So, you’ve got your idea in place and your business is running, now you just need some money. It sounds like you’re ready to raise pre-seed funding.
The thing to note here is that you don’t have to raise pre-seed funding, but it is beneficial. Pre-seed funding is there to build the foundations of your business before you move on to your subsequent funding rounds. It can give you a boost to develop early-stage versions of your product and/or build your team, as well as giving you some steer with the strategy in your firm’s infancy.
“I would always encourage a founder to come out of their comfort zone, and even pitch to investors before they’re ready,” said Adam Beveridge, investment manager at SFC Capital. “Someone pitched to me before they even really wanted to pitch and said, ‘We’re not looking for funding right now.’ And I said, ‘Let’s have a conversation anyway.’ And we did it. We invested after a little while.
“It’s good to practice if you have the bandwidth to take the opportunity to pitch. Being honest and personable goes a long way at the earliest stages of start-up life.”
In principle, you should aim to raise as much as you need, not as much as you can. And make sure you break down exactly how you would spend the money for your investors.
We’ll be looking at where and how you go about raising pre-seed funding.
Who do I get pre-seed funding from?
There are a number of avenues you could go down – and your preferred routes may very well change throughout the funding process.
Your first step is to establish what funding source(s) that you’re going with. “Be clear on your strategy to investors and the type of investor you are looking for, i.e. investors that can provide strategic input and/or opportunities to help grow and develop the business by way of technology or distribution,” said Todd Davison, MD of Purbeck Personal Guarantee Insurance.
Here’s where you could get funding.
Angel investors are wealthy individuals who invest in businesses and may have been entrepreneurs themselves. They’re usually looking for a 10 per cent-25 per cent stake in the business. Alongside the finance, an angel investor will mentor you and provide other support such as access to their network. It’s potentially a long relationship – the length of finance usually lasts between three and eight years, so they’ll get well acquainted with you, showing you how everything works and what to expect.
These individuals can invest alone or as part of a syndicate, where a group of angel investors club together and pool their capital and experience. If they’re higher profile, their cash injection can give you street cred when raising funding in future. Angels may benefit from tax breaks of the EIS and SEIS schemes, but this also means that they can’t take more than a 30 per cent share of your business.
There is the option of finding an angel investor online – maybe by having a peruse on LinkedIn – but scammers could be lurking and posing as the angel you’re looking for.
“There are lots of fake profiles,” said Steven Mooney, CEO of FundMyPitch. He warns that fraudulent angels will seem very interested until the point of transaction. At this stage, they’ll usually ask for a fee, claiming to be an intermediary for a company and that they need to pay a percentage before they can release the investment. As the business owner has put in so much time and expense, they agree to pay the fee and never to hear of the investment again.
He concedes that there aren’t many red flags upfront, so it’s a case of employing your own judgement based on classic telltale scam signs such as spelling mistakes and inconsistent information. Doing your own background research on them is also a wise idea.
A venture capitalist firm (VC) may invest in you, though they’re more restricted as they may need to accommodate their partners’ needs, so will have less flexibility than angel investors.
Friends and family
The familiarity of having loved ones on board is comforting at this early stage in your business journey. However, your relationship with this person is on the line, so it’s good to have family and friends who have invested in businesses before. They’ll know what they’re in for as well as the legal groundwork required. You might not get as much funding as you would from an investor though.
You’ll have seen them online – a business can merely be at the stage of having an idea when they start a crowdfunding campaign. They potentially attract a large number of investors in return – with their investment being exchanged for trial products, credits and merchandise.
It’s a decent option if you only need to raise a small amount – more of a top-up on top your main funding source. “Crowdfunding is a last resort for mainly B2C companies,” said Toby Heelis, co-founder of Virtuall/Eventopedia . “You need to raise the funds yourself before launching a crowdfunding campaign. The ‘crowd’ can be good to top up the round but don’t expect it to fill the round.”
A business accelerator will support your early-stage business through the raising process, along with providing mentoring, training and an equity investment. They’re there to help you to secure investment more quickly and protect their own interests by making a return on their own investment. You’ve also got access to people in their network and a physical office to use as your base.
