Startup Investment 101: Investment Rounds Explained

By Michael Whitehouse

Investment rounds are an essential part of the startup investment journey. Something that we state to our members at 1000 Angels, the private investor network that connects startups with investors, is that If you are a new investor in the startup marketplace, then you will need to quickly familiarize yourself with each round. You will encounter them progressively as you negotiate a deal either with a startup founder, or as an investor looking to attract further capital to an existing organization. Either way, an understanding of each round and why it exists is critical.

Photo credit: http://businessenglishpod.com/

Photo credit: http://businessenglishpod.com/

The terminology used to describe these investment rounds can seem daunting, but it needn't be. At 1000 Angels we want to help new and seasoned investors as much as we can to find startup opportunities.  A big part of this is understanding the various rounds of investment out there so that they may be negotiated with ease and confidence.

With this in mind, let's take a look at some of the most common investment rounds seen in the startup sector, summarizing their function and why they're important.
 

1. Seed Investment

This is the first type of investment round on offer through a startup. It is a preliminary investment stage which is geared towards helping a startup founder establish the direction and goals of their business. The seed stage of any organization is clearly embryonic and is therefore more speculative than other rounds of investment. It is there to establish the startup as a going concern, in many cases going as far as to bring a product to market.

A seed investment should aim to achieve one of the following:

  1. Product Identification: A startup founder may have an idea about the type of product or service he/she hopes to develop, but seed investment is usually a big part of cementing design elements and settling on a defined product for launch.

  2. Marketplace Orientation: At a seed stage a startup may be looking to carry out research into available marketplaces, understanding the competition and how best to sell a product or service within that niche.

  3. Demographic Targeting: It may still be necessary to identify the specific demographic or target audience for a product or service. This might include market research and other exploratory measures to define this more clearly.

  4. Team Creation: There is the possibility that a seed investment could be used to establish a working team beyond the founder(s) of the startup. This could be needed in order to bring the right expertise needed to create or launch a product.

Seed investment is not always necessary as many startup founders will have much of the infrastructure in place before seeking capital. In some instances, however, this type of investment can be critical to bring a startup idea out of its infancy.
 

2. Series A Investment

This type of investment is often the first encountered when the seed stage does not require outside funding. At this juncture most startups have a strong defined idea of what the central goal is behind any product or service and may even have launched them commercially.

Series A investments should achieve one of the following:

  1. Distribution: Optimizing the way that advertising is disseminated and products/services are distributed is a key part of series A investment. This can lower overall costs or increase sales; hopefully both.

  2. New Markets: Launching a successful product in a new region can be costly. This is why series A investment is often sought by startup founders. New markets can be opened up using this injection of capital, engaging with different demographics and furthering brand visibility in the process.

  3. Stage 2: The primary function of a series A investment is usually to take a company to the next level. Capital raised during this round is often used to implement a new business plan geared towards meeting defined business goals. This could include launching a new product or reaching a new sales target.

  4. Shortfall: Series A investment can also be used to make up for a shortfall in capital. A startup may still be a promising investment opportunity, but unforeseen expenses can use up available funds, and so another round of investment might be required to offset this.

 

3. Series B Investment

By the time Series B investment is being actively pursued a startup is usually well on its way to being a truly established business. Production is well managed, advertising in in full flow, and customers or users are actively purchasing an associated product or service as planned. While scalability is a factor in Series A investment, here it is the main focus. This includes:

  1. Team Expansion: As the company grows it is likely that more employees will be required in order to ensure smooth running of the business. This may involve an initial outlay beyond using sales to pay for salaries. It is likely that employees will need new equipment, office space etc., in order to perform effectively.

  2. Globalization: A startup might be selling in one or two regions, but this is often the stage where capital is needed to establish a company on the global stage. Trading in every region can require a significant outlay depending on the nature of the business, and this is exactly why Series B investment rounds exist.

  3. Acquisitions: If a startup has grown sustainably, it may be in a good position to bolster its operations through acquiring another business. This could be in the form of a competitor, or perhaps a related technology or patent which could be incorporated into the company. Rather than using its own reserves it can be beneficial to pursue new investment to fund such an acquisition or merger.

 

4. Series C Investment and Beyond

There is no technical limit to the number of investment rounds a startup can pursue. This depends heavily on any anti-dilution agreements previous investors have acquired, ensuring that their stake is never watered down. As each investment round progresses more and more equity from the company is released, so they are normally not entered into lightly from both investor and founder perspectives.

Understanding the various machinations of each investment round will help a potential investor decide on the most appropriate course of action. With the information contained in this article hopefully such rounds will no longer appear confusing, and so can be entered into confidently and with purpose.

The foregoing article is for educational purposes only and should not be construed as legal advice.  The information described in the above article is just an example of fundraising rounds and may not apply in every deal.  There may be overlap between specific rounds.  The round terms themselves, “Seed,” “Series A, B, C,” etc., may also be interpreted differently by founders, investors, and institutions. Prospective investors should carefully review the documents of any offering which they are considering for purchase and should consult with their legal counsel and professional advisors.

"Money is Local, Impact is Global" for Angel Investing

By Michael "Luni" Libes

In the traditional world of early stage, Angel and VC investing, money is local. Studies show that over 80% of funding at Angel groups and Series A VCs goes to businesses in the same city/region as the funders.

Over in the impact investing space, this rule is not true. Socially and environmentally conscious entrepreneurs are tackling global, planet-scale issues, often well outside the investment hotbeds of San Francisco, New York City, Boston, Seattle, Boulder, and Austin. No city stands out as a leader across cleantech, green, community, and bottom billion targeted startups, and as such, entrepreneurs are not flocking to any one city to find talent or funding.

The diversity of socially conscious entrepreneurs seeking assistance can be seen in this map of applications to    Fledge   , the conscious company accelerator

The diversity of socially conscious entrepreneurs seeking assistance can be seen in this map of applications to Fledge, the conscious company accelerator

Due to this diversity of geographies for entrepreneurs and their target customers, impact investors can’t sit back and only look at deals in their local region. Instead, we see groups like the Element8 Angels in Seattle funding deals across the country, and syndicating deals with other Angel groups in other cities. Plus we see groups like Investors Circle, which is national in nature, with members spanning coast to coast, absorbing smaller local groups like the Colorado Impact Angels.

As much as we in Seattle would like to be the epicenter of impactful enterprise, the trend of equity crowdfunding and international programs like Fledge and Kick are no doubt only going to further stretch the reach of funding across national borders until the dealflow is truly global.

This post was originally published on the blog of Michael “Luni” Libes. Read the original post here. Luni will be a panelist on Onevest’s upcoming webinar with the Angel Capital Association on Impact Investing on Wednesday, April 8th.

Luni is a 20+ year serial entrepreneur, (co)founder of six companies.

His latest startup is Fledge, the “conscious company” accelerator, and Kick, a pre-accelerator, where he helps new entrepreneurs from around the world navigate the complexities between idea and customer revenues.

In addition, Luni is Entrepreneur in Residence and Entrepreneurship Instructor at Pinchot University and an Entrepreneur in Residence Emeritus at the University of Washington’s CoMotion, the center for innovation and impact.

Luni is author of The Next Step series of books, guiding entrepreneurs from idea to startup and The Pinchot Impact Index, a way to measure, compare, and aggregate impact.


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