The Emergence of “Pre-Seed” Capital

Notation Capital, founded by former Betaworks folks, is a new pre-seed investment fund launched a couple of months ago. 

Notation Capital is attempting to institutionalize the round of funding that’s usually done by “Friends and Family”. With just an idea and a co-founder, one could actually raise up to $500K in exchange for 5% to 10% of equity.

Really, pre-seed investing isn’t anything new. A few years ago, these rounds were simply known as seed or angel rounds, lead by early stage investors like SV Angel, Lerer Ventures, or Thrive Capital. Startup accelerator programs like TechStars and Y Combinator also use a similar model.

The thesis here is clear – firms are entering both from below and above the traditional VC-backed period of a startup lifecycle in hopes of capturing more of the returns generated by high growth companies. This is why we continue to see more large and institutionalized seed rounds (by pre-seed capital funds), as well as more large and highly-valued growth rounds (by public and/or PE funds). 

From a risk/reward perspective, I think funds with “bookend” strategies (either preceding or following the traditional VC funds) likely have lower return thresholds. What would be interesting is to see a partnership between very early and pre-IPO strategies – if one could be used to identify the winners and the other used for putting more capital behind those winners. 

Exitround and its effects on behavioral economics

The latest and greatest in the world of acqui-hires is Exitround, a startup who helps other startups get acquired by tech giants. 

My first reaction was skeptical. I’m not bullish on any startups who build their business model around unique market trends. This reminds me a bit of SecondMarket, who started their business in secondary transactions for private companies. As that market declined, it became necessary to pivot and today, SecondMarket is a provider of financial services for private market transaction (including fundraising.)

I’m also not sure if Exitround helps the startup ecosystem. If anything, it would increase the friction between founders and investors by further mis-aligning incentives. In doing so, Exitround would also be meaningfully increasing the noise to signal ratio.

That aside, here are a couple of areas I think Exitround can help:

  • Downside anchor – Exitround essentially reduces founders’ risks by providing a baseline for the downside case scenario. For all those talented folks who are risk adverse, Exitround gives them an extra reason to take the leap.
  • Market efficiency – As a economist by trade, I’m a big fan of market efficiency. Exitround essentially lowers transaction costs and increases liquidity in the market, thus increasing market efficiency as a whole.
  • Resource allocation – One of the tragedies of the Bay Area is the reality that many great minds are helping solve seemingly unimportant (or, very 1%) problems. Acqui-hires allow brilliant young minds, who don’t have the benefits of experience, to help solve a problem they can’t think up themselves. On the other hand, Googlers have confessed that hundreds of very smart people are doing the most mundane tasks. Do tech giants really need to amass more talent?

I think where Exitround will really excel in a down-market, where small, talented startups will not have the revenues or the access to funding to keep afloat. And despite our best current efforts, the economy will remain cyclical and a down-market is in the cards.