Do your research as each accelerator will want different levels of equity. Decide how much investment is being offered and how much equity they’re expecting you to give over. Your time with an accelerator usually last between three and six months, but support can last up to 12 months.
An investment platform can make connections between investors and business owners based on mutual goals and interests.
FundMyPitch invite 60-second video elevator pitches and they’ll pair businesses with suitable investors. This can make the process easier. “First impressions count when we’re living in a video-centric world of online content,” said Mooney. “If you’re giving a 60-second elevator pitch, you’ll probably know within the first seven seconds of whether or not you’ve warmed to that person or that idea, and you want to know more.”
Cash from a previous exit
Serial entrepreneurs – in the unlikely event they’re reading this article – can use money from a previous investment too.
How much could I raise?
You’re looking at $100,000 to $500,000 (£76,700 – £383,500) in pre-seed funding. It really depends on the company valuation and how much company equity you want to give away.
“This is not enough money to launch a full-scale product or service. However, it is enough money to get your company off the ground and start validating your business model,” said Sam Dallow, accounting, finance and tax expert at Counting King.
How long will it take?
It can all happen very fast but be prepared for a real game of patience as rounds could take as long as three months to close.
What can I use the funding for?
You can use it to create a minimum viable product (MVP); build a team (and pay their salaries); develop, market and distribute the product; put together a growth strategy; build your distribution channels; do market research; or build product inventory. Really, you could use it in any way to develop your business, as long as you can communicate it clearly to investors.
How do I prepare for the pre-seed fundraise?
Make your pitch a reflection of your company, its personality and its values. “Pre-seed funding is not easy to get – the competition is fierce. There are many great companies out there that are looking for funding,” said Dallow. “You need to make sure that your company stands out from the crowd.”
Get a team together
Ensure that you’re well prepared for your raise, but above all else, an investor puts their money into a person and their team. James Doherty, co-founder of Plastic-i, said he met his co-founder playing folk music in a pub in Geneva. “It seems to go down well,” he quipped.
There’s no set rule for the size of team you should have at pre-seed stage. “It doesn’t need to be a massive team. It could be anywhere from one to five in the very early stage and even more just depending on where they are within their journey,” said Mooney.
That said, having a co-founder or two on board as a minimum is still a good idea. “That first institutional round – which is typically your SEIS, you want to have a team of ideally two or three evenly incentivised co-founders that bring a strong mix of skills, diversity and backgrounds,” said Beveridge. “That mitigates the risk for investors that occasionally one of them drops off or needs to leave the company. That’s what we look for in teams, a nice balance of youth and hunger versus experience, to cover as many bases as possible.”
Decide on how much equity you want to give away
Beveridge advises giving away between 10 per cent and 25 per cent equity. “There’s definitely a common range at early stage, between 15-25 per cent, or four-to-six-times’ of your round size. It’s not uncommon for some investors at later rounds to take issue with a founder over diluting, so anything over 25 per cent isn’t what I recommend, bearing in the mind the company may want to do multiple funding rounds in its lifetime,” he said. However, go too small and it may put investors off as it gives off the impression that you might not be easy to work with.
Though the sector you’re in won’t dictate how much equity you’ll be giving away, it could be of some influence. “I’m seeing a lot more investments in MedTech and GreenTech companies now,” Beveridge said. “It’s not driving the equity, but it drives the number of investors that come into the round and then that inadvertently drives the equity.”
Build a pitch deck
Remember that your pitch deck will be ever-evolving, as different investors will request varying information. Charlie Hurlock, co-founder of Swoperz, suggests that you prepare multiple versions of your deck and consider using a quick video commentary over a short introduction deck to grab attention.
Clarity is key (including your font) – and keep it short. Beveridge advises that you tell the investor who you are, what you do, what you’re going to do and what successes you’ve had so far. As there’s not a lot of tangible evidence to work through, remember to include traction and what you’re doing to build the right product. Mooney added that it could be through user feedback. It could also be through letters of intent, letters of support or anything that signals how many orders of your product or service that you have.
No matter how prepared you are, there will always be blind spots, which is about the only eventuality you can prepare for. “Investors will likely ask you tough questions regarding your business, so be ready to answer these questions in a clear and concise way. This will show investors that you are knowledgeable about your business and that you are confident in your ability to execute on your plan,” said Dallow.
