Raising money from professional investors before your product is built, launched and generating revenue is far more difficult than when those things have already been accomplished. This can result in dozens or hundreds of investor pitches without success. But very few founders have the financial ability to fund their own startup through the initial phases. This article provides a framework for identifying the investors that will have the highest odds of investing in such a venture.
This article explores just one of the topics covered in Chapter 3 of my bestselling book “Startup Success – Funding the Early Stages”.
You can listen to this chapter now and if you’re interested in the book, you can find it on Amazon here.
What is “Pre-Seed”?
I sometimes find it silly to hear all the different highly-refined definitions of pre-seed, seed and even Series A rounds of funding. But it does make sense to have some common nomenclature attached to funding events throughout the lifecycle of a startup. For purposes of this article, I’ll define the pre-seed stage as follows:
Purpose – Validate desirability (people/companies suffer from the stated problem sufficiently to be willing to pay money to solve the problem) and feasibility (a solution can be built to perform the desired function). This means that at the end of the pre-seed stage, there are probably users/customers of the product but not at any scale or via any yet-repeatable process and possibly not yet paying money to use the product.
State of Product – No working product at a production-level exists but perhaps a clunky, ugly, buggy, and/or expensive version of a prototype exists. But sometimes only a list of feature requirements and high-level design exists (see related article titled “Prioritizing Your Product Roadmap“).
State of Team – It is unlikely that anyone is working on the venture full-time. This means they have other jobs to pay the bills and are working on the venture at night and on weekends. (see related article titled “The 8 Personas of Successful Entrepreneurs – Which Are You?“)
Typical Amount Raised – For a software company, $100-250K is often the target for a pre-seed round of funding (see related article titled “How Much Should You Raise?“). It needs to be enough to build out a minimum viable product (MVP) that is hopefully evolves into a “good enough” v1.0 product to launch in the market. It also needs to be enough to properly form a legal business entity (see related article titled “Your First Cap Table“).
Early stage investors understand the high-risk nature associated with their investments. So that’s not the big issue. But they are also looking for the right trade-off of risk versus reward. Below are some things an investor might seek in order to optimize both:
- Optimizing (reducing) Risk – Look for an experienced full-time team with a successful track record and paying customers for the product
- Optimizing (increasing) Reward – Look for a huge market (TAM/SAM) and a low valuation
Using the previously-suggested definition for the pre-seed stage, the best you could do is 3 out of 4, and that’s assuming you can assemble a full-time team that’s not compensated with cash. You could have a huge market and a low valuation but you don’t yet have paying customers from a launched product. If this hypothetical investor sticks to the optimized risk/reward criteria, they will be seeking seed stage startups, not pre-seed stage.
This basically means the investor is going to have to be willing to absorb additional risk and do so because of the higher upside reward potential that comes from the lower valuations that exist at the pre-seed stage (versus seed stage). Which investors are most likely to be willing to do just that? Keep reading.
The term “hyper-intersected” doesn’t exist in the dictionary but is a term I often use when describing the type of angel investor that has the highest propensity to consider a pre-seed stage investment. It is basically an investor that is able to uniquely lower their risk factor due to having some close affinity (intersection) with one or more attributes of your business plan (examples to come later). This changes the risk-reward equation in a way that allows them to consider a pre-seed investment rather than wait until the attributes of a traditional seed stage investment are met.
I’ll give you a personal example. I spent much of my professional career selling enterprise hardware and software solutions to Fortune 1000 organizations using either a direct sales or channel distribution method of acquiring customers. I am more comfortable and capable of interrogating pre-seed stage startups that have those elements in their business plan. As a result, I feel like I’m better at assessing the possibility of building a viable, scalable and sustainable business that could eventually exit and make everyone a lot of money. I would not feel as comfortable or capable with a pre-seed stage startup that’s building a mobile app for consumers because I’ve never been in that movie as an operator.
Check out this short, 2 min video about the very first sources of funding:
Opportunities for “Intersection”
You’re looking for angel investors that . . .
