An early stage VC investor explains everything you need to know about pre-seed and seed rounds

We’ve now made 14 investments, and in almost all cases Galileo was the first VC investor in each startup’s pre-seed or seed round. We’ve backed some compelling early-stage companies and are on the hunt for more. 

If you’re raising your first round, you should apply now.

A common pattern I’m hearing in some early-stage founders is that they often don’t appreciate how important your first round can be.

Often I hear founders want to ‘skip’ raising a smaller first-round, e.g. pre-seed round at $500k, often to race to raise a much bigger seed round, e.g. raising $1-$2m+, or maybe even ‘wait to raise’ a Series A in the hopes they can raise something bigger.

This is a mistake – you should make your first round count!

Why? Because your first round is often NOT about funding and executing a proven or known go-to-market (G2M) plan. You’re experimenting to work out the best G2M plan and the biggest opportunity. You’re at an extremely pivotal stage as you ‘get into the market’ and look for that elusive product-market fit (PMF).

As a VC fund that specialises in first-rounds and first-time founders, we’re big on helping founders refine their G2M to get to market and make a mark, fast.

These are a few common questions we hear and what we recommend.

But first, what is a seed round?

A seed round typically refers to your first round of equity financing for your startup

Then ‘pre-seed’ appeared as investors started investing even smaller amounts (hello angels and accelerators). Different types of startup investors began to focus on various stages of the fundraising process. For example, you now have seed VCs (us!) and growth-stage VCs (such as Insight Partners).

Is there a difference between pre-seed and seed? Not really. It’s arbitrary and somewhat defined by how much you raise, what you and the investor want to call it and what terms are attached to the raise.

Originally, the first round of venture capital financing was your ‘Series A’. As VC investors typically take preference shares (we normally don’t take pref. shares), a new class of shares was created called ‘Class A’. And then the second round was B, C, D and so on! As venture capital funding matured, founders and investors realised that often founders needed smaller quantum of cash, often without special share ‘preferences’, and thus the seed rounds were born.

Loosely we define it at Galileo and in relation to Australian venture rounds as;

• Pre-seed being below A$500,000 – mostly about experimenting with your G2M plan.
• Seed round between A$500k-$4m – executing on your first stage of the G2M plan.
• Series A, A$4m-10m+ – early growth, winning the first segment of the market etc.

Anything above $4m is typically going to be called a Series A, but we have seen $10m-20m seed rounds in the US. Still, the intent of the round is very similar to a normal A-round – you’re executing on a validated G2M plan.

‍Side note: If you’re wondering if you should raise a seed round or if you’re ‘too early’, check out our post here.

Should I ‘skip seed’ and (hope) to raise a bigger round?

No.

Why? There’s a few reasons as to why you should make your first round count.

Your first round should help you:

• Make meaningful progress to ‘prove out’ your G2M and show bigger investors what they need to see before raising more capital.
• Hire your first employees (this includes paying the founders!), help you make more progress.
• Move faster – iterate and experiment with your G2M plan, gain insights about your first customer-segment behaviour, faster.
• Build trust with investors that you can deploy capital and make good decisions!

Partnering with good pre-seed investors who can help you navigate to early PMF and refine your G2M plan is far more valuable than trying to work things out on your own (often very slowly).

The opportunity cost of waiting can be huge too – will you make enough progress to be interesting to Series A and traditional VC investors? (I can guarantee you’ll find problems with your original G2M strategy, which will change your goalposts!)

Will you be able to execute fast enough (product, sales/marketing, operations) on a bootstrapped budget? 99.99% of the time, the answer is no

Will you find the bigger opportunity or just be steered in the direction of ‘whoever shows you love first’? Just because you find one customer doesn’t mean they are the right customer to go after!

The other often overlooked consideration is that raising a smaller round first proves that you can spend investor money well and make good progress. This goes a long way in building investor confidence as you raise more money in the future – particularly for first-time founders.

Your pre-seed round should fuel your experimentation in-market, learning your first (founder-led) sales strategies, how to work with customers and partners, what channels the best suit your product best and what exactly your ‘killer feature’ is.

The groundwork you lay at seed will set you up for success at Series A and beyond.

Should I raise enough for 1 year or 2 years to ‘focus on execution’?

I’m not sure where this is coming from, but I’m hearing more pre-seed founders trying to raise for 2 years, and it’s not what investors look for in the early stages.

Venture capital is a milestone-based funding game – you raise to hit milestones, which is almost always in 1-year increments.

You want to budget your raise for ideally 12 months at pre-seed. If you raise for 18 months to have a bit of headroom, then great.

This is why the typical advice is to raise what you need for the next 12-18 months. 12 months to execute and 6 months to get the next round sorted.

Often at pre-seed, you don’t have enough interest to raise 18 months of runway, so you usually end up raising less. Again, we see this more commonly (for better or worse) with first-time founders than a founder who has previously raised millions and generated returns for investors.

At pre-seed I would even advise for a raise for 6 months, presuming you can get into the market and start generating revenue to increase that runway. Again, it depends on the level of investor interest in your startup.

But I want a higher valuation, how much equity should I give away at seed?

