Is Pre-Seed Venture Capital A Smart Investment?

On Wednesday I tweeted a link to an article in the Wall Street Journal about Notation Capital.  They’re a Micro-VC fund that just raised $8 million to participate in pre-seed venture capital investments in New York City. 

There has been a recent spark in these types of funds but they make me curios about the end game.

There are several Micro-VC firms like this one, most notably, Brooklyn Bridge Ventures.  I follow Charlie O-Donnell on Twitter and read his blog regularly.  He’s an offspring of USV and the main “pre-seed” guy I watch to see how it shakes out.

Notation Capital says that they’ll reserve half of their fund to allow them to participate in future rounds.  They also state that their typical investment will be between $100,000 and $200,000.  That means they’ll be able to back somewhere around 26 start-ups if they average $150,000.  They’re looking to hit 30.

No doubt pre-seed venture capital is risky.  It’s likely the riskiest form of venture capital investment, but it could also bring big returns.  The VC world started seeing early stage funds as the risky dudes looking to get in early (usually after angels) in hopes of higher returns.  Then the industry moved to seed, now pre-seed.  Are these guys pushing the envelope?  I don’t know yet.

I like the idea of pre-seed venture capital, but I’ve seen this work out better when the firm takes an advisory roll, helping get things structured before they make a financial bet.  This is why you typically see the first investments coming from Angel Investors.  Once the idea is working, Venture Capital will come in with a large check.  The initial investments Notation Capital is making are angel sized investments.  So their acting as the Angel and the VC.

What really intrigues me about pre-seed funds like Notation Capital is their reserve amount.  They’re keeping $4 million for future rounds, that seems low to me.

We like to invest very early.  Getting an idea off the ground is fun and rewarding, so I certainly understand the approach.  But my thinking differs a little on the subject than most I assume.

Of the 26 start-ups they’ll back, let us assume that 8 will make it to a second funding, which is typically where venture funds come into the scene.  I’d like to have more than $500,000 to invest in each at this point.  Moreover, as an LP, I’d like to see the entire $8 million disbursed within 5 years.  Pre growth companies can take a while to gain traction so I doubt they’ll be able to participate in all their second rounds within 5 years.

To that point, I feel that pre-seed funds should raise their fund with the expectation that they’ll raise a Legacy Fund 3 to 5 years after raising the pre-seed fund.  The Legacy Fund would then act as the typical Venture Fund and have a longer horizon.

I don’t know what the returns will be on these funds in 10 years, but it seems to me that most pre-seed investments will be pushing the 10 year threshold for exit, although I’ve seen some successful exits in just 2 years.

I’d really love input on this in the comments. So please fire away.  And feel free to disagree with me, in fact, I hope you do.

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