The Strategic Advantage of Pre-PreSeed Funding: Laying the Groundwork for Success

A Comprehensive Guide to Navigating Early-Stage Investing Before Friends and Family Rounds

Introduction

Understanding the various stages of startup funding is crucial for entrepreneurs navigating the investment landscape. This comprehensive guide delves into why initiating with a Pre-PreSeed round is strategically advantageous, offering a foundation for minimizing risks and maximizing returns in the high-risk asset class of startups.

Ready for Funding?

The journey of seeking startup funding traditionally follows a sequence from Friends & Family (F&F) rounds to Angel, Seed, and Series A rounds. However, this model inadvertently heightens the risk for investors at all seed stages. The introduction of the Pre-PreSeed round aims to redefine this pathway, ensuring a more secure and strategic start for both investors and entrepreneurs.

Importance of Understanding SEED Ecosystem

The SEED investment ecosystem includes many stages such as Your Own Money (YOM), pre-pre seed, pre-seed, seed, F&F, and angel. Startups need to be keenly aware of their initial financial position in order to better leverage the opportunities that come later down the line with SERIES (A,B,C,D) investments. Without a clear understanding of this ecosystem, a startup will never reach its true potential.

Not every startup will look to outside funding to sustain itself. But of the ones that do, there has historically been a non-linear path riddled with conflicting information for founders seeking investment. We could even go so far to say that there are countless funding opportunities available, given the fact that anyone who hands over money to another person so technically call themself and investor- and technically speaking they would not be wrong.

However we know the world of funding and business is much more nuanced.

Does this chart below look familiar?

The F&F Round

You’re sitting around the dinner table or other family/friend gathering and one way or another your business comes up for discussion. You heard from others that you should first seek investment from your friends and family. So you start asking your friends and family, most of whom are neither active angels, nor have run a startup as operators. You may get lucky with some distant family friend who ran a business two decades ago which is ancient at the rate and speed we moved in tech.

Now yes, the foundations of business, revenue, profit, loss stay the same - no need to do any New Math here. But the way to achieve exponential growth via marketing and sales has changed.

So let’s say one of your friends writes you a check because they believe in you and your vision.

That’s great right? Not so fast. Here are a few more follow-up questions:

• Did you give all of the proper financial disclosures?
• Are they writing a check in your name or your business name?
• Is this a gift? Or did you give them actual stock certificates?

Ok - fine, instead we’ll do a loan.

Similar questions apply:

• What the maturity date?
• What’s the interest rate?
• If you're doing business in the US, it needs to at least the going minimum federal interest rate.

Now let’s say you’re a popular person and the entire family and friends circle wants in?

• Did you account for the different valuations with all of the investments?
• And were they done as part of a single round or multiple rounds or was it just adhoc?

“Family and friends are probably not angels, or operators and may or may not understand that at time 0, your made up valuation is bupkis.”

Lacking a well-defined strategy at the outset can spell disaster, not just complicating future endeavors but potentially diluting the stakes of early investors as more seasoned investors enter the scene. This scenario could turn those once amicable holiday dinner conversations sour.

Traditionally, securing funds from friends and family often leads to oversights. These initial backers invest based on personal relationships, not necessarily understanding market dynamics, valuations, or the expected Internal Rate of Return (IRR) on their investments. Their focus isn't on negotiating valuations or scrutinizing business models against quarterly revenue forecasts. While their support is invaluable early on, it doesn't eliminate the need for a structured approach.

As the startup begins to show promise, generating traction and revenue, the need for a more formalized structure becomes apparent. Without it, early friends and family investors risk seeing their contributions significantly diluted in value with the introduction of larger funding rounds.

The Angel and Seed Round

When VenturSeed introduced the pre-pre seed round last year, it was not just another round of funding, but a process to help both investors and entrepreneurs develop the right paths from the start.

"Unknowingly the mistakes entrepreneurs and new investors make in the earliest stages of their company lead larger funds and VC to pass on what they see as an “unsophisticated deal”."

At this stage, the unsophistication is not necessarily about Incorporation in Delaware, Cayman, or other municipality, but the small and incremental mistakes such as:

• How are your bylaws written and why? Can you defend them?
• How many directors have you chosen and why?
• Can you defend having two vs. one class of stock - if not why’d you do it?
• Who is maintaining your books? Aka. Can you be a good steward of our investors' money?

