Let's say you are the founder of a startup.
The startup is past that early, unceremonious pre-seed phase where the amount of money spent on meeting over coffee is greater than what is raised. At this point, your heart and soul, as well as a hefty portion of your own bank account, has been put into establishing the foundations of your company.
You and your co-founders decided to enter an accelerator, knowing how beneficial they can be for startups. Demo-day came and went, and you found yourself the recipient of a generous term-sheet from a renowned venture capitalist firm. Congratulations!
About half a year later, after grinding out the finer points of your business development, the startup is a semi-successful venture with a large consumer base. In fact, the financial team is positive they have a model that can be monetized, but the company needs another round of funding to scale even further.
During the seed-funding stage, the valuation of this company was around $3 million. This is not uncommon; most companies at this stage are around $1-6 million dollars.
In this hypothetical, your company has reached the stage known as Series A funding.
Series A Funding
Typically, a company in Series A funding sets a goal of raising between $2 - $15 million dollars. This number can vary across industries. It's notable that the rise of tech companies with high valuations has increased the average dollar amount raised for a Series A round in recent years because venture capitalists do not want to miss out on the next big thing in the tech industry.
An example of a successful Series A round in the tech world is the recent funding of Chaossearch, a Boston-based log-search and analytics platform, by investors including .406 Ventures and Glasswing Ventures.
Chaossearch raised $9 million in order to enable their development and operations team to extend their log and event data retention and usage.
No matter what industry the company is involved in, venture capitalist firms and angel investors are the primary source of Series A funding. So what do these prospective investors look for in a company in this stage?
Growth from seed stage. Investors want to see how a startup has progressed since the first round of funding. At this point, a venture has already established that they have a minimum-viable product or service.
But has the venture hit certain company-specific revenue goals, or established a solid user base? Is there a tangible demand for their business? Can they prove it? In other words, is it more than just an idea?
A venture must exhibit an understanding of strengths and weaknesses. 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?
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, but one generally helpful tool for self-assessment is a SWOT analysis.
Image source: creatly.com
Equity investors may ask for preferred stock. Investors value the anti-dilution provisions at this early stage because of the high-growth potential of a company in this round of funding. It is common for investors to want preferred stock because of the serious risks inherent in investing in a nascent enterprise.
Companies may find Series A funding difficult. In recent years, seed funding became easier to acquire, nearly quadrupling by some estimates. Concurrently, Series A funding stayed the same. This has led to an overconfidence among early-stage ventures that assume Series A will be the same process as seed funding, when it is much more challenging.
Remember that you are asking for two-to-three times what you raised during seed funding. Investors need proof that they should put an equivalent exponential leap of faith in your company, too.
Companies must be ready to answer tough questions about their viability in this round. The frequency of startups receiving plentiful seed funding means that Series A investors have plenty of options to invest their money in.
Let's return to your hypothetical startup.
Your company was fortunate to receive a generous round of Series A funding. The funds will be used over the next year to hire employees, launch a marketing campaign to attract new consumers, and work on the continued development of the successful product/service that got you to this stage.
At this point, you have given away about 35% of equity in your company to investors, which is not atypical. Most companies give away equity ranging from 20% to 50% after this round of funding.
After a successful launch, the venture has exited the development stage. Your company has proven to investors that you are ready for more. However, scaling up naturally incurs costs.
At this point, the company's revenue is either low, or non-existent. There is a plan in place, but also a need for another round of funding commonly referred to as:
Series B Funding
Series B funding is like Series A in some ways. Your venture will have:
- Venture Capitalists as your primary investors
- A medium-to-large user base of consumers
- A viable product / service idea
- Proof that your company can meet certain goals and expectations outlined by your stakeholders
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.
The expected capital raised in most Series B funding scenarios is between $10 million to $20 million (depending on the industry). Generally, companies in this round have a much higher valuation than they did when seeking Series A funding because they have established themselves as legitimate in the eyes of investors.
Remember the strengths and weaknesses your venture outlined to investors? This is where you prove your assessment correct. The company must have accurate revenue forecasts and prove it can perform well within its industry.
After this round of funding, there needs to be a concrete plan in place where your venture breaks even and begins to create a net profit.
Common stock is often issued at this stage. Investors tend to trust companies more at this stage of fundraising because the enterprise is already bolstered by previous investors, thus improving the reputation of the company in the eyes of other prospective investors.
Usually, the higher valuation of the company at this time means that investors will be paying more than they were in Series A funding.
This influx of financing can be used to grow the business’s various functions: sales, marketing, research and development, product design, etc. The end goal is to establish a business that is profitable and sustainable.
For example, SnackNation recently raised $12 million in funding in a Series B round that will allow them to improve various aspects of their operations. SnackNation CEO Sean Kelly intends to use the funds to improve SEO strategies and brand marketing, as well as bolster their direct-to-consumer side of the company.
After a few years, your company is thriving. The venture surpassed every early-stage goal. The team you surrounded yourself with in series B not only helped you reach your previous ceiling, they have broken through it.
But your company did, and it is a huge success. But why stop there? Your team, and stakeholders, want growth. In order to develop any further, your company needs another round of funding called:
Series C Funding
Luckily, everyone wants a piece of you. Industry experts know the company is profitable because of its track record and high valuation, and this confidence in the business helps even the most risk-adverse investors want in.
The type of investors at this stage are industry leaders and institutional investors, such as:
- Hedge funds
- Investment banks
- Private equity firms
Secondary market groups will also be involved in buying stock from your company at this time. Previous investors will sell shares on the secondary market. Investment banks will sell securities in the hopes of making a profit on a company’s rising share price.
The money raised in this round will be used for fully developing a product or service, creating a new product or service, capturing significant market share, acquisitions, and expansions. The company wants to scale, and stakeholders will often expect double the value of the investments they make at this juncture returned to them in the future. Oftentimes, a company will use this round of funding to expand internationally.
When companies make it to this stage, their valuation is typically around $100 million.
Pinpointing exactly how much companies raise on average in this round of funding is hard because the reality is that most startups never make it to this stage, and it is difficult to measure across different industries. Recently, GreyOrange, an industrial robotics company, raised $140 million in a Series C round led by Mithril Capital. That example is on the higher side of the kind of money a company can raise in Series C. A more practical example is LendInvest, a UK-based online lending platform that raised $39.5 million in a Series C round. Like the preceding series of funding, the actual dollar amount one can raise depends on the company and is also industry-specific.
A company going through this final round of external equity fundraising is likely gearing up for an IPO. The influx of investments often boosts the valuation of a company, which is obviously beneficial during the leadup to an IPO. Valuation is at the highest it has ever been at this point for a company, so usually companies will choose to move forward with an IPO rather than pursue any more additional rounds of funding.
Putting It All Together
They foundational understanding of the differences between Series A, B, and C is to know the specifics of what investors are expecting to see from the startup at each stage, both past accomplishments and obvious signs for future growth. Additionally, the benchmarks for each stage of funding can vary from industry to industry, but by doing research, a contemporary range should be present itself and help with expectations