November 17, 2017
Mary Ann Azevedo is an Austin-based business writer who has written for Venture Capital Journal, San Francisco Business Times, Crain's and Silicon Valley Business Journal.
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As seed and series A rounds have grown increasingly larger over the past decade, a new category of funding has emerged: the pre-seed round.

What exactly is pre-seed? Since the round type is still new and evolving, there’s not yet a concrete definition of what defines a pre-seed firm. But industry observers say seed rounds today closely resemble what Series A funding looked like five to 10 years ago in terms of round size and valuation. So, it’s probably safe to say that pre-seed capital is what seed funding was 10 years ago.

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But just why is there a need for another stage in capital?

In October, Crunchbase News’s Jason Rowley wrote that the number of seed and angel deals increased by 8.77 percent in the third quarter of 2017 compared to year-ago period. However, total dollar volume fell over the same timeframe. Rowley continued: “Globally, seed and angel-stage companies raised $380 million less in Q3 2017 than they did in Q3 2016, a decline of just over fifteen percent..”

Rowley also found that “[c]ompared to last year, the average early-stage round is now $4.6 million larger, corresponding to a year-over-year change of 43.4 percent.”

All this backs up the notion that investors aren’t putting as much into seed rounds as they used to – thus leaving a hole attempting to be filled by this new breed of “pre-seed” firms.

To fill the gap, a handful of funds have recently formed to exclusively invest in the new and evolving “pre-seed” stage: Afore Capital, XFactor Ventures, K9 Ventures, Notation Capital, and Precursor Ventures.

Meanwhile, a number of other firms may not have an exclusive focus on pre-seed investing but are still doing some of it, such as Village Ventures, NextView Ventures, betaworks ventures, Initialized Capital, Bolt, Resolute.vc, and Brooklyn Bridge Ventures.

Deals Before Deals

Among the largest of these new pre-seed firms is San Francisco-based Afore Capital, which closed on a $47 million fund in May 2017, exceeding its $40 million goal.

Both co-founders, Anamitra Banerji and Gaurav Jain are engineers by training, both having worked as founding product managers – Banerji at Twitter and Jain at Android Nexus. After a collective 16 years in the operating world, they both went into institutional investing – at different firms.

They decided to join forces in 2016 and launch Afore. The premise behind the firm is that a median size seed round has increased from $1 million to somewhere between $3 and 5 million.

In setting up their fund, the founders performed an analysis of more than 180 unicorn companies—startups valued at over $1 billion—and their earliest funding rounds. They found that, in the U.S., more than one-third of those unicorns started with rounds that today would be considered pre-seed level, including Uber ($200,000), Airbnb ($620,000), Stripe ($120,000), Lyft ($300,000), and Pinterest ($600,000).

Since October 2016, Afore has made 17 investments, the majority of which it leads. Its average deal size ranges from $300,000 to $600,000.

Photo credit: Christophe Testi for Afore Capital

“We found that more often, companies were not raising seed as the first money going into a company,” Jain said.  “There has been a fundamental shift with investors telling founders to raise an angel, or friends and family, round and then build the product and some traction before coming to them for funding.”

Afore’s aim is to institutionalize that angels, friends, and family round.

“What was once a Series A is now a Series B and what was once a Series A is now a seed round,” Jain said. “So we saw a market opening to start a venture fund that fills the gap. The same thing happened 10 years ago when seed funds got started.”

The pair is quick to point out that they are not replacing angels, but rather working collaboratively with them.

“We’re complementary to angels but a very different product set,” Jain added. “We’re writing a much larger check, for starters, while angels tend to be more strategic.”

The changes can be confusing for founders, noted Banerji.

“Today a seed round is more like $3 million so another term has to be invented to address what used to be seed stage investing,” he said. “So there’s this gap between what a founder is looking to raise and traditional seed funds are willing to invest that is getting larger and larger. We’re looking to fill that gap with an institutional grade fund.”

Looking ahead, the pair believes this is just the beginning.

“We don’t see this as a fad,” Jain said. “The cost of scaling has increased while the cost of starting has decreased. So we think the notion of pre-seed funding is very much here to stay. It’s fundamental to the venture ecosystem.”

The pair acknowledges that investing at such an early stage is riskier than at a later stage.

“But we believe that companies that are able to raise less than $1 million with a concrete product roadmap and distribution make for more robust companies when they get to the seed stage,” Jain said. “So those with more early traction come out ahead in our opinion.”

Seeds On (Pre)Seeds

Jenny Lefcourt, a general partner at Freestyle Capital, a standard seed-stage focused firm, welcomes the new generation of investment firm that is pre-seed.

“Typically our entrepreneurs are raising $2.5 million to $3 million, and we’re writing a check for about $ 1 million,” she said. “Most of the companies that are ready for that have proven something, have had some traction and have built a team.”

The cost of scaling has increased while the cost of starting has decreased.

Before pre-seed came on the scene, it was mostly angels and friends and family that had capitalized the company to get to a place where they were ready for a firm like Freestyle.

“It’s impacting us in a positive way,” Lefcourt said. “They’re in a stronger place when they come to us even if it’s the same amount of capital raised.”

For its part, Freestyle has participated in rounds with pre-seed firms such as Precursor Ventures but still maintains its status as a seed investor. Lefcourt agrees, however, with the Afore team that the terms of what constitutes a seed round has changed over the years.

“Seed never existed back in the day until Series A rounds got larger. Series A has moved up further and seed too has moved up further and gotten larger,” she said. “So I do think pre-seed is serving an important role in the ecosystem.”

Doing A Lot With A Little

Earlier this month, Conversive – a startup that helps businesses build the virtual equivalent of face-to-face conversations – closed on a $600,000 round of pre-seed funding.

Kevin Lenane, co-founder of Conversive, said via email his company’s technology-heavy product and the need to get to market quickly made it important for the company to raise money earlier than “normal.”

“We are helping define a new domain in conversational technology and there is an abundance of new entrants in the space,” he wrote. “The earlier we can take some funding, the earlier we can start building the business, putting us higher up on the food chain once the market itself matures.”

Whether pre-seed venture firms are here to stay or just a short-term phenomenon remains to be seen, but one thing is for certain: the venture landscape is changing in a fundamental way and the firms and founders that can swiftly adapt will likely be a step ahead.