In an earlier blog, we discussed the fundamental differences between two different types of funding rounds: Series Seed funding and Series A funding. By definition, seed rounds are private offerings of securities that are targeted toward smaller groups of investors, each of whom will contribute investment in exchange for preferred securities and limited investor protections. In contrast, a Series A usually involves higher levels of investment, classically with institutional investors, who will expect more stringent protections for their higher contributions of capital.
For most early stage startups, knowing the difference between the two types of rounds only answers half of the important question at hand: Which type of financing is right for your company at this particular moment in time? And what are the stakes involved in making the wrong choice? Here are some things to consider.
Choosing A Series Seed Investment
Our clients usually go with a Seed round when they are very early stage -- perhaps just a year or two into their business. While many investors may be fine with purchasing a convertible note, established angels or early stage VCs may want to directly own some of the business and obtain basic investor protections. If that’s the case, a Seed round makes the most sense. Companies should expect to receive anywhere from $1-$5 million for a Seed, depending on the industry and the company valuation.
Choosing A Series A Round
Series A financing usually requires entrepreneurs to prove to more serious investors that the business is functional, sustainable, and scalable. This may mean proving that a customer base is already in place, a prototype has been created and mass production has been priced out, long term costs have been analyzed, and the company can grow without experiencing risky and expensive stops and starts.
Checks at the Series A stage are larger, because investors see something they like and want the company to use the money to scale. Investors at this stage usually invest somewhere between $2 million to $10 million. Investors will also expect to receive standard investor-side protections, such as a board seat, veto rights over certain business transactions, approval of future funding rounds, and possibly things like a cumulative dividend or drag-along rights.
But choosing a funding option isn’t always as simple as these descriptions would suggest, and while these are general trends, companies have a lot of flexibility in determining the sale of their securities. Sometimes, even for an established business, setting high investor expectations can be risky, and companies deciding between the two types of funding may elect to start with a Seed round so that they can reasonably demand a higher valuation at the Series A and give themselves more breathing room to develop the business. While checks are larger at a Series A, expectations run higher commensurately as well. As market conditions tighten for early stage funding, we have also had several clients turn down Series A funding which they felt was not good for their companies.
The best approach is to make sure that the financing you decide to seek is part of a much larger financing and revenue strategy that looks out to the medium and long term. Don’t look for investment like a pinball in a machine: have a focused, targeted strategy about where you want the business to be in one year, three years, and five years, and execute on that. If and when a funding round seems possible or you get a term sheet, you’ll know where that type of funding fits into that strategy, and what terms will be fair.