Making Sense of Funding Rounds
Every now and then, there’s news of how a start-up has closed a funding round. Sometimes we hear that they’ve closed a Series A or Seed round. You might be wondering what these funding rounds mean and what they have to do with anything. In this article we will explain what these funding rounds mean to help you understand what’s going on the next time you hear start-up news.
Funding rounds are stages that start-ups go through to raise capital through private equity investors or venture capitalists. The seed round is known as the first round in start-up financing. Each round thereafter is called either “A”, “B” or “C” to signify the number of venture financing rounds the company has raised. For example, a company raising a series “A” round is raising the second funding round.
Prior to raising a round of funding, the company seeking funds undergoes valuation. The valuation process consists of evaluating the market size, management, maturity of the company, track record, revenue, risks, what the company is worth and any other information that might interest investors.
Types of funding rounds
- Pre seed/ Seed Round
This funding round is usually carried out in the idea/concept stage of the company. At this stage founders are expected to prove that there is a market for the product as well as show a proof of the idea or a prototype.
Capital raised in this round is often used to back up development of the product, carry out further research, test the product and hire a team. In this round, potential investors include family, angel investors, friends, the founders, venture capitalists, incubators, etc.
2. Series A Round
The main purpose of the series A round is to ensure continued growth. Investment at this stage is still considered high risk as the company, despite having a working product or service, is still trying to steady its foot in the market. At this stage, it’s important for the company to develop a business model that works and brings in long-term profit as investors are more interested in the strategy than just the idea unlike in the seed stage.
Although some angel investors invest in this stage, investors at this stage are often traditional venture capital firms. Returns from the series A funding round are lower than returns from the seed round. In a series A funding round, a company typically raises a larger amount of money than in a seed round, which can lead to investors owning a smaller percentage of the company and lower returns. Companies that raise a series A round are typically further along in their development and have a higher valuation which also leads to lower returns for investors.
3. Series B Round
This is the second stage of the venture financing round. Investors in this stage are often venture capitalists and private equity investors. By now the company has gotten capital enough to grow, mature within the industry and has a positive track record.
The valuation at this stage is higher and the risk is lower hence an increased cost of investment. Signs of growth at this stage include an expanding customer base, successful launch of products and services and increasing revenue. At this stage, funds raised are often used to explore new markets and expand the team.
4. Series C Round
This round of funding often occurs when the company is preparing for rapid growth or acquisition. At this time the company is very successful; has proven that its services/products are a success, increased its market share or developed a new product/service. Investors at this round invest with hopes of getting up to double or more of the amount invested into the company.
In Series C round, groups such as hedge funds, investment banks, private equity firms, and large secondary market groups invest in companies as they have already proven themselves and have an excellent track record.
5. Later Funding Rounds
Each next round of funding takes on the letter after the previous round. Similarly, after Series C is Series D round. Usually, companies do not get to Series D and at Series C they are getting their exit strategies ready to smoothly approach IPO- Initial Public Offering.
However, some companies might need some extra funding after Series C and may move on to raise Series D, E or even F. This happens if the company was unable to meet up with its target amount in the Series C round or as a result of lower valuation which often affects future investment.
Even fewer companies go beyond Series E funding rounds. Companies in this funding round often haven’t made enough capital to survive on their own and hence require extra funding. Companies that go onto later funding rounds have the possibility of their equity and valuation being diluted.
6. Initial Public Offering- IPO
This is the final stage of the start-ups’ existence. An initial public offering (IPO) is when a private company offers shares to the public in a new stock issuance for the first time. It allows a company to unlock huge amounts of funding via equity capital from public investors.
This process demands the company to become more transparent and maintain good relationships with shareholders. IPOs allow private investors to exit from their investment as it typically includes a share premium for current private investors.
Conclusion
Each funding round basically operates in the same manner; it involves a company receiving funding from investors to remain awesome, hopefully. However, each round meets new demands from investors and the company on a different scale, needs and maturity.
Now when next you hear funding news you’ll be able to better understand the profile of the company, why it’s a seed funding round instead or if a series E funding round would have been better. Furthermore, it will also help in evaluating market prospects.
