Raising pre-seed or seed funding is one of the most exciting yet challenging phases for any startup founder. You're not just pitching your idea; you're building trust with potential investors while trying to maintain momentum. One of the smartest strategies to navigate this process is tranching, which involves splitting your total funding target into smaller chunks raised at different valuations over time.
This strategy is gaining popularity among founders because it allows you to reward early investors, create urgency, and maintain flexibility—all while inching closer to your larger funding goal. In this article, inspired by insights from Hustle Fund VC’s Elizabeth Yin and my own experiences, we’ll explore how to raise pre-seed / seed funding in tranches.
Let’s dive in and understand why tranching might be the fundraising secret sauce you’ve been looking for.
Why Should You Tranche Your Fundraising?
At the early stages, it is relatively difficult to accurately arrive at the valuation of a startup, since there is usually very little (financial) data available. Thus, traditional “round-based” (equity) fundraising is becoming less common, particularly in the early stages.
Many pre-seed and seed rounds are now raised using SAFEs (Simple Agreement for Future Equity) or Convertible Notes instead of equity rounds. These tools make the fundraising process faster, simpler, and more founder-friendly.
What Makes SAFEs So Useful?
SAFEs, introduced by Y Combinator in 2013, are simple legal agreements allowing startups to postpone assigning a valuation to their company. Instead of focusing on valuation during early stages, you agree on a valuation cap or discount rate with the investor.
Benefits of SAFEs include:
No need for a Lead Investor: You can close deals with individual investors without needing a syndicate.
Flexibility: Raise funds in parts and at different terms (i.e. valuation cap, discount rate).
Low Legal Costs: SAFEs are ready-made agreements that require minimal customization.
This flexibility makes SAFEs the perfect tool for tranching your fundraising.
Download the SAFE agreement on the YC website, and mutually sign with your investors. The new version (Sept-2018) incorporates certain changes, which are here.
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What is Tranching, and Why Do You Need It?
Tranching is simply dividing your fundraising goal into smaller portions, or "tranches," and raising these amounts sequentially. Each tranche can have a different valuation cap, allowing you to incentivize early investors with better terms.
For example:
You can just take 1 tranche now at a lower valuation, and then raise subsequent tranches later at higher valuations.
Or, you can split the finding in to 2-4 different time periods or at various pre-defined milestones, albeit at same valuation.
Or raise all at one stroke at a much lower valuation.
Unlike equity, this flexibility of raising in tranches is gold.
Why Does It Work?
Rewards Early Investors: Early investors face more risk, so offering them lower valuation caps is a fair reward.
Creates FOMO/Urgency: Limited time offers for each tranche encourage quick decision-making by indecisive investors.
Tests the Market: By raising smaller amounts first, you can gauge investor interest and adjust your strategy.
Improves Momentum: Even a partially completed tranche can generate the FOMO/urgency and build confidence among later investors.
Notably, you can also decide on a valuation cap that is different for each investor. No longer does everyone have to be in the same round with the same terms. This makes sense because your investors should all be different in their "value adds" so shouldn't they get different terms?
How to Tranche Your Fundraising?
Here’s a practical guide to implementing the tranche strategy.
Step 1: Define Your Total Goal and Tranche Sizes
Let’s say you need $1 Mn in pre-seed funding. Now, if you go to investors and ask them to give you the full $1 Mn, most of them won't commit so easily. Why? Because it's always better for them to wait until other investors commit, and investors know they've enough time to twiddle their thumbs. Not a good situation for any entrepreneur!
However, let's say, you're lucky to get a lead investor, who agrees to invest the full $1 Mn albeit at $3 Million Pre-money valuation, your equity dilution would be as below:
Post-money valuation = Pre-money valuation + Investment amount = $3,000,000 + $1,000,000 = $4,000,000 ($4 Mn)
Investor's ownership (%) = (Investment amount / Post-money valuation) x 100% = ($1,000,000 / $4,000,000) x 100% = 25%
At a pre-seed round, you are in the weakest negotiation position (with investors) than you'll ever be. You don't have the leverage, but, to agree to 25% dilution.
