How Much of the Seed Playbook Applies to Pre-Seed Investing?
I was an institutional seed investor at Uncork Capital for about five years before I started Precursor Ventures. Prior to my arrival at Uncork, I felt like the seed ecosystem was starting to develop some norms around some of the core questions about investing in seed-stage companies and those norms started to get more established toward the end of the last decade. Most of the core questions came down to a few potentially difficult decisions:
- Should you bridge or extend your own portfolio companies? Over time, I think the consensus for most seed firms is “maybe” — not a blanket yes and not a blanket no. It truly depends on whether the company is doing well, what the milestones are for the next round, how much other people want to put in and where a given fund is in terms of its deployment and reserves cycle.
- Should you invest in the bridges / extensions of other people’s portfolio companies? I’d argue that over time the answer to this question largely became “no” in most cases. For firms that mostly lead institutional seed rounds of $2–3 million, many of them decided not to participate in or lead the seed extensions of other firms. This gap created an opportunity for firms like Bullpen Capital to focus on the “post-seed” round and bring new eyes to these companies and fund the ones that have good prospects.
- How much traction or evidence is enough to invest up front? In my opinion, the institutional seed market is fairly bifurcated. There is a tier of founders who, based on reputation, past experience, quality of idea or some combination of the above, can raise $2–3 million or more with very little to no traction. If you are in this bucket, you generally know it up front. For those who are not in that bucket, raising that institutional seed round as the first round of capital is challenging.
- How much traction or evidence do companies need to get to the next round? This is the eternal question and my simple answer is that the bar is always moving based on what the next round of investors feel is indicative of success. Once upon a time $100K per month or $1 million per year in ARR was thought to be special for SaaS companies looking to go from Seed to Series A. Over time, getting to $100K became more common and the bar for special achievement started to increase to be closer to $200–250K per month in recurring revenue. The point is that the bar will always increase to the point where it’s perceived to be a meaningful cutoff between the good and great companies. And there will always be companies that can raise without those metrics on the basis of a strong story and a good team.
- How much runway is appropriate for companies at this stage? Once upon a time the ideal seed round gave a company enough capital to get through 12 months of operations. As the gap between seed and Series A started to increase (the so-called “Series A Crunch”), common wisdom was that 18–24 months was a more appropriate runway for seed stage companies looking to get to Series A. I still feel like this is the norm.
When I first started Precursor, my default was to apply most of the same rules I described above to my pre-seed investing. With the benefit of a few years of investing, I’ve come to believe that the basic guidelines for pre-seed investing are a bit different for some basic structural reasons.
I will be the first to recognize that there is a legitimate argument as to whether distinguishing between seed and pre-seed is a distinction without a difference. I generally agree that seed is a continuum, but in a world where a) seed rounds can be as small as $500K and as large as $5M and b) investors spend time labeling rounds (pre-seed, seed, seed 2, seed extension, bridge, post-seed, etc), there is no such thing as a normal seed round. I think different entrepreneurs have different paths and experiences that result in different fundraising journeys.
Now, on to some of my thoughts about the different principles for seed and pre-seed investors:
Should you bridge or extend your own portfolio companies?
This is a much harder question to answer at the pre-seed stage. For one, the amount invested in companies at the pre-seed stage is often less than $1 million in total. By contrast, the bridge decision for institutional seed companies often happens after at least $2–3 million have been invested in the company. In some ways, walking away from a smaller loss and admitting defeat earlier in a company’s life is easier. So that should, in theory, make it easy for pre-seed investors to pass on a bridge or extension and allow companies to fail. This is, though, harder in practice because we are talking about people and relationships and in most cases you learn a ton about a team between the time you first invest and need to make a decision on making a second investment.
My view is that the calculus is harder at the pre-seed stage for two reasons. One there is not a “post pre-seed” institutional vehicle that can come in and give you fresh eyes on a really early-stage company. Second, in many cases a pre-seed fund might be the only entity in a pre-seed round that has the capacity and dry powder to write a second check; the early angels might be tapped out or unwilling to write a second check. So if the pre-seed fund doesn’t step up to participate, the round is unlikely to happen.
