country. In such geographies, geo specialists can be an integral part of the fundraising process.

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This is best achieved by pulling together a list of VC firms that have made 5%+ of their portfolio investments in your specific continent (along with at least a few investments in your country). Identifying VCs that have made at least “1” investment in a set of similar countries can be a great way to identify firms that may not have invested in your specific country, but are likely to be “open” to doing so.

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