For those who aren’t well versed in the field of entrepreneurship, Series A, Series B, and Series C might seem like confusing terms—but they are simply arbitrary terms to define the different stages of the companies that are raising capital, and necessary to ensure that your company survives after you wipe out the investments of your generous friends and family. Startups go through a series of funding from venture capital firms, where capital is raised in multiple rounds of financing as valuation of a company may increase. A company’s valuation may increase when there is an increased probability of success, proof that the concept is effective, and growth in the customer base. Starting from the seed stage, through angel investors and the series rounds, the amount of money intends to increase, with early investors investing in subsequent rounds to maintain their share in the company over time. The main differences between these rounds are the maturity level of your company, the type of investors involved, the purpose of raising capital, and how you aim to allocate the funds.
How does funding work?
Congratulations on registering your company! Once your uncle’s cash has run out, you need to start looking for your next funding source because if you run out of money, your startup dies. Unfortunately, investors aren’t altruistic entrepreneurial-loving business people. They may be genuinely interested in your business, but they ask for a portion of your company in turn for providing the capital. Before each round of funding, your company undergoes a valuation of your management, effectiveness, market size and customer base, and the risk of investing.
Seed Funding consists of small angel investors who make several small ($500k or less) seed stage investments, generally pre-Series A. They are called “Seed” because of the very early stage, size of their funds, plethora of seed deals a company receives. Think of a tree. This round nurtures the seed (idea for your startup) to hopefully grow into a operating business. These investors seek an equity stake in your company in exchange for their investment. Usually these investments are meant to support the company until it successfully generates its own cash flow, or until further investments. Seed money may include money from your friends and family, known literally as “friends and family funding”, angel funding, and crowd funding.
Angels are individuals who invest their own money part time. They will provide the capital for your start up, usually in exchange for convertible debt or ownership equity. Unlike Venture Capitalists, they invest their own money and don’t work for firms. They usually have experience in the industry they invest in and bring in knowledge and support alongside capital. You may argue that they care more for liquidity than venture capitalists because they are investing their own money, and will work hard and closely to make sure that they profit off of their investment in your startup. Usually, these investors have already made it and want to give back to the industry by helping the next generation of entrepreneurs. Besides, startups provide a sense of intellectual satisfaction, and who wouldn’t want to relive that buzz!
Crowd funding is a practice of funding a project by raising capital from a large number of people, hence the word crowd. It is a form of crowdsourcing, a specific sourcing model that uses contributions from Internet users to obtain needed services, products, or ideas. Think Kickstarter, the best-known example of crowd sourcing to collect funds from an international crowd. In this 21st century age of the Internet, this concept has meant to mean funding via the Internet, as opposed to benefit events or mail-order subscriptions. Do you remember the “Coolest Cooler”? This cool cooler features a blender, waterproof Bluetooth speakers, and an LED light. It raised $13,285,226 from 62,642 backers—that’s a crowd!
Series A Round of Funding (Venture Capital Round)
The Series A round of funding is the first round of financing that a startup receives from a venture capital firm. This means that it is the first time your company offers ownership to external investors. You have figured out your product and user base and you need capital to scale your distribution, adapting your product or service to multiple markets, and figuring out a proper business model. Your goal in the first round of funding is to receive enough money to pay the salaries of your time, afford additional market research, and finalize your product or service to be introduced to the market. Series A funders are taking a large risk that your concept will succeed and therefore they will get a larger payout when your company succeeds. They usually expect some form of guarantee in the case that your company fails and they get some of their money back before the seed investors or the founders.
At this point, valuation consists of:
- Proof of concept
- Progress made with the seed capital
- Quality of the executive team
- Market size
- Risk involved
Series B Round of Funding
The following two rounds have less lucrative payouts in the event of success, but they should carry less risk because at this point your concept has been proven effective. Unlike the previous stage, your product or service has already been finalized and has been sold in the market. This second stage is required when your company is ready to scale up, compete with other similar companies, and have a market share. This stage is important for strategic hiring that were not previously affordable and may take your business to the next level, such as marketing team to put out a bunch of ads and a new sales team. The goal of this round is to have a net profit. At this point, the investment risks are much lower than in Series A because you have had a “test run” and you can provide data regarding the performance of your company.
At this point, valuation consists of:
- Performance of the company in comparison to others in the industry
- Forecast of revenue
- Assets like Intellectual Property, etc.
Series C Round of Funding
Yay! You have proved your success in the market. You are generating revenue, you continue to grow, and your business model works. In this third round you are looking for greater market share, acquisitions, or to develop more products and services. In short: you are accelerating what was done in the previous Series B round. Perhaps you want to go international or make acquisitions to buy other similar companies. It is final stage before an Initial Public Offer (IPO). At this final round, the valuation of your company will be done on hard data points.
Companies usually go public to raise more money, but this time from millions of people—regular people. An IPO allows you to sell stocks of your company on the stock market and anyone can buy them, this is known as issuing equity to the public. Prior to the IPO, all of your investors are holding restricted stock—stock that can’t be sold for cash. This is because pre-IPO your company is not “verified by the government”, which is what the IPO does for your company.
Companies fall into two broad categories: private and public. Most small companies are privately held. However, large companies can be private too, such as IKEA, Domino’s Pizza and Hallmark Cards. Any one can incorporate a company, which will have few shareholders. It usually isn’t possible to buy shares in these type of companies. On the other hand, public companies have sold at least a portion of themselves to the public and trade on a stock exchange. This is why you hear “going public” when a company sells their first sale of stock to the public. These companies have many shareholders and are subject to strict rules and regulations. These companies are required to have a board of directors, report financial information every quarter, and report to the Securities and Exchange Commission (SEC). Stocks of these companies are openly traded on the stock market and anyone who has cash can invest. Going public raises a lot of money for your company and can open many financial doors.
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