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
Why is seed financing very risky? In order to find a successful project, the PEI will have lost a lot of money on other losing projects. The PEI deals with the banking system in this phase. Practitioners say that out of 1 0 0 projects you will only find only 1 0 successful ones.
What is the seed valuation for 2024? ›
During the first half of 2024, however, the price of doing business went up. The median seed-stage valuation leaped from $13.3 million in Q4 2023 to $14 million in Q1 2024, then climbed again to $14.8 million in Q2, according to Carta's preliminary data from the quarter.
What are the advantages of seed investments? ›
2. Expertise and Guidance: Seed investors bring valuable expertise and insights to the table, which act as the most important advantage. Their experience can guide startups in navigating challenges and making informed business decisions, ultimately enhancing the startup's growth and development.
How much return do seed investors get? ›
The TLDR; seed investors shoot for a 100x return; Series A investors need an investment to return 10x to 15x and later stage investors aim for 3x to 5x multiple of money. This translates into portfolio returns from 20% to 35% targeted IRRs.
Why is seed financing risky? ›
Seed financing is the riskiest form of investing. It involves investing in a company in its earliest stage of development, far before it generates revenues or profits. Due to such reasons, venture capitalists or banks usually avoid seed financing.
Can seed funding be debt? ›
The two most common categories of seed investments available to startups can largely be categorized as convertible debt financing or convertible equity financing. Understanding the differences between the options is essential for a founder to choose the form of financing that is right for her or his startup.
What percentage do seed investors take? ›
Seed round investors usually receive an equity stake of between 10% and 20% of the company in exchange for their investment. It is common for seed round financing to be made up of investors who are already familiar with the founders and their brand.
What is the 10000 year old viable seed? ›
In 1954, arctic lupine seeds belonging to the species Lupinus arcticus were found in the Yukon Territory in glacial sediments, believed to be at least 10,000 years old. The seeds were germinated in 1966.
What is a good seed valuation? ›
Generally seed stage valuations are anywhere from $2 million to $10 million and upwards of $20 million (for more experienced entrepreneurs). This is a huge range, reflecting a huge range in demand for different kinds of companies. Market size should also affect the valuation that investors are willing to invest at.
Do you pay back seed money? ›
Does seed capital have to be paid back? You don't have to pay back seed capital as it's often provided in exchange for equity or a stake in the startup. Investors who provide seed capital become shareholders in the startup, and their ROI comes from the business' future success.
Seed funding is essentially equity-based funding, which requires investors to invest money into the business at the very early stages. In return for the investment, the investor is given an equity stake. An equity stake is a share of the business.
What happened to my SeedInvest account? ›
Can I still access my SeedInvest portfolio? No, the SeedInvest website has been retired. Will my SeedInvest portfolio transfer to StartEngine? Yes, please follow these instructions to do so.
How much equity should I ask for seed funding? ›
The general rule of thumb for seed rounds is that founders should target giving away between 10% and 20% equity.
Do seed investors get diluted? ›
This research shows an average of about 28% founder dilution — almost 30% — from Seed round to Series A. Founder dilution from Series A to Series B is about 11%. By Series B, on average founders own less than 30% of the business while investors own more than 55%.
What is the IRR for seed funding? ›
According to research by Industry Ventures on historical venture returns, GPs should target an IRR of at least 30% when investing at the seed stage. Industry Ventures suggests targeting an IRR of 20% for later stages, given that those investments are generally less risky.
What does seed mean in financing? ›
This financing is referred to as seed capital. Seed capital—also called seed money or seed financing—is referred to as such because it is money raised by a business in its infancy or early stages. It doesn't have to be a large amount of money. Because it comes from personal sources, it's often a relatively modest sum.
What happens in seed funding? ›
Seed funding refers to the initial sums of money a business venture raises, the seed funding represents the initial equity funding stage. The early investment that seed funding provides to a business is normally used to facilitate business growth and stimulate income generation.
What is seed money in finance? ›
Seed money, also known as seed funding or seed capital, is a form of securities offering in which an investor puts capital in a startup company in exchange for an equity stake or convertible note stake in the company.
How much seed funding is good? ›
If you can manage to give up as little as 10% of your company in your seed round, that is wonderful, but most rounds will require up to 20% dilution and you should try to avoid more than 25%.
