I’ll try my best to share how I think about diligence at the Pre-Seed stage in 2021. The main idea I try to keep in mind here is that the right amount and type of diligence can create the same conviction pre-traction that we need at the Seed and Early Venture rounds. The diligence is entirely different, however. Let me explain.
First, I think we need to push back on conventional venture wisdom to invest in companies that are going after large markets and can generate massive outcomes. At the Pre-Seed stage this is pretty much impossible to do. So, I think it’s important to focus on the 5-9 month window after funding and what the team needs to achieve in terms of meaningful milestones. We are fine with the market looking small because if the product is successful then there could be a larger meta-market that it can raise funding for. The two major founder character traits here are the Founder-Product Fit (FPF) Test and the ability to execute at an incredible level. FPF is an analysis to see if this founder has the right insight, relationships, and skill-set to reach Product-Market Fit eventually. We know what world-class execution looks like.
Second, thoughtful product strategy trumps fundraising, marketing, and distribution strategy. These founders must be maniacal about making the product better all the time, which includes knowing the user-hangups with the most popular applications is an important part of the end analysis. To continue the example, if the company-under-diligence can show that a rough, unsmooth product works, then we can back into market analysis. I think it’s important to think about what will get consumers to bend over backwards to use the product as an initial question in this analysis. It’s okay for this to be a working hypothesis (for us) that’s revised over the course of conversations before investing into the company.
Finally, the FPF analysis might only show that these entrepreneurs can crack the PMF nut and only that. What I’m saying here is they may not be great operators for a big company one day. This might be their first company. They could be uncomfortable owning a P&L. What should concern us is the founder profile that tends to succeed in Pre-Seed:
- Does the funder have a unique insight into the market opportunity;
- What is the contrarian point of view on product versus incumbents in the space;
- Is there some history of moving with speed;
- Can the business grow over the nine month period post-investment? If they grow as the company matures, all the better. That’s not the driving element of the investment thesis, though.
The Pre-Seed stage is interesting and is worth looking at given the potential return profile. Further, we are classical Seed investors and we tend to have one crack at a deal (maybe two); rolling up our sleeves and doing Pre-Seed investing gives us a meaningful look with the opportunity to build a strong founder-investor relationship.
Ruminder D. 