Fund Raising

Fundraising – 04 Stages, Rounds, Series, Classes…No more confusion, please!

The differences between rounds, series, stages, classes. Legal terms of start-up equity fundraising explained in detail

There have been so many confusions about Venture Capital financing lingo, that it was time to set the record straight.

The round: A round is an occasion where a company needing equity financing is gathering people to get new equity financing. This doesn’t mean that there is a new share class (or series) created necessarily. It can just mean: please get us more cash, we give you some shares. It is called round, because some investors gather as equals a-round a company that they want to invest in and they get the same types of shares. An investor can participate in the round or not. There might be more investors that want to participate. But in the end, those that get to participate join the “round table” of discussion. That’s all it is. A round table where the terms of the investment are being discussed.
The important thing is that there is no new class. It can be, that an “internal” extension occurs, where the company raises new money with a new valuation but with the same share class. It can be that an “external” extension occurs, where a new investor joins. Again, no new share class is being created. Despite that, a lot of things can be changed and negotiation, including changes to the AoA (beyond share capital increases), changes to the RoP, changes to the voting rights, etc. So changes to the shareholder agreements and the investor agreements can occur. But no new class is offered. If everything is “sober” and people are formally correct, such extensions are labeled with a prime. See below. But it can happen that no prime is attached to the round.

The class: A class (most commonly confused with a series) is a technical term referring  to the series of the (preferred) equity that is distributed. Typically, founders hold common stock in their company and they raise funds by giving out preferred shares for money. During a new round with new investors, there is typically a negotiation between founders, new investors and old investors that leads to the creation of a new share “class” to mitigate diverging interests. A new class typically gets a new letter. So there are typically class A to Class D (or more) shares. The further down in the alphabet the letter of the share class, the higher the preference of claims typically attached to this class of shares (B has preference over A). This confusion of series and class typically leads to the confusion of round and series.

Why you would call this series is explained later. Simple explanations are the following ones:
(1) share classes are provided in a “series” of rounds,
(2) even public (post-IPO) companies can have different classes of stocks (Alphabet/Google, Berkshire, etc.) and hence using a different term specific to venture capital makes sense.

The prime rounds: Once you get the idea of classes and preference between these classes, it also becomes clear why prime rounds exist. Because – in a prime round – there is no new share class that is being distributed in a new round. So the company recently raised money using a class A preferred share stock class. It requires more money. It could go to completely new investors and ask for money and ask for a new share class being created and a class “B” round – during a new round table discussion – would be created. But if there is a prime, it basically means : new money raised / new round, no new class generated. The easy and straightforward explanation for this is that all investors just provide more money and dilute the founders: trading common stock for class A preferred shares in this case. It can also be the case that the founders and an investor together go for a trade sale. The investor sells all or parts of this class A shares – in which case no money is raised – and the founders sweeten the deal by offering the new investor further shares – common to class A. In any case, the investors would call this an “A'” [A prime] round. The founders would say they raise an “A'” series, because they want to tell that they have progressed instead of saying the just need more money.

Now there are people that call “A'” a new series. And this is also part of the confusion. It is a new round. A prime comes after A, so it is a new round in the “series”.

The stage of investment: The class of shares and the “series” has really absolutely nothing to do with the stage of investment. A company existing for 30 years might decide to now go the equity financing route and offer some typical class A shares under the hope that it is providing a solid venture investment case. It would raise an “A round”. Most likely, it is stable enough to not hand out a “convertible loan” based financing – although convertible loans can happen at any stage and typically they convert at the next round. So the big confusion comes from the three terms “angel round”, “seed round” and “A round”. This confusion is resolved fairly quickly: an A round is a round where class A shares are distributed for the first time. There exist no external investors with preferred stock ownership of the company prior to the “A round”. Period. A seed round or angel round can have whatever type of financing. If the angels invested using a preferred class, it is still an “A round” and any venture investor investing later will invest in something higher than “A” or the prior “A” is fully converted into common stock and cash positions and the angels participate in a new “class A” stock type. It still should be called class B, but it can happen that the class A has been completely redeemed and doesnt exit any more. So the term “class A” and “class B” also implies that there is no other prior preferential stock class before A and that A actually still exists. Someone is still owning this class A. And this is important. Once there is a class B, the class A can not be redeemed any more before class B is redeemed. Because B is preferential.

So again: what does this all have to do with stage of the company. Conceptually: Nothing. Statistically: companies investing on “series A” stage typically expect the company to have the age and revenue characteristics of the “typical” series A venture capital investment. Some revenues, no cash flow positive, product completed, etc. But strictly speaking: no, the letter in the “series” has nothing to do with the stage. If the company is an investment case and it is 2 months old and already had A and B rounds, then it is still a “series C” it is raising – although this scenario is unlikely – and if a company is 120 years old and goes for a convertible loan financing, it is still a “pre A” financing and somewhat a “seed” financing, although nobody would invest in the convertible loan structure and it would likely be a class A stock deal. Got it? Good.