- Know You Well – Close business associates are possibly the best example. Friends and family also obviously meet the criteria. But if you decide to go that route for part/all of your pre-seed funding, please tell them 3 times to their face that at this very early phase the odds are high that you won’t be able to pay them back. If they still definitely want to support you by investing and are also an “accredited investor” as defined by the SEC, go for it.
- Know Your Industry – I’m talking about the industry you will sell into. Examples are education, healthcare, financial services, etc.
- Know Your Target Customer – If you’re building a horizontal solution (not only focused on specific industries), seek angels that know the type of customer you will target. I’m talking about corporations, government institutions, small-medium sized business (SMB) or consumers
- Know Your Product Category – Examples include consumer electronics, mobile apps, data center hardware, consumer packaged goods (CPG), medical devices, enterprise SaaS software, professional services, etc.
- Know Your Business Model – Examples include 2-sided marketplaces, technology licensing, direct sales, self-service, retail distribution, etc.
- Know Your Technology – Examples include artificial intelligence (AI), virtual reality (VR), Blockchain, etc.
- Are Local to You – With this they are best able to be an advisor to the company.
- Have Previously Invested Alongside an Existing Investors – Once you get some investors on-board, try to find out who they have invested with before.
Imagine if you found an angel investor that met all of the criteria. Your odds of getting them to invest are infinitely higher than an investor that doesn’t match any of the criteria. But since that’s a Utopian investor that either doesn’t exist or should instead be a co-founder of your company, can you find some investors that match any three of the criteria? How about four? You get the idea. The list serves as your possible menu of filters.
The odds of the investor getting serious about making an investment are directly proportional to the number of check marks you can place next to the criteria listed above
Now you know why the title of this article starts with the phrase “threading the needle” and the featured image involves multiple threads through the head of the needle. It’s not easy.
There are a few conditions that require greater levels of or more instances of “intersection”. The most common ones are listed below:
- Just Got Started – You’re just past the blank sheet of paper and without some semblance of a business plan, team, customer discovery or product requirements
- Will Serve a Niche Market
- Have a Highly-Disruptive Product or Business Model
- Expect a Long Time Before Launching Your Product – Hardware products and healthcare solutions that require FDA approval are good examples that might take years before a launchable product is ready
The list above is not a complete disqualifier but rather narrows the field of possible investors even further due to the increased level of hyper-intersection that’s required.
I was an early investor and multi-year board director for a telemedicine software startup. They experienced trouble convincing traditional tech angels to invest during their pre-seed stage. But as they approached physicians that owned their own practices to be their first beta testers, a couple of them quickly asked if the startup was raising funding. These docs completely understood the value proposition that was being offered and probably also wanted to have some bragging rights at cocktail parties.
What’s interesting is that these docs didn’t just invest the typical $25-50K. Some of them invested $100K and one of them ended up investing something like $300K over multiple funding rounds.
What is the equivalent for physicians in your case? Restaurant owners, marketing agency owners, senior partners at law firms, fitness studio owners, etc, etc.
Funding Alternatives Not Covered
Angel investors and friends/family are certainly not the only source of funding for pre-seed startups. If you’re not able to find any that are hyper-intersected enough to invest, you might need to seek alternative funding sources. I’m not talking about raiding your savings account, selling your car, borrowing against your 401K or using excess income from your day job. Those are forms of bootstrapping (read related article titled “How Long Should You Bootstrap?“). Below are some example alternatives:
- Bank Loan (but be careful about a requirement to personally guarantee)
- Pre-Sales (either from your website or a crowdfunding portal)
- Accelerator Program – some come with funding if you get accepted
Actually some of these alternatives can serve as great complements to angel investors. Grants are non-dilutive, pre-sales shows evidence of market desire and getting accepted into an accelerator programs can give credibility and lots of helpful resources.
I don’t want this article to suggest that finding hyper-intersected angels is easy because it’s not. It’s unbelievably difficult because 1) the more criteria you need to match the fewer candidates there are 2) angels don’t walk around with a sign around their neck informing you about the ways they might “intersect”. You’re going to need to be driven, creative, scrappy and unstoppable if you’re going to have a chance of applying the principals suggested in this article. The good news is those are the same attributes you need to build a successful business anyway. I wish you luck finding success with your pre-seed round of funding.