The state of pre-seed investing in 2023
It's pre-seed, but not as you know it
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Yesterday, PreSeed Now hosted a roundtable discussion for pre-seed investors, looking at the state of the market right now.
It was a really interesting discussion, attracting investors (and a few founders who hustled their way in!) from across the UK. So today we’re breaking from our usual format to share the points the talk brought up.
Read on if you want to understand how investors are thinking about pre-seed right now.
The roundtable took place at the Climb23 conference in Leeds, where I was also interviewed on stage by Aleksa Vukotic of thestartupfactory.tech about how founders should think about attracting attention and communicating their offering.
That was a fun session, so thanks to everyone who came along.
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The state of pre-seed investing in 2023
This article is based on what investors and others at the PreSeed Now roundtable event yesterday shared, along with thoughts inspired by other conversations I’ve had recently on the topic.
Pre-seed used to be that small initial investment in a founder at the very beginning of their startup’s journey. Maybe they’d built an MVP and they were pre-revenue, but that money helped get a promising founder off the starting blocks to validating their business.
Pre-seed in 2023 is very different. In the current climate, it’s often the case that only ‘spectacular’ founders–those with outstanding founder-market fit or with a successful exit already under their belt–can raise a traditional pre-seed round.
Many investors now seek founders with early traction and revenue, even at this earliest stage. For them, it’s about supporting entrepreneurs who have shown they can support themselves.
If you’re a B2B product business, this might not be the end of the world.
Sure, raising that first round is harder than when interest rates were low and all you needed was the right pitch and a twinkle in your eye. But hacking together an early version of a product that proves you can make money isn’t bad discipline for showing you’re investable.
That said, the current approach from early-stage investors leaves a question over how deep tech startups, often university spinouts, find their first investment.
Spinning out about spinouts
University spinouts are often R&D-heavy businesses that are years away from generating revenue. But they have the ability to change the world and reap huge rewards if their cutting-edge tech eventually breaks through.
Being one of the first into a successful deep tech business can be an enormous win for an early-stage investor, but the appetite for these kinds of deals is lower than it once was because of how risky they are.
The message to deep tech startups from the investors in the room was to focus more on grant funding from the likes of Innovate UK for longer, and find ways to monetise earlier, even if the core product might be years away from realisation.
That might not be so easy. It comes at a time when figures show grant funding in slight decline, while the long-bemoaned problem of universities hobbling their own spinouts by hogging the cap table remains unresolved.
Some universities and investors argue that cap table hogging is not really an issue, and that any problems can be ironed out in negotiations, but from what startups and investors say, it’s clearly still a problem in some parts of the country.
The problem, we’re told, isn’t that the university tech transfer offices are out of touch with the needs of startup. It’s more that higher-ups at some universities simply don’t understand how spinout cap tables need to be structured in order to leave room for sufficient later-stage investment.
If a university spins out a startup while taking only a small equity stake, all those bosses see is a university failing to make the best return on their research.
The emergence of spinout-focused venture builders that specialise in commercialising university IP is a positive development in this space.
But companies like Cambridge Future Tech, Post Urban Ventures, and Bulldozer tend to take very hands-on involvement in the startups they help spin out at first. That limits the number they can support at any one time.
Dealflow and startup hype
Judging from my own inbox in recent months, dealflow is very active right now. Pre-seed investors very much agree they’re spoiled for choice.
Some investors at our roundtable had concerns that ‘hype’ around launching tech startups and raising investment can set founder expectations too high.
Not all those startups are up to scratch. Wannabe founders armed with nothing but an idea and a dream of a big exit have started to return to investor inboxes at a time when there is very little appetite for that kind of deal.
That said, overall, startups today are arguably better than they have ever been. The level of education and community knowledge available to founders is way ahead of what was available just a few years ago.
That means for all the founders with unrealistic expectations, there are plenty who are of a much higher calibre at a much earlier stage than could have been expected just a few years ago.
Still, there’s a strong feeling that more founders need to learn to understand how investors think and what their motivations are. This is a problem that led me to create the (now slightly out of date) Making Sense of VC podcast series a few years ago.
More hands-on help in this regard can be found from good-quality accelerators and startup support programmes, but it’s clearly an area that needs more work in the UK.
A bit of hype can be a good thing
There’s a counterpoint to the argument that startups should avoid ‘hype’. What some early-stage investors see as an unrealistic round size might look to others like a lack of ambition, and setting their bar too low for achieving growth in competitive markets.
One founder I spoke to recently told me she has no qualms about pitching for what some would see as a large pre-seed round, because she has belief in her product, her timing, and her qualities as a founder.
And what some investors might see as detachment from market realities could be seen by others as exactly the self-belief, tenacity, and vision that can thrive if it’s substantially backed at an early stage.
A bit of hype, vision, and excitement isn’t a bad thing, some in the room felt. Let’s face it, the UK is hardly like Silicon Valley was not so long ago - awash with investors chasing me-too deals with hyped-up startups that end up going nowhere.
Can UK startups really make a mark on the world stage if they’re all founded by dead-eyed realists?
When the economy is in a good place, the goals of investors and founders are often aligned. Not every tech startup should take venture capital, but it suits many.
Right now, the attitude of the typical investor isn’t fully aligned with the typical founder. There’s no easy answer to that, as both sides have good reasons for feeling like they do, but it makes life harder for everyone.
Opening up more opportunities for founders around the UK, some VCs who previously focused on London now have targets for the number of investments they should do with startups based outside the capital.
While this is great for regional diversity, diversity among the founders who get funded is still a real problem that needs fixing, and one that investors narrowing their focus and slowing the pace of their deals might feel less pressured to address.
Investors setting a higher bar is an emotive topic for founders who pour their hearts and souls into their startups. ‘Pre-seed’ just isn’t what it used to be. The culture and approach to early-stage startups that sprung up in the wake of Y Combinator and The Lean Startup just isn’t the reality anymore.
You could argue that the kinds of ‘pre-seed’ deals investors want to do these days are more akin to a small seed round. But hey, ‘Small Seed Now’ just doesn’t have the same ring to it as a newsletter title, does it?
– Thanks to Samantha Deakin for copious note-taking during the roundtable –
Back next week
Normal service resumes on Tuesday, when we’ll have another compelling early stage startup for you.
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