With an extensive startup, legal, or financial background, many first-time entrepreneurs without extensive startup and finance background undoubtedly make these mistakes.

Investors at this stage want to ensure that there is generally a product and some sort of initial traction, mostly in the form of revenue.

Wait a minute - a minute ago weren’t we talking about our idea and initial funding and now we are looking at expectations of a prototype and revenue?

Confused?. you're not alone.

You see the traditional Angel and Seed round was previously the first point of outside capital for a startup and sometimes the angel would be a family member, friend, or close family friend. The amount of capital provided also varied with no clear demarcation.

With the introduction of pre-seed funds just under a decade ago and recently the new pre-pre seed round, the trajectory for raising capital has become much more clear.

So Where Do We Go From Here?

For starters, the diagram and flow of funds should really look something like this.

• YOM (Your own money)
• Pre-pre-seed/match capital funding (arrow to show this is where we come in)
• F&F Funding
• Angel Round (Community Networks)
• Pre-Seed Round
• Seed Round

Let’s break out each component to see why it’s critical for entrepreneurs to set up a structure like this and what the ultimate goal would be for each milestone.

YOM (Your Own Money)

If you cannot invest your own funds in your business, why should anyone else put their hard-earned money into your business?

Your own money doesn’t have to be a million dollars. For example, on our vestedcofounders.com platform, entrepreneurs can escrow $1000, $5000, $10,000. Along with their co-founder, these “skin in the game” amounts are the minimum needed to either build an MVP prototype, operate with a small skeleton crew and prove there is a viable customer base willing to pay money.

Team:

• Just you and your 2-3 co-founders.
• One-time contractors for small jobs that you do not have the internal skills to complete.

Goal:

• 10 Customers MRR for a single quarter (3 Months)

Why:

• At this level, your early adopters have parted with their hard-earned money not once, not twice, but three times. There is a pattern here.

Investment Amount Range (Min/Max): $2K - $20K

Pre-Pre-Seed/Match Capital (VenturSeed)

(arrow to show this is where we come in)

So you have 10 customers. Far from scaling, and definitely not ready for lots of capital, but there is something there.

Here we tune the engine and add three things:

• Iterative Feedback/Customer Service.
• Start with very micro social and marketing test ($100/$200 etc)
• If a pure tech product: Committed developer (with guard rails) if the product is a tech-first product
• If not a pure tech product: SAAS tool or other will suffice with a one-time contractor

Team:

• Your 2-3 co-founders (to quote a famous phrase - one of your co-founders may have lost oxygen during the climb)
• 1-2 dedicated skilled contractors who deliver on very specific weekly or bi-weekly metrics and performance milestones.
• CFO (note titles are irrelevant) - but you need a reputable and reliable person at this stage who will be the fiduciary of the company. Reputation matters.

Goals:

• 25-50 Customers MRR for a single quarter (3 Months)
• Intensively listen to your customers, especially the ones that are parting with their hard-earned money month after month
• Break Even/Reinvest
• Put together the financial story and financial plan including burn rate and revenue to date
• Craft Subscription Agreements ability for investors to track their investments should be set up.

Why:

• At this level, you are still in the early adopter phase, but now you have much more early adopters. No massive scaling because your product is still in beta.
• A Small financial plan is easier for the next group.

Investment Amount Range (Min/Max): $5K - $20K

Friends and Family (First OPM)

So this is the first OPM money you are taking. However, you don’t need a comprehensive pitch deck quite yet - but solid revenue projections and your vision.

The reason this F&F round comes after the pre-pre-Seed is because you want to approach your friends and family just like you would any other sophisticated investor and not doing so in our view would be disrespectful to your friends and family.

This round of funding is an arm's length should take no longer than one week - since you would have already all of the components put together.

Keep in mind that there is no family and friends exception when it comes to securities, so the same rules would apply when asking money from your mom, dad, or uncle as a VC investor. Many are surprised to hear this.

At this point, you are still operating very lean, but starting to grow but you do not know the upper end of the market. At some point your market (potential customers) will tap out - no matter how much money you spend, so we still need to keep a careful eye on the numbers.

