On Tuesday, I wrote a post to help define pre-seeds and give context to their rise. You can find that here. On Wednesday, my partner David wrote about how we’ve been using our office space (and network and other resources) to support pre-seed companies. Today, we continue our look a this trend by getting more specific about our approach to these rounds as institutional seed investors.

At NextView, we consider ourselves to be High Conviction, Hands-On Seed Investors.When we talk about seeds, we mean your first outside round of financing at the earliest stages of your business. Looking back at our current fund, 75% of our initial investments were made when the company was very much pre-product. We don’t delineate between seed or pre-seed rounds, but as that definition has come into vogue, it’s clear that we are quite active as both “pre-seed investors” and “institutional seed investors.”

In my prior post, I talked about the rise of the pre-seed and a more nuanced definition of a pre-seed based on milestones, not financing labels. In short, I believe that the most accurate definition is this:

A pre-seed is an early round of financing that is designed to help a company achieve certain intermediate milestones PRIOR to the magic combination of strong PMF + meaningful traction.

These rounds can be a variety of sizes, and are usually at the earliest stage of a company’s life.

But let’s make this more concrete in the context of an entrepreneur raising a round:

How NextView Approaches Pre-Seed Rounds

At NextView, we pride ourselves as being a “one-product company.” This means that we have resisted the temptation to create a “pre-seed program” or some structurally different approach to investing in different sorts of companies. All of our investments are equally meaningful to us, and we don’t distinguish based on stage, check size, board involvement, etc.

So when it comes to what the market regards as “pre-seeds,” we simply do the same things we typically do, but slightly tuned to this stage of company. But we still think of these investments in terms of milestones and conviction. I’ll also share some other criteria we consider as well as some brief examples below.

Milestones:

For every investment we make, we detail the specific value-accretive milestones that a company will seek to achieve during our funding round. We also think about both the actual value creation as well as the external “credit” the company will get for this value creation (not always one and the same in the short term — this is a topic for another post).

Ideally, a funding round gets you to a value inflection point. As a founder, you and your team are building value every day, but there are certain step-function moments where the value creation significantly increases. This is the best time to fundraise because that’s when you are able to command a meaningfully higher valuation for your next round to minimize your own dilution.

So, when we do a pre-seed, it’s almost always because we perceive there to be a step-function value inflection point that is worth targeting in the near term, prior to fully establishing PMF and traction. We work with the founders to lay out these specific milestones in some level of detail, and then we work backwards from there to think about a funding plan that allows them to achieve these milestones (or not) with some level of cushion.

Conviction:

When it comes to conviction, we tend to ask ourselves two questions. First, do we have full conviction around this investment? Regardless of check size, the reality is that the earlier a company is in its lifecycle, the more time we tend to spend with founders. This is not a passive pre-seed program, so our team pushes each other to make sure that we do have full conviction around this investment, even if the initial check size is smaller and the milestones to be hit are not PMF or substantial traction, as they would be with a more sizable seed round.

The second question we ask ourselves is if it makes sense to do a full institutional seed instead. This comes down to our conviction around the risks associated with the various milestones and our conviction around the composition of the team. (If you wanted to go deeper into my personal decision-making workflow, here’s a flowchart we published last year.) If there really isn’t a great value accretive near-term milestone, then a pre-seed doesn’t really get you anywhere. On the flip side, there is some substantial near-term hurdle to clear that is critical for the company, or if the founding team is incomplete, it may more sense to stage the financing appropriately.

This staged approach is often much better for the founders as well. It creates focus and discipline and instills pressure to remain lean and not expand the team too quickly. Paul Graham has written that he’s found that small teams tend to get the most done early on and that expanding the team too quickly is a mistake that he often sees among YC companies. We tend to agree here.

One practical way that we’ve found to be helpful at this stage is simply to be co-located with each other. This is why most pre-seed companies have worked in our offices with us, right in our main co-working area. This allows the founders to save on rent but, more importantly, easily draw on the human capital of the full NextView team and our extended network. In some cases, we have regular standup meetings with the founders, but in other cases, it’s more free-flowing. My partner David wrote yesterday in greater detail about some of our learnings from co-habitating with pre-seed companies.

