Homan Yuen is an early-stage startup investor at NewGen Capital.
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- There’s more to early-stage funding than VC money
A curious gap has emerged in the early-stage investment landscape: While emerging startups are able to raise very small, sub-$500,000 rounds, seed and pre-A investors are requiring increasingly higher revenue and market traction milestones before they deploy capital to companies. Lately, it seems as if the single, discrete “seed” round of $1-$2 million has largely disappeared.
The milestones these seed and pre-A investors require today resemble those needed for Series A financing pre-unicorn mania (before 2012), but a large majority of these financing rounds are smaller in size, utilize convertible notes and are not priced like a typical Series A round. At the same time, what is today called a Series A requires metrics and milestones that resemble the “classic” Series B.
It’s tempting to dismiss this milestone creep as a cyclical correction, but the emergence of a new category of investment fund and round called “pre-seed” suggests that this change will crystallize this new fundraising landscape for the next couple of years. The pre-seed round is usually smaller than $500,000 (almost never larger than $1 million) and is for companies that have interesting ideas that need to move beyond a potential proof of concept.
What comes after pre-seed is now less clearly defined and organized. Asa result of this new status quo, an emerging startup with just an idea or prototype might be able to raise up to $500,000 pre-seed from formal pre-seed funds, angels or “friends and family.” However that amount is often not sufficient to hit the requirements that early-stage investors require for bigger, pre-A raises (often requiring completed pilots, sales, a healthy customer pipeline, proof of accelerating user acquisition).
Many companies I met amid the height of startup frenzy have returned to raise a new round; they fall into one of the following two scenarios:
Scenario A: The Scenario A company raised a full seed round of $1-$3million at the height of the recent frenzy. Thinking that the growth it bought would stick or that raising additional funds would continue to be equally easy, this company failed to achieve the milestones it claimed would be met with the seed-round proceeds.The company now needs additional capital.
This type of round has traditionally been identified as a “bridge” round, but companies are rebranding the additional capital raise with new terms like “seed plus,” seed prime,” “double seed” or “second seed” to avoid the dreaded “B”-word and its associated negative baggage. These companies are more likely to face a down round or will die if their runways end before they can raise additional funds.
Scenario B: The Scenario B company has bootstrapped itself or previously raised responsible amounts of capital and has achieved meaningful traction and/or promising revenue metrics. While such a company could have raised a Series A round a couple of years ago, Series A investors have dramatically raised their requirements and expectations.Because the goal posts have now moved, this company may receive less-than-favorable terms or no terms at all from traditional Series A investors.
Instead of engaging these traditional Series A investors, this company will raise a convertible note from seed investors. These seed investors typically have not invested at Series A milestones/maturity. But these same investors are also not targeting the pre-seed arena. This strategic move would, in theory, enable the company to build up further momentum in order to raise a healthy and positive Series A round.
Across the board, the market is asking companies to do more, with less, and at a much faster timeline. This new fundraising reality will hit hardest the companies that raised seed rounds in2012-2015, because these rounds were designed to enable the company to hit the previously lower Series A milestones. Entrepreneurs raising for companies founded after 2016 should also take heed and plan their fundraising pacing and strategy in light of these new rules. If your company is facing this gap, here are some ways to avoid or minimize its impact on your ability to grow:
- Identify and pursue non-dilutive sources of capital. Make good use of government, academic and nonprofit grants, awards and tax breaks where they are applicable.
- Keep burn at a minimum from Day One, and avoid vanity expenditures. Anything that does not directly lead to long-term customers and sustained growth must go.
- Build long-term infrastructure to fuel growth; like it or not, the days of burningcheap VC money to buy growth through subsidies is over.
With support from Ivy Nguyen of NewGen Capital.
FAQs
Since the startup is in its early stages and often hasn't yet proven its merit in the market, this funding generally involves risk on the part of the entity that is funding. But high risk also comes at a point when the startup's valuation is at a low and has potential to scale and yield lucrative returns.