Your entire team should be very numbers/analytical minded.

TEAM:

• Your cofounders
• Perhaps one dedicated full-time remote employee
• At least 2 dedicated full-time contractors
• CFO

GOALS:

• 100th Customer Milestone MRR for a single quarter (3 Months)
• Intensively listen to your customers, especially the ones that are parting with their hard-earned money month after month
• Break Even and Reinvest
• Determine if you are going for an acquisition or profit strategy over the next 5 years as the trajectories are vastly different.

WHY
Your family and friends may not understand a 10K or financial statement, but they will see that you are making real revenue - not pie in the sky projections.

Plus, depending on your family and friends, your trust factor may already be built in.

INVESTMENT AMOUNT RANGE (MIN/MAX): 10K - 25K

Angel Investors/Groups

Once we reach 100 customers, things get interesting. You'll start to get larger investors interested. They may entice you with larger sums of money you don’t really need - yes there is a thing as being overfunded. Instead, start with angels and groups where you can set the terms since we have cash.

TEAM:

• Your co-founders
• Perhaps one dedicated full-time remote employee
• At least 2 dedicated full-time contractors
• CFO

GOALS:

• 100th Customer Milestone MRR for a single quarter (3 Months)
• Intensively listen to your customers, especially the ones that are parting with their hard-earned money month after month
• Break Even and Reinvest

WHY
The previous rounds are what we call the hypothesis rounds, small amounts of capital over several iterative periods to continuously determine if the business is truly viable.

Now we are starting to get what we call the acceleration money.

INVESTMENT AMOUNT RANGE (MIN/MAX): 25K - 100K

Pre-Seed Funds

Pre-seed funds are generally a very good next step as they provide capital quickly as long as you have a solid product and have some customer traction. Here you are starting to play in the VC world. Not all pre-seed funds are the same and you still need to keep a discerning eye on who actually is a pre-seed fund and who is just looking for deal flow.

TEAM:

• Your co-founders
• Perhaps two dedicated full-time remote employees
• At least 2 dedicated full-time contractors
• CFO

GOALS:

• Find Product Market Fit
• Exponential Growth
• Keeping your 100 Customers without attrition and growing more accounts.
• Intensively listen to your customers, especially the ones that are parting with their hard-earned money month after month
• 1-2 More Key Hires, either in one of the following (in this order): Sales, Engineering, Marketing

WHY
The next round of funding, seed may not come for another year, so you’ll need to be both financially diligent about where you spend the money.

Competitors and bigger companies are coming after you and you need to be primed to gain market share.

You’ll also need to keep an eye on your strategy you decided earlier in the game.

INVESTMENT AMOUNT RANGE (MIN/MAX): 100K - 500K

Seed Funds

Seed funds are the last stop on the local train before you get to the SERIES levels of funds. After this stage, it is an express ride to acquisition or sustainable profits. IPOs are usually not our focus.

At this point, you have product market fit and are growing sustainably. Your team may have an idea of where you will cap out in market share, but you have not hit that bridge yet.

You’ll need key hires without growing too fast and a culture that people will want to work in.

It’s at this point that you will begin to have two centers within the company.

• Your Cost Center
• Your Profit Center

The hardest part of this is ensuring both teams are aligned with your overall customer success, which means retained income. As a founder or executive leadership, it’s 100% about managing the business and its people and less about being involved in every little detail or being a blocker for some team or division (that is if you want to grow).

There are many tales of founders who wanted to control everything and hence not able to grow the company at the rate it needed to be successful - so don’t let that be you.

TEAM:

• Your co-founders
• Your leadership team and board
• You’ll have a few dedicated full-time staff
• Within this will be some contractors
• CFO

GOALS:

• Growth
• Conversation starts to shift to market share.
• Intensively listen to your customers, especially the ones that are parting with their hard-earned money month after month
• The order of hires may change depending on how tech-heavy the product is. Sales, Engineering, Marketing

WHY
The series round is very different and there is a huge gap between seed and Series A,B, C, D

Competitors and bigger companies are coming after you in full force as it becomes a zero-sum game.

INVESTMENT AMOUNT RANGE (MIN/MAX): 1M - 5M