A few days ago our portfolio startup Plenti made the news with a new $1.5 million Seed round. This was yet another milestone for the Warsaw-based on-demand tech rental platform and one that will significantly boost their growth in the months to come.
We would like to congratulate the entire team at Plenti and welcome the new investors on board. It is amazing to see the startup grow so fast!
We invested in Plenti in early 2020; now we have a chance to pause for a moment and reflect on our investment model and how it can be advantageous for both startups and investors.
The three core assumptions of the model are:
· Investing small tickets early, i.e. angel stage/pre-seed stage
· Bringing co-investors to the table early
· Startups skip the regionally popular seed ticket of c. $500k and move straight towards late seed rounds of $1.5–2$M.
Overall, we strongly believe that this model is super beneficial to both the startup and the early stage investor. Below we try to break it down to address the details.
1) Small tickets early on
The startup gets cash early and can deploy it to learn a lot faster. KPI requirements are set lower and the team can quickly focus on what matters — as opposed to bootstrapping all the way to a larger first round. Furthermore, there isn’t that much burn at this stage yet. Therefore the situation tends to be more comfortable for the founders than it would be if they bootstrapped hard, got all those liabilities, and found themselves running out of cash before they ever really began.
The investor has a favorable risk-reward profile, as the valuations are lower, but the risks around the team and market are generally very similar as in a typical seed round. It would be hard to argue otherwise — does hitting that 10k MRR threshold really change the big picture? We believe that it really comes down to whether this particular team can build something big enough in this particular market.
The caveat is to really limit dilution by raising just the right amount that will carry the project all the way to a larger late seed round. It is also worth noting that the CEO will have to start fundraising again relatively shortly after the first pre-seed round. How to minimize the risks associated with that? Ideally, by securing commitments of bridge financing, perhaps in the form of convertible debt, from your early stage investors.
2) Co-investors at a super-early stage
The startup enjoys far more access to smart capital from the very start. The co-investors will also come in handy when the startup fundraises again — just like in Plenti, where Allegro founders invested in our super-early round and followed on at late seed. Could you do it with a simple angel round? Sure, you could find a few angels by yourself as a founder and perhaps this would be great, too. But then is it generally beneficial to have this group of angels (or a syndicate) led by a fund with a clear, long-term investment strategy and a track record? We would argue that it is indeed.
The investor spreads out the risk and learns a lot faster. The exact ticket and equity stake per investor are minor issues — if you correctly pick the winners very early, the returns will be healthy anyway.
Yes, it does take some extra work to bring more parties to the table at an early stage — both for the startup, as well as the lead investor. Despite that, we are sure that the benefits here far outweigh the operational downsides.
3) Leap from pre-seed to late seed
The startup has a better blended cost of capital when these deals are properly structured. The mechanics here are simple: by leveraging a small early seed round, a startup can prove its traction and raise the late seed with an advantageous valuation. This, in turn, will improve the chances of meeting the requirements of Series A investors in the future. The cap table remains healthy and there will still be a lot of space for next rounds.
The investor should enjoy a healthy valuation increase between pre-seed and late seed — and it will happen relatively quickly, ideally within 12 months. This is a great opportunity to bring more smart capital to the table. The risks are further dispersed across a larger pool of investors.
A simple case study (with numbers)
Let’s look at a recently formed startup. The current stage is as follows:
· Fundraising: no cash raised yet, bootstrapping modestly. All equity in team’s hands.
· Product: raw MVP
· Traction: super-early traction with first few orders
· Strategy: determined to take the VC path and scale quickly
They have two main options right now:
1) Raise a quick pre-seed round, deploy the capital and work towards a major late-seed fundraising
2) Bootstrap and raise a typical seed round
Now let’s look at the mechanics:
In the first case, let’s say that the simple pre-seed terms are €150k for a 12% equity stake. This will provide a 9 month runway. After 9 months, with the support of investors, the startup is able to achieve a €20k MRR and has positioned its product and operations well for future growth. They can now raise €1.5M in late seed for a 20% stake. Their total seed fundraising is now at €1.65M, and post-dilution they retain 70%+ in the company. Their capital position will allow them to work towards a series A in the next 12–16 months.
The second case has a bit more variety to it:
· Some seed investors might be able to offer a larger ticket immediately, at the same valuation as the pre-seed investor does. So we are talking about €300k for 24%; €375k for 30% is not unheard of in the CEE. The blended cost of capital is incomparably higher than in the first case.
· If the startup doesn’t take that deal and decides to continue bootstrapping in order to secure better offers, they are risking growing too slowly — and this jeopardizes the whole project. Bootstrapping all the way to raise a late seed like the one from the first case will be difficult for most teams due to cash and network constraints. And so, even if they manage to secure a better deal, how much better will it actually be and at what time cost? Let’s say they are able to eventually raise €650k for 25% seed round (hats off if you can bootstrap to get there!). Now they have less than 5% left to give up in the company to raise the missing €1M — a daunting task, indeed.
Is this a one-strategy-fits-all thing? Certainly not. In many areas reaching a strong proof of concept within the constraints of the pre-seed ticket will be tricky. That being said, we really believe that you should always raise just the amount of money that you need — anticipating a decreasing cost of capital in the future.
At AIP Seed we have a lot of confidence in this model. There is just so much startup potential around the CEE, and more broadly, Europe — and we believe that a more systematic approach to early stage investing will be one of the cornerstones of future growth.
The market has been long plagued by low access to angel investment, which often barred teams from ever starting. If they eventually did start, it would prove difficult to make it to a decent seed round before they ran out of money from FFF or got tired of bootstrapping. This situation is definitely improving right now, and so we are seeing an increasing number of great teams build their success story by leveraging the opportunities now present across the CEE. We are really excited to be a part of this pivotal story.