05 Mar Pre-seed, Seed and Series A …what does it all mean?
Raising capital is an inevitable part of a business for most startups. If you are reading this post I assume you are looking into the possibility of raising capital, or have made the decision to do so. There is no clear-cut definition to the rounds of raising capital; below we provide some common guidelines. Some entrepreneurs seem to think they do not need to raise money. The data suggests however, these startups often fail or sit idle whilst their competitors overtake them. In my opinion, capital equals speed. You can build out any vision over time, but the slower you move the more competition risk you are exposed to. Speed allows you to build a product that is defensible. This post covers off the difference between pre-seed, seed, and series A rounds.
It’s a numbers game
We all know the success stories. They surround us every day on Tech Crunch or AngelList. The founders appear to be a special bred of an entrepreneur, something you could only aspire to. But if you actually dig down, they experienced the same struggles as you are suffering now. Even Jeff Bezos struggled to raise his first round. It is important to remember that for every unicorn, there are hundreds of companies that fail. Investors at any round are aware of this. Although it appears the odds of success are stacked against you, this also means given good traction and a working MVP, someone will invest in you.
Differing fundraising options
Surprisingly, the choice between a pre-seed, seed, and a series A isn’t always straightforward. What is even more complicated is where you sit on this spectrum, and most mentors will offer different views to these questions. Someone’s definition of seed is another’s definition of series A. But the main thing to remember is that they are all stepping stones on the road to IPO, or other exit options. What does not differ is the order. Below we provide some common definitions:
- Pre-seed round: a pre-seed funding round is generally the first round of money in. It is generally used for early-stage product development, and more often than not, used to build a minimum viable product (MVP). Amounts raised at this round are generally less than US$50k.
- Seed round: a seed round is a round of related investments, generally with less than 15 angel investors involved. The aim here is to inject the MVP with “seed”, so it can be tested and give the founders time to assess the product-market fit. Amounts raised at this round vary, but companies can raise anywhere from US$50k to US$2m.
- Series A: ideally series A is a round with a smaller number of VCs, or high net worth angels, who contribute an average of US$2-10m in exchange for equity. These are generally the first group of investors to receive preferred shares (we will cover share types off on another post), and will often request a seat on your board.
Pre-seed – fertilize your land
This can actually be the most awkward round of raising capital. Just as people do not like to tell you your baby is ugly, people close to you do often avoid telling you your idea is a flop. Funding for pre-seed normally comes from the 3F’s (Friends, Family, and Fans!). However, incubators and accelerators sit in this camp if you are lucky enough to get into one. Equity is your most precious asset in a startup and you should hold onto it like water in a drought. You want to get the best metrics possible before you head into your seed round, as a lack of traction will result in you parting with more equity. Like growing a plant, pre-seed is getting the soil ready.
- Funding at this level is small, less control is given away;
- A chance to maximize the future fundraising opportunities through testing;
- Time to build an effective core team; and
- Examination of possibilities beyond your prototype, without the watching eyes of big money.
Seed round – time to sow your crop
To keep the analogy going, a farmer with fertile land now needs to decide what to grow, and when. Like trees, businesses do not grow overnight. Trees develop from seedlings and form roots and foundations before they grow into the masterpieces we see before harvest. Seed rounds are meant to supply a startup with the capital they need to build the kind of foundation that yields a profitable business. Founders may think they know everything, but they do not. Therefore the seed round is a great time for a founder to fill their “knowledge gaps” with new members of the team. Seed round funding is typically used for things like hiring key team members, testing the market in more detail to gain ideas, and further developing and testing potential MVPs. The key here is to take your time and find the right seed round partnerships before you move on to series A.
- Time to tweak your business model;
- Additional time to connect, and talk with business partners & mentors;
- Lower dilution – your equity is your biggest asset; and
- Greater flexibility to pivot and experiment without big money watching.
Series A – Grow, grow, grow!
With a solid foundation and healthy looking seedling, now it’s time to grow. Series A will be your first large investment round, which is made up of one or more VCs. Here they will pour significant investment into your startup and apply pressure for you to grow fast. This is where having good foundations are important. In a series A round, VC’s are no longer thinking your idea will fail, so they will apply pressure. Before you enter this round, make sure you have both a product-market fit and proven systems in place. It is not common for founders to skip the seed round, but it happens from time to time. This generally occurs if a company is experiencing huge traction. Sometimes, a unicorn is spotted early and an eager VC will want to get in before the crowd. However, don’t let your ego get in the way, this can often end badly. There are many reasons why most early-stage founders are better off taking a seed round before taking the big money.
- Ability to scale fast;
- Large partner with deep pockets;
- Follow-on investment likely as VCs dislike being diluted; and
- Increased notoriety, prestige, and name recognition.
Bottom line: Which should you raise?
Every company and circumstance is different. There is no manual for startups and you will realize there is often 1000’s of people willing to give advice. The best advice is to listen to it all, make your own decision, and follow your gut. Series A comes with pressure, so having a product-market fit will make it easier to build a scalable marketing plan, and avoid hiccups. Startups burn through money, and sometimes it is better to make your mistakes in the pre-seed and seed phases. More so, equity is your biggest asset, the better your metrics the less you need to sign away to a VC and less control they will have.
The catch 22 is this, raise too much capital and you’re parting with precious equity. Rise too little, and you run the risk of feeling frustrated by an inability to grow as fast as you want and could result in you closing your doors early. We recommend following the pre-seed, seed, series A trajectory.