Raising Seed Capital? Why Smaller Rounds Make Sense (Now More Than Ever)
Having been in the founder game for over two decades, I regularly see a worrying trend among new founders: the pursuit of raising millions in their initial funding rounds. While chasing big numbers is tempting, I advocate for a more sustainable approach—raising around $500K in pre-seed funding and focusing on generating revenue, even if it’s modest, particularly when your product isn’t fully developed. This strategy can set the stage for more substantial funding while grounding your startup in real-world market feedback and financial discipline.
Look, I get it. You need that $1-2 million to build your vision. But if you’re raising your first cheques beyond friends and family, there are ways to make your life much easier. If I had my way, I would never let a founder raise more than half a million dollars right out of the gate. Even if you had a product that warranted that type of capital, if you haven’t gained substantial revenue or traction or have demonstrated you can manage a small amount of capital, you’re asking for more complications in an already incredibly complex challenge.
The Power of a Lean Pre-Seed Round
When you start with a smaller funding round, you’re forced to prioritize. With limited resources, every decision, from product development to market entry, must be strategic and efficient. This lean approach conserves resources and fosters a culture of innovation and agility within your team.
I’ll be direct. Any minimally competent founder can take a couple of million dollars and build something that makes money—but that doesn’t mean the company will generate an ROI and be viable in the long run. The formidable founder investors want to trust with their money can do more with less. I always say to start with 1% of their trust and earn the other 99%. In other words, starting with a $1 investment and then asking for the other $99 will be much easier.
Generating Revenue with an Unfinished Product
The key to success in this early stage is generating revenue, even if your product isn’t fully fleshed out. Here are some ways to think about it that demonstrate traction and prove to investors that you would be fine with or without that (that creates the FOMO you want).
- Minimum Viable Product (MVP): Develop a basic but functional version of your product. It should solve the core problem for your target customers without all the bells and whistles.
- Pre-Sales and Subscriptions: If your product is software or a service, offer early access or pre-sales at a discounted rate. This generates initial revenue, builds a customer base, and provides valuable feedback.
- Beta Testing Programs: Charge for beta access, allowing customers to shape the product. This approach can validate your market and generate early revenue.
- Licensing or White-Labeling: If applicable, license your technology or product to other businesses. This can be an effective way to generate revenue while expanding your product’s reach.
- Consulting Services: Use your team’s expertise to provide consulting services related to your product. This can support revenue while you’re still refining your product.
The above can easily be accomplished for under $100K or less. You could even bootstrap with your personal funds and make revenue your first investor after you make it. That’s a much more compelling story.
How I “Faked” My Startup to Make Money to Build It
My first HRTech SaaS started with a PowerPoint presentation, and the software was a bunch of Excel spreadsheets. I sold the concept to the first client and then asked them how much they would pay. They told me $3K, and I told them to give me a week.
Here’s the thing: They had no idea that the software did not exist. I totally faked it by making all the deliverables by hand. I did that enough times to make over $100K and invested that into building the first MVP. The best part was I already knew what to build and what would make more money. Even better, I only took a couple of small angel cheques for a grand total of $10K. I interviewed at Y Combinator, which was incredibly validating and helpful, but I didn’t go because I got an offer to sell the company.
Full disclosure: My interviewer at Y Combinator gave me the feedback I needed to get to product-market fit. And the fact I interviewed in the first place created the right FOMO to initiate the acquisition.
Benefits of a Smaller Upfront Round
- Less Dilution: Raising a smaller amount initially means giving up less equity. This is crucial for maintaining greater control over your startup and reaping more benefits in the long run.
- Greater Focus: With a smaller budget, you’re more likely to focus on what’s essential, avoiding unnecessary spending and making your business model more efficient and scalable.
- Proof of Concept: Generating revenue early on, even in small amounts, validates your business idea. It demonstrates to future investors a market demand for your product.
- Easier Subsequent Funding: Once you’ve shown that your business can generate revenue and grow with a lean budget, raising more significant amounts in later rounds becomes easier. Investors are more likely to bet on a company with a proven track record, even if it’s brief.
Before the HR SaaS, my first startup was acquired by an international family office. My new CEO once told me, “Ed, access to too much capital leads to undisciplined decisions.” I couldn’t agree more, especially in today’s market conditions. The economic cycle has reset, and there’s a new normal for startups until conditions get frothy again and capital becomes abundant (leading inevitably to lower-quality startups, but that’s how cycles go).
As tempting as it might be to aim for a multimillion-dollar seed round, there’s wisdom in starting small, particularly in today’s unpredictable market. By raising around $500K in pre-seed funding and focusing on early revenue generation, you create a strong foundation for your startup. This strategy not only tests the viability of your product in the real world but also sets you up for more substantial and successful funding rounds in the future. Not to mention that you can then raise capital using alternative vehicles such as revenue share, which I’m working on with platforms like Raze.finance.
Remember, in the world of startups, it’s often the case that less is more, especially at the beginning. Go show the investors what you can do!