What is seeding investment? ›
The term seed suggests that this is a very early investment, meant to support the business until it can generate cash of its own (see cash flow), or until it is ready for further investments. Seed money options include friends and family funding, seed venture capital funds, angel funding, and crowdfunding.
Is seed funding private equity investment? ›
seed capital is funding that is provided to a startup company to help with the initial stages of business development and growth. Seed capital is typically provided by angel investors, venture capitalists, or other private investors. private equity is a type of investment that is made into a privately held company.
What is the success rate of seed funding? ›
As this Crunchbase data summarizes well, once the amount of funding for the seed stage startup surpasses the $1 mil mark, the post-seed funding raising success rate increases from ~30% level to over ~55%, and given about 35% companies that get Series A to fail in the US, this indicates approximately 60% failure rate at ...
Do you pay back seed funding? ›
After seed capitalists have been introduced to entrepreneurs, seed money providers will agree on the amount of seed money they'll invest. This seed money is then repaid within a specific time frame with interest attached.
Is seed investment worth it? ›
Why Raise Money? It's highly probable that a startup without any kind of seed funding will collapse. A common mistake that many founders make is underestimating the sheer pace and nature of a startup -- the high rate of growth requires a substantial amount of capital to eventually achieve profitability.
What are the cons of seed funding? ›
Cons of Seed Funding
Meeting the conditions and expectations of investors may require significant time and effort. Loss of Control: When angel investors or other external sources of seed funding get involved, business owners may risk losing control over key decisions.
How do seed investors make money? ›
Investors provide the seed (the initial investment), which the business owners nurture into a healthy tree (the business). In exchange, the startup owners must concede some form of return value to the investor, such as a percentage stake in the tree (company), or a share of the fruit it produces (profit).
What is a typical return on a seed investment? ›
Given that generally a seed investment is a private transaction, the actual results rarely get reported in any reliable method. That said I have worked with enough investors on both the buy and sell side that I can fairly confidently say most private investors are looking for a 20–30% annual return on their investment.
What is a good return on seed investment? ›
Venture capitalists (VCs) and angel investors are looking for big wins because startup investing is risky. Here's the simple takeaway: High risk, high reward: They aim for returns much higher than normal investments (think 20-40% per year) because many startups fail.
The average time it takes for startups to close their initial seed rounds of funding is 3-6 months. However, this can vary depending on a number of factors, such as the stage of the startup, the amount of funding being raised, and the experience of the founders.
How much equity do seed investors get? ›
How Much Equity Should be Given Away in a Seed Round? A general rule of thumb is giving away between 10-20% equity during a seed round. This may likely be to angel investors who are willing to put in checks right at the origin of a company during the early stages.
Is seed funding debt or equity? ›
Seed funding is the first official equity funding stage. It typically represents the first official money a business venture or enterprise raises. Some companies never extend beyond seed funding into Series A rounds or beyond. This early financial support is akin to watering the seed planted during pre-seeding.
What is the risk of investing in seed capital? ›
The biggest risk of seed investing is that the company may not be successful. There's always a chance that a startup will fail, no matter how good the idea or how talented the team. And if the company does fail, the investor will likely lose all of their investment.
Should I get seed funding? ›
Why Raise Money? Without startup funding the vast majority of startups will die. The amount of money needed to take a startup to profitability is usually well beyond the ability of founders and their friends and family to finance.
Is seed money considered income? ›
Is Seed Funding Taxable? Seed funding, similar to other forms of investment capital, should not be taxable when received. It is an investment in your company and does not count as income.
Is pre seed funding worth it? ›
Pre-seed funding is usually provided by angel investors or venture capitalists who are willing to take a risk on an early-stage startup. One of the benefits of pre-seed funding for entrepreneurs is that it can help them get their business off the ground without having to give up too much equity or control.
