A Pre-Seed Primer (if by Primer u mean Rant)
In general, I’ve been hesitant to write about VC industry dynamics and instead much prefer to opine on companies, industries, or behavior shifts. I think this is because (a) I simply don’t know how much I can add to the conversation…very few people write about VC nuances well (Semil Shah is one obvious exception). And (b) I find most VC “tips” or whatever to be the lowest common denominator of content. I mean who hasn’t seen infinite articles on how to form a pitch deck or how to find an angel investor. Probably a bit mean spirited but it doesn’t interest me. But I felt it was worthwhile to make an exception and offer some thoughts on the emergence of pre-seed investing as its vitally important for entrepreneurs to understand.
What is Pre-Seed?
The trend was first written about by Manu Kumar at K9 Ventures in April 2014. In it, he noted:
Seed is not the first round of financing any more. In fact after noticing this trend last year, I have transitioned to calling most of my initial investments “pre-seed” rounds, where the company raises close to $500K, before raising a full seed round. The Seed round is larger — closer to and sometimes upwards of $2M. The Series A is now the fourth round of funding for a company — the first is usually friends and family, or an incubator (~$50K), then pre-seed (~$500K), then seed (~$2M), then Series A (~$6M-$15M).
And the trend is building. Last month, Notation Capital raised an $8M seed fund, noting amongst other observations that “There are so few real VCs willing to invest in pre-growth. They all want to invest in the growth chart.” And yesterday, Charles Hudson, a Partner at SoftTechVC (one of the original MicroVCs) left his post to form his own pre-seed fund, citing a desire to get his hands dirtier at even earlier stage with entrepreneurs.
The Pre-Seed Evolution
This is really the only relevant part of this post (the rest is just my formalized fluff to make myself look smart): High level – the venture landscape has changed and “early stage” or “seed” or “microVC firms” are not going to be the proper source of funding for most entrepreneurs.
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This is Chicago Ventures’ evolution as a fund. Chicago Ventures was born in December 2011 (let’s call it 2012) amidst the boom in MicroVC funds, of which there are now more than 200. Many of these funds will fail, but others are building strong networks, brands, and track records. I’d like to think we’re on the right trajectory in those areas, but as you’ll note, the consequence of our success was that as we did our job well, we moved further upstream in the investment stack.
We’re not the only ones. I’d imagine many iterative MicroVCs have experienced similar shifts. A deepening risk aversion is a natural consequence of the current ecosystem dynamics: incrementally more startups, increasingly verticalized target markets, and growing non-institutional early stage capital. Venture Capital is a game of missing information and the current setup provides even very early stage investors with a greater information advantage than ever before: and for us, there’s simply no option but to take it. (Remember, that we have a fiduciary duty to our investors as well). The even better news for MicroVCs is that with a few exceptions, the market is so oversaturated with startups, that even by waiting an additional 9-18 months, our entry valuation (albeit often higher) is still low enough to make fund economics work.
What this means is that many of the outlets that used to provide $250k checks to early stage entrepreneurs no longer exist.
Entrepreneurs need a new option: a firm whose model is based on high variance investments in exchange for increased ownership and lower valuations. These are the new Super Angels. Funds such as K9 Ventures, Boldstart, Ludlow, and Brooklyn Bridge Ventures are great examples of quality firms filling this gap. Their models are predicated on having the conviction to place bets before larger investors step in.
In my opinion, entrepreneurs reading this at the 2-6 employee stage, with a product only a couple of months old or still in MVP mode, should be approaching these firms first and avoid wasting time with traditional seed VCs. The pre-seed firms are working hard to build strong upstream syndicate networks and if they believe a larger institution could be an appropriate partner, will make the recommendation accordingly.
#Chicagoness
If you’re not from Chitown, you can skip this section. High level - I maintain the highly controversial and unpopular opinion that Chicago has degraded over the past three years from a pre-seed funding perspective. And it is a real crying shame.
That seems like an insane proposition given the explosion in the Chicago tech scene, 1871’s hyper-growth, incubators such as MATTER, and the proliferation of local seed funds: Chicago Ventures, Lightbank, Hyde Park Venture Partners, JUMP Capital, and MATH.
But again, it’s all in how you define “seed.” If you’re a company in market with traction, a relevant team, 18 months of metrics and looking to fundraise $1-3M to step on the gas, Chicago is strong as hell. But if you’re earlier, there’s a gaping hole.
3 years ago, Chicago’s 45 most active angels merged together into a single entity, Firestarter Fund which often serves as a follow-on fund for $750k-2M rounds. The intentions were beyond noble but it had the effect of pushing most of those angels’ money upstream into larger financings. Other angels merged into Corazon Capital – a group I personally believe is phenomenally value additive, hands on, a dream investor – but again, a lot (though not all) of that money is being deployed further upstream.
The flip side is that there is more private Chicago money looking to enter the venture class: real estate professionals, banking, HFT, etc. But this money overwhelmingly does not have experience in helping build or manage early stage startups. Worse, because they are largely not price sensitive, they will inflate entry valuations to the point of being unpalatable for institutional seed VCs once the company hits an early growth curve. This forces those companies to continue tapping non-institutional money ad nauseum.
There may be relief in sight: local pre-seed institutions are emerging. JumpStart Ventures founded by ContextMedia execs Rishi & Shradha have made nearly 20 early stage investments over the past year. Wintrust recently announced a pre-seed equity fund. But there remains a massive hole for local startups at a critical juncture – where they need $250-500k to add a couple team members and experiment in market.
My Feelings
Earlier this week at an event I hosted, a founder who’d just closed her pre-seed round remarked to me how taxing the entire process was. Rolling closes over many months, lots of small checks, etc. She was relieved but visibly exhausted.
That in itself doesn’t bother me. Entrepreneurship isn’t easy – difficulty is simply the reality. One of the variables a firm like Chicago Ventures optimizes for is to spot the survivors: the hunters, the killers – founders with thick skin who can push through rough patches with positivity. What does bother me is that the founder mentioned has effectively no outlets for empathy or professional support. Despite raising capital, she is still largely on her own.
Empathetic support and experience are the roles pre-seed funds can fill. It isn’t charity – these firms should be appropriately compensated for their risk and infrastructure. But it’s hard to build healthy, balanced entrepreneurs and startups if there aren’t healthy, balanced institutions supporting them.
Till next time,
Ezra