Understanding the “Pre-Pre Seed Round” and its industry investors

Back in ancient history (10 years ago), after the initial friends & family round of funding, a startup would raise a “seed round” to build the business and bring the product to market. Once the company established market traction, the venture capitalists would pile in with a proper round of funding known as Series A.

Investors in the seed round were typically small, individual investors known as angels, who would put in $25k each. Together, they’d raise around $500K, maybe up to $1M.

Since then, the seed round has exploded in size and valuation. According to Crunchbase, the average seed round now raises close to $5M. At that size and valuation, the startup needs market validation before professional investors are ready to write million dollar checks on a $25M valuation.

Hence the rise of the “pre-seed” round. In the good old days (2 years ago) startups raised a pre-seed round to reach the milestones needed for seed funding.

But in the past couple of years, along with the huge influx of money into venture capital came another huge expansion in funding and valuation. Even a pre-seed round now has an average valuation nearing $10M.

While this is great for startups that have made it over the hump of getting the product to market, it leaves founders with the same, familiar problem of how to find funding before the professional investors are ready to pile in.

If you’ve built a couple of unicorns already, you can call up the VCs you made billions for and have a check within an hour. For everyone else, before investing $2M, investors need evidence that the company will succeed. That usually means showing market traction — i.e., initial revenue. The biggest dividing line for startups is between pre-revenue and in-revenue.

Angel Investors Flock to In-Revenue Startups

There’s a pervasive myth that angel investors are super-nice rich people waiting to write big checks to help get deserving businesses off the ground. This couldn’t be more wrong.

Angel investors like me who regularly listen to pitches and invest in startups are looking for financial return. Yes, we enjoy participating in the startup community and live vicariously through the companies that succeed, but fundamentally, this is an investment, just like real-estate or public stocks.

We invest in the best opportunities we can find based on risk-reward. Because we’re generalists, investing across different sectors, we don’t have deep industry expertise. Realistically, the only way we can evaluate a startup is by looking at results. Having paying customers changes everything.

Though the revenue itself may be tiny, paying customers changes the startup from a vision to an operating business. We can talk to customers to understand their motivations instead of simply trusting the founder. We can judge market size ourselves by extrapolating how many others people are just like the first users.

Once the company is in-revenue, raising funding becomes infinitely easier. Which leaves founders in a quandary — how do you raise money to build the product to get into revenue? If the company is too early for VC funds, and even too early for angels, who are the investors at this stage? And what the heck do we even call the stage before the pre-seed round?

The “Pre-Pre” for Industry Insiders

There’s no widely used term for the round between friends & family and pre-seed. I’ve heard it call “extended friends and family” or “bridge to pre-seed.” I suggest we start calling it the “Pre-Pre”, short for pre-pre-seed round.

This round is not for general angel investors or VCs. The company is too early for them, though a few may join to get their feet wet, often as a personal investment to avoid the overhead of a formal fund investment.

This round goes beyond friends and family, though some may participate, too.

The key investors in the pre-pre are an extended network of industry insiders.

Industry insiders are people with deep experience in the industry the startup is targeting. Industry insiders don’t need a pitch deck explaining the problem, solution, and market size. If fact, if they ask for a pitch deck, you’re probably talking to the wrong people.

People to look for include:

  • Industry executives
  • Big customers
  • Industry influencers
  • Conference organizers and speakers
  • Mentors at industry-specific accelerators
  • Founders of other startups in the space
  • Early investors in other startups in the industry

As soon as you give the elevator pitch to an industry insider, they should understand what you’re doing and why. If they aren’t enthusiastic about it, you need to find out why. If they don’t get it immediately, you have a bigger problem.

In the pre-pre stage, all that should be needed is a 1-page overview of the business and a standard SAFE agreement. A customer presentation is more helpful than an investor deck.

But you can’t just reach out to an industry insider and ask for an investment as you would for angel investors and VCs. These people are not investors and are not looking for deal flow. But they are willing to help you with far more than just money. They can provide advice and mentorship as well as referrals to customers and employees.

So start building the network early. This is your extended team, and may be more important to the company’s success than your actual employees.

Reaching Out for More than Money

Start with a short call to get their advice on the product. The goal is find people who can help with the business. Most people feel honored to be asked for advice from a fresh startup whereas asking for money is an immediate turn-off. Worry about the investment later.

Build a network of people whose advice and guidance you’d find invaluable. Get them excited about the company and take advantage of everything they have to offer. Build a board of advisors that includes their input regularly. Don’t hesitate to reach out whenever you have a question that could benefit from their experience.

When the time comes, get them to help with the fundraising. Some may invest themselves, others may introduce you to friends with deeper pockets.

Expect the investments to be small, a little from each person. Offer an attractive valuation as reward for their assistance. The pre-pre isn’t an efficient way to raise millions, but it’s the best way to raise a small round from people who are there to support you.

My Own Pre-Pre-Seed Investments

As an angel investor, I do most of my investing together with my colleagues in a couple of angel investment groups. Even if I don’t know much about the business, I can rely on the wide experience of the group to vet potential investments.

Although we don’t have a formal rule against investing in pre-revenue startups, with a few exceptions it rarely happens. (Life sciences is always an exception since what constitutes validation is completely different than for software.)

However, there are 2 verticals where I’ll invest in a startup that’s too early for angel groups: computer networking and energy sustainability.

I’ve built 2 startups of my own in computer networking over 20 years. I know the industry, I know the customers. If a startup comes along that looks interesting, I can call my former customers and ask their opinion. I can call my technical co-founder and ask him to evaluate the product. Within an hour, I know all I need to know. If it looks good and the valuation is attractive, I’m in for a small investment.

Energy sustainability is a much wider space, covering everything from battery technology to solar cells, to making buildings energy efficient. Energy sustainability is a personal passion of mine, and I especially enjoy mentoring cleantech startups for the good of the planet.

Though I have a degree in energy engineering and a master’s in energy policy, I can’t claim deep expertise in any specific area. However, by working with the startups over an extended period, I get to know them well. I follow their progress, contributing where I can. When they’re ready to raise a round, there’s no question I’d participate.

In other words, I invest in startups in energy sustainability and computer networking (and only those two areas) at the pre-pre round before typical angel investors. But I also want to be involved, putting my experience, connections, and passion to use beyond just writing a check and hoping for a payout in 10 years.

So start early and build a deep network of mentors, advisors, and fans. We’ll give you advice on the product and strategy while helping promote your product. When the time comes, we’ll be there to help with funding the difficult pre-pre round.

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