Enter the tranche strategy, and here's how you do it.
Instead of raising $1 Mn all at once, divide it into smaller tranches. For e.g.:
Tranche 1: $300,000 at a lower valuation cap e.g. $3 Mn (rewarding the early backers, and using that as a leverage for later tranches).
Tranche 2: $300,000 at a slightly higher cap e.g. $4 Mn.
Tranche 3: $400,000 at the highest cap e.g. $5 Mn.
With tranche strategy, you not only save 1.52% in equity ownership, but enhance your chances of fundraising.
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Step 2: Set Terms for Each Tranche
For the first tranche, offer a lower cap to attract investors quickly. For e.g.,
We’re raising the first $300K at an $3 Mn valuation cap, but this offer is only valid until [specific date] or until we hit our $300K revenue milestone.
This exclusivity rewards early movers while signaling to others that the terms may not last.
Step 3: Create Momentum
Once you start filling your first tranche, let other investors know:
Hey, just an update - we’re almost full on the first tranche with only $100K left. After this, the cap will go up.
This approach builds momentum and creates FOMO/urgency for indecisive investors.
What Happens After the First Tranche?
Once the first tranche is filled, it also allows you to test the pricing of the cap. You've 2 options here:
Assess the Market: If raising the first tranche was quite easy (you've a TON of demand), it means the cap was set low, consider increasing the cap for the next (second) tranche.
Postpone Further Fundraising: If raising was quite a challenge (i.e. no demand), then either the cap was set too high or no one seems interested. In case of "no demand" pause to reevaluate your pitch or achieve a worthy milestone before continuing.
By testing with a small first tranche, you're not giving up much equity. Even if you priced it too low, that momentum is still valuable to you.
Once you've got some money in your hands, you need subsequent cash even less. So, now you can afford to ask for a higher cap on the later tranches. It's less critical than the first tranche. Once you're close to using the first tranche, it is time to go to the rest of the investors, and keep them abreast of the situation.
Hey, just wanted to let you know, we now have $100K left of our first tranche. After that, the cap (in the 2nd tranche) is likely to go up. Would you like to be in?"
Subsequent Tranches
Once you fill the first tranche at those special terms (i.e. lower cap), you can assess whether it was easy or hard to raise. If it was hard, you might not want to increase the cap, or consider postponing the rest of the raise depending on your learnings.
Can You Use This Strategy with Large Investors?
During fundraising, the founders should talk to lots of investors - big and small.
If you’re speaking with larger lead investors, let them know:
We’re raising a $1M round and starting with smaller checks via SAFEs/Notes. Would you like to review us for a larger check?
Lead investors may consolidate your SAFEs into a single equity round later. This is how to reconcile lead investors into this process. However, if no lead investor comes forward, you can continue raising smaller amounts using tranching.
Benefits of Tranching in Pre-seed and Seed Funding
Minimized Risk for Founders: Testing the waters with smaller tranches helps you avoid overcommitting to unfavorable terms.
Increased Investor Interest: Early movement on a tranche creates urgency, and makes other investors more likely to jump in.
Flexibility: Adjust terms as you learn from market feedback.
What About Later-Stage Rounds?
While tranching works brilliantly at the pre-seed and seed stages, it’s less practical for late-stage rounds. The larger checks require more due diligence and standardized terms. However, you can still use urgency tactics - such as setting deadlines for commitments or highlighting traction milestones - to maintain momentum. And since it’s late-stage, hopefully, the traction speaks for itself unlike in the early stages.
Summary: Why Tranching is a Smart Move
Raising pre-seed or seed funding in tranches is a win-win for both founders and investors. Founders gain flexibility and momentum, while investors receive fair rewards for early commitments.
By dividing your funding goal into smaller parts and offering varied terms, you can create urgency, build trust, and ultimately secure the resources your startup needs to grow. If you’re an early-stage founder, consider adopting the tranche strategy for your next raise. It could be the edge you need to succeed in today’s competitive startup ecosystem.
Content updated on 2-Jan-2025.
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Related Article: How Convertible Notes and SAFE Notes Affect Your Equity Ownership?
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