On the weekend I was chatting with someone who was interested in starting a software company here in Sydney. The conversation moved along to fund raising and my acquaintance said rather flatly, “I don’t really understand what people mean when they refer to different rounds of funding.” I quickly realised that if one person didn’t understand what funding rounds were, there were probably a fair few people who didn’t, so why not do a brief overview.
What I’m going to talk about below are industry terms that are commonly used in the US. I’m also envisioning a company going through the process that does some kind of consumer internet software or small SaaS product – I’m not talking about people trying to build semiconductors or compete in the Enterprise software space, that requires MUCH greater capital. Also, just remember this isn’t legal or financial advice, so before raising funding, get in front of some proper advisors.
Friends and Family Round – This is a very early round of funding (probably less than $100k) where you put forward an idea that you’re working on or would like to explore to those people who know you best. Most VCs would say that these people aren’t necessarily investing in your idea, they are investing in you. While you may have raised this round of funding informally, make sure you go through and get it documented correctly for everyone’s benefit. Improper documentation or vagaries with this type of funding might mean later on that potential investors may be turned off because of uncertainty of future claims.
Angel or Seed Round – This is also a very early round of funding, usually when you have a solid idea, can articulate a potential market and have some kind of prototype. The common trend in this particular round is that the Angels or Seed investors are getting 10% to 15% of the company post-money and are investing somewhere between $250k and $1m. This round is seen as being necessary to take the idea/prototype through to a launch ready product. You may also have to setup a more formal Board of Directors at this point, because some of these investors will want to oversee where you’re taking their investment, but this also gives you a vehicle to tap into their expertise as advisors.
Series A Round – At this point, your company will certainly have a ready to go product or thereabouts. This is commonly seen as a round that’s raised to take a product to market. Series A investors are usually proper venture capitalists with funds, but this round might also include Seed round investors who have the right to invest in future rounds to avoid dilution. In an “A” round, you might be raising $2m – $7m depending on who you are and what type of market you’re tackling. By this stage, outside investors will probably own 30% – 40% of the company and there will almost certainly be a requirement for the founders to set aside a portion of their shareholding for future staff options. If you haven’t had to form a formal Board up to this point, you most certainly will now. Expect your VC to want at least one seat on the board and they’ll probably push for an independent director too. Angels will probably drop off your Board at this point.
Series B Round – When you begin looking to raise the “B” round, you should have a product (or products) in the market, incoming revenue, a client base you can reference and some market intelligence and feedback to drive decisions. The typical “B” round is used to fill out sales and marketing to try and grow your footprint. You’ll probably find that your “A” round VC will want someone else to lead this round although they may certainly invest and take up as much of the round as they can. This isn’t an insult – this is their way of “pricing the deal”. If your company is doing well, your “A” Round VC will be out banging on doors, using their network to help get another investor to come on board. By this stage it is hard to start estimating how much you’ll raise because it depends on so many variables, but as a CEO or Founder, try and get yourself as much runway as possible out of this round. Expect by this stage to not own the majority of your business and it is unlikely your Angels or Seed investors will want to invest at this point because it is probably priced out of their scope.
Series C, D, E Rounds – I’ve just lumped a bunch of these together because they all serve more or less the same purpose. You’ve built a company to a stage where your investors (and probably the founders) are looking forward to some kind of liquidity event. The purpose of these rounds are to set your business up to achieve that liquidity event. Your investors may want you to use the money to bring in a professional CEO and some high powered senior execs. If you’re company is considering an IPO, then this round will be used to get the balance sheet in order and have the cash on hand to go through that process. Again, it is impossible to say how much money you should raise from this round, but the founders will probably own 30% or less of the company now.
This list is by no means exhaustive, you’ll often hear terms like Bridge Loans and Convertible Debt being bandied around. These types of funding effectively are loans from an investor that can be turned into discounted investment in future rounds if certain outcomes are met. Normally, companies that run out of money and aren’t quite in a position to raise more look to existing investors for these types of finance. These are not financing rounds directly as they are not capital injected into the business in return for shares, they are loans with warrants.
