It is often said that “There’s not a lot of ‘fun’ in funding.”
Raising equity funding for your startup is a long, difficult, and often demoralizing process. However, if you are successful, you walk away with money that will help your startup grow and become everything you hope it could become.
Startups don’t just raise a lump sum of cash or get a startup business loan and then be set up for life. In fact, the number of times startups are going back to the market to raise more capital has been growing. Each of these raises is known as a ‘funding round’. So, when you hear discussion of Series A, Series B, Series C or D funding rounds, these terms are referring to the processes of growing a business through outside investment.
How Funding Works: Before exploring how a round of funding works, it’s necessary to identify the different participants. First, there are the individuals hoping to gain funding for their company. On the other side are potential investors. While investors wish for businesses to succeed because they support entrepreneurship and believe in the aims and causes of those businesses, they also hope to gain something back from their investment. For this reason, nearly all investments made during one or another stage of developmental funding is arranged such that the investor or investing company retains partial ownership of the company; if the company grows and earns a profit, the investor will be rewarded commensurate with the investment made.
Pre-Seed Funding: The earliest stage of funding a new company comes so early in the process that it is not generally included among rounds of funding at all. Known as “pre-seed” funding, this stage typically refers to the period in which a company’s founders are first getting their operations off the ground. The most common “pre-seed” funders are the founders themselves, as well as close friends, supporters, and family.
[Read Also: 5 subject areas to develop Nigerian youths]
Seed Funding: The very first money that many enterprises raise, whether they go on to raise a Series A or not, is seed funding. You can think of the “seed” funding as part of an analogy for planting a tree. This early financial support is ideally the “seed” which will help to grow the business. Given enough revenue and a successful business strategy, as well as the perseverance and dedication of investors, the company will hopefully eventually grow into a “tree.”
Seed funding is used to take a startup from idea to the first steps, such as product development or market research. Seed funding may be raised from family and friends, angel investors, incubators, and venture capital firms that focus on early-stage startups. Angel investors are perhaps the most common type of investors at this stage.
This is also the end point for many startups. If they cannot gain traction before the money runs out (also known as running out of runway), then they’ll fold. On the other hand, some startups decide that they are not interested in raising more money – that the level they reach with seed money is good enough or that they’re able to grow more without more investment and choose to stop raising funding rounds at this point.
Series A Funding: Once a business has developed a track record (an established user base, consistent revenue figures, or some other key performance indicator), that company may opt for Series A funding in order to further optimize its user base and product offerings. In this round, it is important to have a plan for developing a product that will generate long-term profit.
In Series A funding, investors are not just looking for great ideas. Rather, they are looking for companies with great ideas as well as a strong strategy for turning that idea into a successful, money-making business. For this reason, it’s common for firms going through Series A funding rounds to be valued at up to $15 million.
By this stage, it’s also common for investors to take part in a somewhat more political process. It’s common for a few venture capital firms to lead the pack. In fact, a single investor may serve as an “anchor.” Once a company has secured a first investor, it may find that it’s easier to attract additional investors as well. Angel investors also invest at this stage, but they tend to have much less influence in this funding round than they did in the seed funding stage.
It is worth noting that you may also hear about “Series AA”. This comes from a 2008 Y Combinator simplified set of Series AA Preferred Stock financing documents, which helped streamline early stage equity investments from angel investors. So, while sounding like a Series A, Series AA refers to a seed round from angel investors or a VC seed fund.
Every investor looks for something different, but there are several universal metrics potential investors use to measure a startup, including:
- Product/Service Evaluation. Can the team satisfy market needs? Does the venture have users/consumers, and is it receiving positive feedback from them?
- Market Awareness. What is the target market demographic of the company? What is the ideal customer? How do they behave? Is the market large enough to support the company, or is there an exit strategy in place?
- Competitor Assessment. Who are the direct competitors of the company? Indirect? What differentiates your company from theirs?
[Read Also: Strategies to Reduce Expenses and Save Money]
A company going into Series A funding needs to be prepared to answer these questions and more about their own strengths and weaknesses. Every case is different.
Series B Funding: Series B funding is like Series A in some ways. The differences between the two rounds of funding are the scope of the venture and the amount of capital raised, as well as the solidification of serious expectations set forth by investors.
A startup that reaches the point where they are ready to raise a Series B round has already found their product/market fit and needs help expanding. The big question here is: Can you make this company that you’ve created work at scale? Can you go from 100 users to a 1,000? How about 1 million? The expansion that occurs after a Series B round is raised includes not only gaining more customers but also growing the team so that the company can serve that growing customer base. At this stage, it is no longer possible for the founder to “wear all the hats,” so raising enough money for competitive salaries is essential.
Series C Funding: Businesses that make it to Series C funding sessions are already quite successful. These companies look for additional funding in order to help them develop new products, expand into new markets, or even to acquire other companies. In Series C rounds, investors inject capital into the meat of successful businesses, in an effort to receive more than double that amount back. Series C funding is focused on scaling the company, capturing significant market share, acquisitions and growing as quickly and as successfully as possible.
Companies that make it to the Series C stage of funding are doing very well and are ready to expand to new markets, acquire other businesses, or develop new products. Commonly, Series C companies are looking to take their product out of their home country and reach an international market. Series C is often the last round that a company raises, although some do go on to raise Series D and even Series E round — or beyond.
When companies make it to this stage, their valuation is typically around $100 million.
Series D Funding: A series D round of funding is a little more complicated than the previous rounds. As mentioned, many companies finish raising money with their Series C. However, there are a few reasons a company may choose to raise a Series D.
- They have discovered a new opportunity for expansion before going for an IPO, but just need another boost to get there. More companies are raising Series D rounds (or even beyond) to increase their value before going public.
- The company hasn’t hit the expectations laid out after raising their Series C round. This is called a “down round,” and it is when a company raises money a lower valuation than they raised in their previous round.
A down round may help a company push through a tricky time, but it also devalues the stock of the company. After raising a down round, many startups find it difficult to raise again, as trust in their ability to deliver on their promises has eroded. Down rounds also dilute founder stock and can demoralize employees, making it difficult to get back ahead.
Understanding the distinction between these rounds of raising capital will help you decipher startup news and evaluate entrepreneurial prospects. The rounds of funding work in essentially the same basic manner; investors offer cash in return for a stake in the business. Between the rounds, investors make slightly different demands on the startup.
Company profiles differ with each case study but generally possess different risk profiles and maturity levels at each funding stage. Nevertheless, seed investors and Series A, B, C and D investors all help to nurture ideas to come to fruition. Series funding enables investors to support entrepreneurs with the proper funds to carry out their dreams, perhaps cashing out together down the line in an IPO.
Beyond the basics of having a great idea with great potential, impressive traction to date and all, keep in mind that nothing will take the place of a compelling business opportunity, the proven ability to execute and the right team. That all said, you need to also position yourself to be noticed and then believed in by the right people. Who you know and what experiences you’ve had along the way will be key in establishing this positioning. Ask for introductions, attend conferences, build your circle of people that can help you directly or indirectly.