I’ll also say that I don’t think we are going to see the emergence of “post pre-seed” funds (that’s a mouthful!) in the way that we have seen credible, good post-seed funds. The amount of money needed to bridge or extend pre-seed companies is small per company and the number of companies that could benefit from such financing is also small relative to the pool of pre-seed companies. My expectation is that pre-seed funds (including Precursor) will be responsible for providing intermediate financing for their own portfolio companies that need more runway.
Should you invest in the bridges / extensions of other people’s portfolio companies?
For pre-seed investors, I suspect the answer will be “no” in general as well. There are two factors that I think will push the market this way. Today, most pre-seed funds are really small and struggle to have enough money for first checks and follow-on investments in their own portfolio companies. Investing in a bridge of someone else’s portfolio company will compete with writing a new check to a new company. I’m guessing that on average most people will opt to invest in new companies with unknown problems than to invest in existing companies with some traction but that haven’t cleared the seed bar.
I have become more liberal in looking at companies where we did not invest in the original round but where we are able to invest on a bridge or extension. We have a few of those companies in Fund I and they have generally been good investments to date. But I feel like that puts me in the minority and I don’t think that’s likely to change in the near term.
How much traction or evidence is enough to invest up front?
This is one area where I think most pre-seed firms see the most divergence. At Precursor we have a saying — it’s never too early to invest in a great team and we are happy to invest “pre-anything” if the structure and terms make sense. I think that the small universe of active pre-seed firms is actually quite heterogeneous. There are firms who need to see a live product and some traction before they invest and there are others who will invest in raw teams that don’t have much traction. I think this heterogeneity is a good thing for entrepreneurs — fundraising is fundamentally about matching and more firms with different lenses means more choices for entrepreneurs and firms to match.
The good news for our ecosystem is that I do not feel there is consensus among pre-seed firms about how much traction is enough to invest and I don’t think that is going to change. This is because the outlook and views of each firm are largely driven by the experiences and preferences of the GPs who run those firms. Unless those GPs have fundamental changes in their views on what works, their strategies on when and why to enter is unlikely to change.
How much traction or evidence do companies need to get to the next round?
Weirdly, I don’t think the answer here is fundamentally different from what I wrote above. In the same what that I think Series A investors are looking to identify special seed-stage companies that can become long-term winners, seed investors are looking for special pre-seed companies that they believe can become big winners down the road. I have looked at all of the data in our portfolio and we have plenty of companies that have gone from pre-seed to seed without meaningful revenue and others who have struggled to raise in spite of evidence of revenue or use traction. Revenue or user traction is not sufficient to unlock follow-on financing.
As institutional seed investors become more sophisticated and institutional in nature, I suspect they will look for the same thing that good Series A investors want to see — great teams in interesting markets that have the opportunity to be category creators or winners. Metrics will be an important part of that equation, but metrics alone will be (and already are) insufficient to get investors excited. So companies that can establish themselves as subjectively special will have an easier time raising money and getting attention from investors. Being special is a mix of having the right team, the right story and the right timing and it’s hard to put numbers around what special feels like.
How much runway is appropriate for companies at this stage?
This is one area where I hope that pre-seed investors maintain discipline. I feel really strongly that 12 months is about the right amount of runway for a pre-seed company. We have many instances in our portfolio where a year was not quite sufficient to get to the milestone needed to raise the next round. However, I think that 12 months is a good amount of time to assess three core things. First, you get a lot of data about how well a team can execute and find product-market fit with whatever they build. Second, you get a lot of data about the state of the market and whether the company’s timing is right relative to the opportunity; sometimes companies start too soon or too late to succeed. Third, combining the two points above you get some sense as to whether more capital is likely to change the trajectory of the company. Sometimes the market is too tough, hasn’t gone the way the company predicted or simply hasn’t materialized. There are many reasons why companies don’t succeed and I feel like the first 12 months are meaningful.
I also think the 12 month threshold is the right balance between giving companies enough time to figure things out and having the pressure to figure things out quickly. This is not to say that I think pre-seed investors should abandon companies that haven’t figured it out at 12 months — we have supported many companies through pivots that have lasted much longer than that. But I do think that 12 months is a really meaningful checkpoint to figure out what’s working, what isn’t and what to do next.
Thanks for reading this fairly long post! There are lots of topics I couldn’t cover, including how to deal with pro rata, down rounds, Board seats, and a bunch of other stuff that might get into a future post.