Finally: The Series. Now we collected all reasons why “rounds” are also referred to as series.
(a) because rounds happen after each other with a clear index
(b) because the earlier “classes” of shares (e.g. A, B, C) do not cease to exist legally untill the event when an entire “series” from the latest class – e.g. “class D” – starts to convert on a specific event (e.g. an M&A transaction or an IPO or a new investor buys out all prior preferred stock owners). An then the conversion starts from the highest preference class D down to A successively.
(c) because despite the complete lack of conceptual connection between stage of development of a company and the “class” of stock, people mean the prototypical venture that at a prototypical stage of maturity will raise the prototypical class of stock commonly used to raise the “k-th” round in the series of rounds. Or in other words: Because everyone was too lazy to invent a new word next to round, series and class to clearly identify the stage of development in one single word. And buzzwords like “pre-revenue”, “pre-stable-revenue”, “pre-profit”, etc are suggesting a level of “comparability” of companies that just doesn’t exist. So everybody talks about “a seed” or a “series A” opportunity.

So if you are a round-focused person, you can call an A’ and A” a new series and stress that it has been raised after A. Or you are a class focused person and you call A’ and A” a round and A and B and C a new series. Because this creation effects you somewhere down the line.

Prototypical use of primes: Now that we understood all the terms, it bears mentioning that a prime round is what it is: the expected time and money needed to make it to the higher share class [making the company attractive enough to have a new investor invest ] has been exceeded and someone [of the existing investors ] had to pull an extra string to not have to flush more money into this company – if a trade sale occured – or was not able to save himself from shooting more money than expected at the investment. So this is why prime rounds are also understood as “in trouble” rounds. Seven prime rounds in a row and you might never have a new share class created, ever.  In the special case when a company actually pivoted and isn’t the company it used to be, they replace the prime with repeating the letter. Let’s hope you will never see an AAAA round. But who knows, you might see an AA”.

All understood? Good. And of course this all contradicts this picture that I created a while ago.

Talking Series A, B, C

Nevertheless and despite our nomenclature clarification, the reality is that investors that drop the letters “Seed”, “A”, “B”, etc. mean something by it. Everyone fucks up the names and sometimes they say it’s an “A round”, or a “Series A” or a funding round with Class A shares being distributed.

But independent of nomenclature mishaps, there are typical expectations that warrant a good raise.

A good Seed fundraise includes a very good business plan, for a very good product, created by a very good team, with a very clear milestone plan, a very achievable hiring and execution plan and it will lead ideally to a runway of 14-18 months, and the expectation is that the product is finished by end of months 10, and cash is coming in from revenues in by months 12-14. And ideally, you raise your Series A with a finished product, a ramped-up sales team, first revenue successes and a demand in the market.

Hence entering a good Series A, where you hire marketing and sales resources, professionalize the sales process and you show a very solid go-to-market plan that tends to work. At the end of your runway from your Series A, you ideally showed fantastic CARC to TVL ratios in a set of segments for a very high market and you are expected to grow your product into the market taking serious market share in the evangelist and early adopter segments. Hence raising your Series B.

With a series B in place, you might want to get that chasm crossed. You might have almost been cash flow positive or even break even on your business model, and hence you are starting to raise actual growth capital. The kind of capital that professionalizes your land sales and customer success and expansion sales strategy, you are running inside and outside sales teams – in B2B – in at least 3 core regions and you are growing into a solid case of having geo-diversification with strong growth in three geographic markets where you are crossing the chasm in all three. Perfect? Good.

You are entering your Series C raise, and your next goal is to build and create derivative monentization strategies, capture market share, build and strengthen partnership relations and start to get a stable and defensible foot into the door. The big customers are coming at you and you are able to serve and grow the organization to support the increasing demand. YOu are also testing new business models to expand your penetration and adoption rate and retain your stellar revenue growth. Cool. Right? Very hard.

By the time you are raising your series D, you better have a serious exit strategy. You either start catering your company towards a potential buyer, think about a going private scenario or even a management buyout or an IPO. You now maximize your maximum market share and expand into the most attractive and strategically relevant side markets. Your internal processes have been professionalized substantially and you are becoming a stable going concern.

So from this perspective, you have to know that extensions are bad, going from Seed to A to B is good. Raising the right amount you need at a fair valuation is always going to be better when you do it directly compared to raising a tiny Seed, then another tiny Seed extension, and yet another extension, before raising a shitty Series A. Etc.

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