Research your investors
Networking will be beyond vital in discovering the net of potential investors you could approach. “For the early-stage companies that are starting out, it’s key to get your face in front of these investors. It might not be the right investor who you’re pitching to at that particular point, but Investors talk to each other, the circles, and the word will quickly transcend,” said Mooney.
It’s also crucial to do research on the investors themselves: what they invest in, their portfolio and their recent investments. This will help you shape different pitches for different investors, as mentioned above.
You should always be direct when addressing investors, but you can find them in an indirect way. Consider approaching one of the portfolio companies that belongs to your target investor. “Reach out to founder, talk about their engagement with the investor, understand more about their motivations and ask how best to approach,” said Jonathan Carrier, co-founder of Allye. “Don’t ask for an intro, but understand with that company how you could help them – can you leverage your network, can you offer some insight or make an introduction that helps their business? This is the best referral you will be able to get.”
Using tools like Pitch Book, CrunchBase and Beauhurst will be invaluable in your research on investors, funding and high-growth companies.
Investors are always keeping up with what’s going on in the funding world – they may even come to you. “I find my opportunities in all sorts of different sources,” said Beveridge. “I see that the IUK publish all their grants online. It’s public record, so it’s very easy to go and look at the companies that are publicly funded. There are so many accelerators out there or companies that have won awards or are in the news.
“I always try and keep abreast of what’s going on, on all the disruptors and innovators in every sector, then reach out to them. That’s worked out quite successfully so far.”
Work out your company valuation
Your valuation boils down to business value equals assets minus liabilities. It’s not an exact science, so it’s best to seek out guidance on your valuation.
Flexibility around your valuation will go a long way. “The most common problem I have getting an investment done is where a founder is perhaps a little bit stubborn on their valuation in regards to round size,” said Beveridge.
Prepare your term sheet
Your term sheet is a list of terms your investor is willing to offer in return for their investment.
“Be clear on your term sheet about your business valuation, how much you are prepared to give away to investors in equity and for how much,” said Davison. “Make sure you’ve done some benchmarking with other businesses in a similar lifecycle stage or industry to make sure that you aren’t over/undervaluing the potential of the business.”
What you might get
It’s not a simple case of pass or fail – even if you don’t get the investment you went in for, you could come out with an alternative, such as the details of a more appropriate investor.
Instead of a cash injection, there’s the possibility of a convertible loan note. This is where investors agree to give money to investors in the form of a loan and instead of a cash repayment, the debt is converted into shares at a later point down the line – perhaps when the business raises a new funding round or after a particular maturity date. This is a great move if getting a valuation figure is difficult.
“I rather like the lyrics to a song which goes, ‘If you ask for money, you get advice…’” said Beveridge. “Every conversation with an investor is an opportunity to build a bridge and learn. If you get a ‘no’ on your first round, make sure you get the feedback and say, ‘Okay, what do you want to see me do differently in this pitch?’ and, ‘Can we keep in touch?’ so you’ve got a bridge for the future and make a point of following up with quarterly/bi-annually emails or newsletters, that kind of thing.”
It’s not terribly likely you’ll bag pre-seed funding after your very first pitch, so be persistent. “Raising pre-seed funding can be a long and challenging process,” said Dallow. “Don’t feel too discouraged if you fail to get funding immediately. Keep pitching to investors, and eventually you will find the right people who believe in your company.”
What comes next after pre-seed fundraising?
Due diligence will come next, making sure your house is in order before the investor fully commits. Most funds will have preset requirements, going through financial models like cash flows, balance sheets and profit and loss forecasts, so be really clued up on your numbers.
“It depends on each company’s case-by-case – some companies don’t tend to need much support and it’s very much just a case of minimum reporting obligations whereas some companies want to lean into it a bit more,” said Beveridge.
Once you’ve established a relationship and are going steady, investors should start thinking about their seed round straight after their pre-seed. According to Sifted, most start investing seed a year after pre-seed. Be warned, it’s not just an easy cruise through the next part of the process. “Pre-seed funding is not a guarantee of success,” said Dallow. “However, it does give you the resources you need to validate your product or service, build a team, and conduct market research.”