By Sergei Bogdanov
Securing pre-seed funding is a pivotal moment for any startup, but it’s never an end goal. It’s a tool that should be approached with careful planning to maximize its value.
In Yellow Rocks’ P2S program, we’ve seen how mismanaging funds can jeopardize a startup’s future.
I want to shed light on the aspects influencing business angels’ and venture investors’ decisions that can help a startup secure follow-on investments after the pre-seed round.
Early-stage investments: What are they for?
The period following a pre-seed investment is a time for experimentation.
Founders should meticulously study the market by engaging with as many audiences as possible, testing hypotheses and messages, and building an MVP, or minimum viable product. The goal is to find what the market craves and develop an appropriate business model for its distribution.
Pre-seed funding typically provides a runway of six to 18 months, so it’s crucial to define the startup’s next goals, determine what is necessary to achieve them, and carefully plan financial allocation.
Prioritizing sales
At this stage, founders should prioritize sales above everything else and demonstrate that their idea can generate revenue, even with an MVP. Without proof of market demand and a well-honed monetization model, investors won’t see a potential for the following funding, even in the latest tech innovation.
Business models can often be tested by low-cost methods like customer interviews and surveys. These approaches provide valuable insights without significant financial investment.
Compact product development
While sales drive growth directly, a functional product is crucial to maintaining customer and investor trust. However, excessive R&D spending at this stage can quickly deplete resources.
Startup teams should focus on developing a basic MVP that addresses the core issue. Adopting a lean development strategy allows making functional improvements in the product based on user feedback and avoiding actions that don’t contribute to sales.
Scenario planning
By preparing best-case, worst-case, and middle-ground scenarios, startups can adapt quickly to changing circumstances while protecting their financial runway. Each scenario should include actionable steps to ensure flexibility in uncertain markets or unpredictable sales cycles.
Avoiding common financial pitfalls
Misallocated pre-seed funds can derail even the most promising startups. Here are some common mistakes:
Overpaying for talent: Hiring expensive specialists too early can strain budgets. If a new hire doesn’t fit the corporate culture, severance costs add to the financial burden. Freelancers and outsource consultants can become a rational choice.
This concerns founders’ salaries too. First investments are not expected to become a self-enrichment opportunity, which means the founder’s salary should be the lowest possible.
Premature relocations: Moving employees to a central location can be disruptive and expensive. Working remotely or at co-working areas is much more economical.
Branding and marketing: At this stage, startups need to focus on testing various sales channels and gradually increasing marketing budgets.
Proper naming also deserves attention. It’s always a compromise between the idea, a free domain and common sense. Keep it short and catchy.
Cash traps for first-time founders
First-time founders often fall into financial traps, which may become fatal for a startup.
- Broken cap table: If investors see that founders were not thoughtful enough and have forfeited 25% equity at the “friends, family and fools” stage, they will avoid funding such a company.
- Insufficient personal investments: Failing to invest personal finances in building an MVP may be a red flag for investors. If a founder doesn’t use available resources, such as money after a previous exit or funding, it demonstrates a lack of commitment and potentially higher risks for investors.
- Underestimating burn rate: Lack of control over the burn rate can lead to rapid depletion of funds. It’s crucial to plan expenses ahead of time and closely monitor current spending.
Preparing for seed funding early
Even during the pre-seed phase, founders should begin laying the groundwork for their next round. This includes:
- Building connections with potential investors;
- Refining pitch decks, including all key performance metrics; and
- Documenting traction and milestones.
Having a clear roadmap for scaling helps attract future investors and expedites the fundraising process.
Conclusion
Pre-seed funding is the key that opens the gates to a market playground for founders, where they should take every opportunity to study, communicate with customers and enthusiastically test hypotheses, as the price of mistakes is low.
Prioritizing sales, avoiding financial pitfalls and planning strategically can help startups make the most of their initial investment while setting the stage for long-term success.
Sergei Bogdanov is a co-founder of the Pre-Seed to Succeed investment program, and a managing partner at Yellow Rocks! He co-founded the program in partnership with three venture capital firms: Altair Capital, Smart Partnership Capital, and I2BF Global Ventures. Bogdanov is also an entrepreneur, investor, subject-matter expert, Global Student Entrepreneur Awards jury member, mentor and speaker with extensive networking across Europe and the U.S.
Illustration: Dom Guzman
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