Criteria:

It’s always tricky to define criteria for an investment. The reality is that we look at pre-seeds the same way we look at larger seeds (do you sense a trend here?). But we emphasize a couple things a bit more

First, as discussed, we look for strong alignment around milestones. Second, we tend to look for situations where the founder has very strong founder/market fit. Third, we look for founders that are customer obsessed, and are inclined to do the careful work of customer development that makes the pre-seed really productive. Fourth, we look for opportunities that we think can scale to be very large, important companies. Even if our initial investment is small, the goal of a pre-seed isn’t to own a big piece of something with a smaller terminal value than a larger investment, but to get a huge company off to the best possible start as early as possible.

Examples:

Below are couple examples of companies that we’ve worked with and invested in after having strong conviction and meeting the criteria above. (Both aren’t public just yet, so I can’t reveal the company names at this point.)

The first is a consumer focused company that is in a highly regulated industry. In this case, the intermediate milestones were (1) recruiting a technical co-founder and a team member who could help handle the regulatory challenges, (2) strike a partnership that would be critical for the company to operate, and (3) create more definition around the initial product offering. This was accomplished with $250K of funding in about 6 months.

The second was a B2B SaaS company with a particular product thesis that needed to be tested prior to their building out a larger team or a commercial-grade product. In this case, it was a two-person founding team, and the exercise was to essentially convince a few customers to provide their data to the company so that the founders. The duo then hacked together a service to analyze where there was signal in this data, and send those lessons back to the customers. One major test was whether they could mine the data well enough to then help their customers take valuable actions based on the signal, all of which could then be productized. This took about 6 months as well.

Addressing the Common Question of Adverse Selection

In my last post, I ended with a question that sometimes comes up. The question is, “Do pre-seeds actually result in adverse selection? Otherwise, why wouldn’t a team just be able to raise a larger seed round?” Here’s my view on this:

First, there is indeed a risk that a pre-seed round ends up being a vehicle for adverse selection. This is why we try to avoid this through some of the mechanisms described above (conviction + criteria). But this is a risk.

Second, pre-seeds do tend to attract less proven founders, but that’s different than saying “lower quality.” But being “proven” has less to do with actual quality than it does a knowledge gap. Many times, we just don’t know founders well enough, or it’s difficult to really ascertain whether a founder is good, great, or exceptional prior to working with them. This is especially true for foreign founders who may enter the US with a limited network and a prior operating track record that is harder to evaluate (though we’ve invested in several successful companies that made this very move). But my point is that some of the very best founders we’ve worked with have been “unproven” — and this is not just true for our portfolio but also for some of the very best companies ever to be created.

Third, a pre-seed isn’t just about economics for an investor or the difficulty of fundraising. Pre-seed rounds also give founders surprising freedom and flexibility where a larger round would not. Going into a smaller pre-seed, everyone should be on the same page about the goals and risks ahead. If it looks like early experiments are not going in the right direction, it’s actually easier at this point to have a conversation with us as your investors about what that means. Is there a promising pivot to look into? Should we just consider it a failed experiment and move on to something new?

Time is a founder’s most valuable resource, and so a founder would want to be in a situation where he/she can retain flexibility around their time commitment to a project and not feel compelled to grind something out if they don’t believe in it. But that obligation exists more frequently after raising an institutional seed round or even jumping right to Series A. This is why we typically recommend not building a huge syndicate during a pre-seed — you want everyone involved to be on the same page around what success does or does not look like. On the other end, it’s very possible to emerge from a failed pre-seed in better standing as a founder than when you started. But I find it’s harder and harder to do that the more capitalized a company gets.

So, that’s how we think about our pre-seed investing here at NextView. Above all, we frame pre-seeds as a natural part of our singular focus on being your first outside investor and helping startups gain initial traction. Sometimes that requires what others are calling pre-seed. Sometimes that requires what others think of as an institutional seed. But rather than think in terms of round labels, which not only change frequently but are actually NOT the point of founding a company, we prefer to think about company progress.