Valuations are getting very frothy at the moment, both in equity-land and especially in crypto land. This is not a good thing and will lead to bad founder-investor partnerships. Just have a read about valuation ‘corrections’ already happening because of cooling public markets at the start of 2022.

Yes, there are founders raising at US$10m-20m valuations with essentially just an idea in the US, but that does not mean you should too [let alone can]!

For one, you’re not in the US (yes, even if you can meet investors there, location does matter), and for many (most) founders, you have no track record of commanding a valuation like that.

Let’s say some angel investors are happy to give you a $10m valuation because X company in the US was in the news and got that too.

In 12 months time, you need to at least double that to $20m valuation on essentially just your idea and hope you make enough progress. Keep in mind many of these early investors won’t lead your next round! So will traditional VC funds give you that valuation?

Keep in mind as well that what you might read in the press isn’t always reality – high lofty valuations (particularly at later stages) reported in the press won’t really consider the true deal terms at play. Investors have various levers they can push to improve their up or downside protection, and part of negotiating a later stage round valuation will be choosing how these are set.

For example, an investor might be happier investing $100m at a $1bn valuation knowing that in the event of an exit, they first get 2X their money back before anyone else – the infamous liquidation preference clauses are making a comeback. If the company hypothetically exited at $300m, they would get paid $200m, and investors would split the remainder. These kinds of terms are very uncommon at pre-seed (in fact, shouldn’t even exist) and more common in series A and beyond.

Valuation strategy is an important aspect to keep in mind. Don’t blow your valuation out of the water just because you can – raise what you need and look to aim for a sensible dilution of ~10-20%.

Dilution ranges we’ve seen are:

• <=10% for small pre-seed rounds, typically with investors and accelerators that invest less than A$100k-$200k.
• Between 10-20% for seed rounds where you’re raising between $200k-$2m.
• Between 20-30%+ is generally for larger Series A+ rounds. We think this is too much dilution for founders in their seed round; if you’re raising a lot of money then expect to give up a lot in the early days.

So, what are good seed stage investors for your startup?

Make your first round count!

At the pre-seed and seed stage you want investors who focus on investing in companies at your stage.

Later-stage and global investors who typically don’t invest early anyway are set up for a totally different kind of support. They generally aim to help you with execution once you have early (or late) signs of product-market fit, not experiment with very early go to market strategy.

My tips are:

1. Keep it local, get investors who have an affinity for your market (you’re selling into) and can help navigate to the bigger opportunity. Talking to international investors too early is a waste of time.
2. Look for specialised seed investors – setup to support you at pre-seed and seed e.g. they have a program, they have focus, or experience in this stage of company building.‍
3. Look for investors that can open doors e.g. angel investors that have had an successful exit in your industry, can help win key customers, influence the market, give legitimacy to your startup.

Extra Resources

Australian Seed VC Investors List in 2022

Here are a few of our friends we recommend that are currently very active in seed investing in Australia. 

If you’re a seed-focused VC investing in AU and don’t know us, please reach out.

You can also check out Airtree’s comprehensive investor list here too.

• Galileo Ventures
• Possible Ventures
• BlackNova
• Alberts Capital
• Artesian (Climate, AgTech and AI)
• Tidal Ventures
• Jelix Ventures
• Folklore
• Rampersand
• TEN13
• UniSeed
• AfterWork
• Antler
• Investible
• And more including accelerators, angels and syndicates here
  

Seed Fundraising for Crypto startups

I wanted to call out that fundraising for crypto startups is starting to emerge as a different type of track to ‘traditional VC’ fundraising which is both awesome and interesting.

At Galileo, we’re backing crypto startups and keen to see more founders across all areas, including NFT related, DeFi, protocols, consumer and enterprise.

The valuations in crypto land can be pretty wild as we’ve seen recent success stories of Coinbase, Binance, OpenSea and others.

Keep in mind that the same type of principles still applies – approaching your first round as a partnership, investors that can give support and have (some) experience and have a long term horizon is still all-important. Regardless of the underlying structures, you want to deploy over time.

What we’re seeing is that:

• Some companies are raising equity-round first (this is where we like to participate), before looking at doing private token sales and then progressing to public token sales.
• Founders should have a plan about what type of crypto company they’re building and where it starts and ends, e.g. will it become a DAO or will it stay private and centralised?
• Founders should have a think about what is the most appropriate structure and important given the problem they’re tackling too – it’s all a moving target right now!
• Valuations for token sales are high compared to similar-stage companies for equity (i.e. I’ve seen private token sale valuations between US$10-50m+ for pre-customer products) for a lot of different types of tokens – but equity valuations are closer to what we would typically expect in the first early rounds. Token and equity valuations may differ in the first rounds!

Crypto fundraising mechanics are a moving beast, but we recommend having a watch of Jesse Walden’s (former a16z crypto partner) video with TechCrunch on “Fundraising and Deal Structure” for crypto startups.

If you’re a first-time founder looking to raise the first round we want to hear from you! Apply today and we’ll aim to get back to you with real feedback from a real human. Galileo is an early-stage Australian VC firm based in Sydney, Australia.