The story of every great technology startup often starts with an idea, most times a crazy and ambitious idea that becomes a solution to address a large market gap using innovative technology.
For a startup founder looking to bring their world-changing solution to the biggest possible market, whether bootstrapped, funding with revenue or seeking out external capital, fundraising is essential.
But at the early stages of a business, founders can find the fundraising process confusing and complex, and in a market downturn external fundraising can be even more daunting. Many start by bootstrapping with their own funds, but with great businesses, things can move quickly — and it’s not always apparent if the time is right for fundraising, or how to begin.
So, what are your options? Over this series of blogs, I’ll be exploring some of the essential questions related to early-stage funding. We’ll explore strategic and tactical insights from what capital sources to explore as you fundraise, how to approach investors to the tech stack essentials to help on this journey, and what should be in your data room. I’ll also explore the most common reasons founders miss out on funding and what to do about them.
But first, let’s look at the basics. What is a pre-seed round, and what are your options if you’re thinking about raising one?
What is a pre-seed round?
Pre-seed is a colloquial term for the earliest stage of the fundraising process. The pre-seed round is nuanced, and over time the lines have blurred on precisely what level of business is in this stage. It ranges from a team with an idea and no product but a potentially huge market gap to a team already generating revenue on its MVP Pilot.
Essentially it depends on the market, business model, and investor preferences. However, as the name implies, pre-seed signals an incubatory point in the start-up lifecycle. Typically, it is one where there is some exploration of a potential solution to a problem. At the pre-seed stage, the founders identified a market gap; however, the solution is still being formed and validated.
Bootstrapping founders may find that their own funds are enough to get their business off the ground — but a growing business can burn through this very quickly. Founders might require external funding to grow and build a solution that can sufficiently compete and dominate.
When is the right time to start looking for pre-seed funding?
Timing is a critical consideration that impacts the success of a fundraise, and different investors are more suited for different stages of a startup. Most investors want to fund something that shows initial signs of market pull and success. They want clarity on how the funding sought will unlock further growth, which has an impact on the timing of when to get in front of investors.
It is important to think about when you fundraise in the context of your startup’s traction and progress so far, questions answered, and the key milestones additional funding promises to unlock. Ultimately, fundraising is a sales process: you’re selling your equity for investment, and you want to sell from a position of strength.
Although at the pre-seed stage there is very little to show in terms of financials, it is often best to fundraise when you can demonstrate that there is a large market gap with some proof points. It’s good to demonstrate that there are willing users, who they are, and that the time is ripe to build a product that will ride a huge market wave.
What are the options?
Most founders probably start with their own savings or funds. However, as you explore external options, an excellent first port-of-call is to explore whether you have access to non-dilutive equity options. Innovate UK offers grants that help build a startup without any dilution to ownership, and there are a couple of grants that could be available linked directly to the solution your startup is solving for.
Equity financing is the next logical choice because at this stage, as a business without any strong cash flows, accessing debt can be challenging. While venture debt is an option, it is generally considered later. But there are other avenues it’s well worth considering.
Family and Friends:
The first step to external equity funding often starts with the familiar: family and friends. These could be family members, colleagues or former colleagues, former bosses, or others you know with some disposable income. They’ll likely be backing you first, and their faith in your vision will be based on their previous relationship with you.
Not all founders are fortunate to have this option, and many great businesses were built without it, but it’s an option to explore for those who have the network.
Ex-operators, entrepreneurs, executives, and others who invest in early-stage startups are known as angels. It’s not always easy to find them; well-known angels are often inundated with requests, and they don’t always advertise when they are actively investing. A great way to uncover angels is to keep a keen eye on press releases of pre-seed rounds, and these will contain details of the angels who invested and offer a great way to find ones who may be interested in backing your business.
Sometimes you can find angels in unexpected places, so as you look at this option, it helps to “always be pitching”. As you navigate your daily life, tell people about what you’re building — investors can be found in the unlikeliest of places. Someone I know once pitched her doctor and got an investment on the spot!
Making the right choice of angel is important because beyond the investment, they provide a strong signal that validates your startup to other potential investors. This might mean finding an angel who’s built a successful business in your space before — but a direct thematic fit isn’t always relevant. It’s still a great sign if your former boss at a startup backs you, even if it isn’t in the same industry.
Some institutional investors focus on pre-seed stage. Often these are accelerators, offering a fixed investment and a scheduled program of training, support, and introduction to investors for a stake in your venture. They often have a healthy list of co-investors who invest alongside the accelerators on demo day, creating a demand and supply dynamic that could work in your favour. It’s a great idea to check in with other founders who’ve gone through accelerator programs, to learn from their experiences and find out if they’d recommend the process.
Large established funds are also taking an increasing interest in pre-seed stage investment and setting up teams to lead this. At Octopus Ventures, we’ve just launched a new team, with a view to giving Europe’s pioneers their first fundraising leg-up. Until now we’ve been focussed on later-stage investment, but we want to extend our commitment to supporting the businesses poised to build a better tomorrow to startups at a much earlier stage — as early as the first cheque.
With support at such an early stage comes the potential for follow-on investment, although this isn’t guaranteed with any early-stage institutional investor.
Beyond capital, established funds can offer nuanced support to startups. An investment from a large fund is a strong industry signal that can boost confidence in the potential of your startup not only to other investors, but also early-stage employees and customers. Beyond the great brand, the benefit of these funds is that they often have well developed portfolio support teams — like Octopus Ventures’ People & Talent team — as well as relationships with potential co-investors from which early-stage founders can greatly benefit, well beyond the initial investment.
Having weighed up the various options, it’s time to build a list. A successful fundraiser is often more about organisation than anything else. To start, build a strong and exhaustive pipeline of potential investors who fit your stage and focus area. The investors could range from your friends and family, angels, and accelerators, to institutional funds like Octopus Ventures.
This requires quite a bit of research, and we have a few resources at the end of this post that might be helpful. You should use the list to highlight a few key criteria, such as who they are, whether you have direct access to prospective investors, or if you’ll depend on a mutual contact, how strong the relationship is, and their average cheque size.
Getting a sense of the different fundraising opportunities out there is an essential starting point. But there are other considerations. Find out what you need in your data room, and what you should be looking for from your tech stack — we’ll be looking at both of these in more detail in later blogs as well as our list of reasons why early-stage investors may say no, to fully insulate your pitch before you start making your approach.
And if you’re building a startup to solve a large problem and are looking for your first round of funding, we want to hear from you. Get in touch to tell us about what you’re building here.