What's The Difference Between Series A & Series B Funding?
Fundraising for any startup is an important part of the growth journey. In fact, it’s vital. An important reason why some startups fail is that they lack the ability to attract enough financing to fund their plans. All startups want to achieve high growth, and this means that they usually will need to burn through capital. This is done to sustain the growth needed to move on to the next stage of the growth cycle and ultimately leading to the company making a profit and realising an exit.
As a startup founder or entrepreneur, there’s a whole new language and terminology to learn. Venture capitalists and angel investors will talk about funding rounds, equity stakes, valuations and hundreds of different metrics! Understanding these terms is important to be able to effectively communicate with potential sources of capital.
If founders aren't able to communicate the strengths and successes of the business, investors will find a company that can. Being able to speak the same language as investors is the most efficient way of examining the insights into a business and sharing appropriate knowledge. It’s one thing having a good idea and a plan of what a startup wants to spend investor cash on, but if founders can’t discuss an equity plan for subsequent funding rounds or a strategy for achieving an exit, investors may challenge the expertise, and ultimately the ability of the business leaders to be able to achieve high growth.
Below we describe the different classifications of funding and explain some of the terminology.
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What’s the difference between series A and series B funding?
Startups are very unique entities and exist in order to disrupt and challenge traditional business models. A startup is a young company that has developed (or is developing) a unique product or service. This means that no two startups are the same, but there are some common features across all startups. One of them is their desire for high growth. Another is the need to find cash to be able to fund that high growth.
So how are startups funded?
There are essentially five different fundraising rounds that can generally be attributed to all startups, although each growth journey is slightly different.
1. Bootstrapping: This is the cash raised during the earliest stages of a startup’s life. This cash can be made up of savings from the founders and maybe even revenue generated by the startup, if any is available. Strategies such as quick inventory turnover and taking pre-orders for products can make cash available, this helps to fund operations for a bootstrapped startup.
Bootstrapping a startup does not include money raised from venture capital or other outside investors.
Bootstrapping a company happens when startup founders run the company with little or no assets. An advantage of running a company like this is that the founders can maintain full control over the startup, as opposed to the situation where angel investors or venture capitalists provide funding at this stage.
A startup that’s funded through bootstrapping needs to keep an eye on its outgoings. At this stage the finite resources need to be balanced between funding growth and making savings. This balance is vital and the business plan at this time needs to recognise the steps needed to take the startup through to the next stage, seed funding.
2. Seed Funding: this would be considered as the first official funding stage. Much like the name, seed funding, cash investments at this stage are hoping to create a situation where the startup can grow and flourish in the future.
Seed funding is generally used to carry out the business strategy of the startup, designed to grow the company and if they need it, reach the next funding round, Series A.
The sources of potential funding at this stage are numerous, including founders, family, friends, venture capitalists and angel investors. Investing at this stage is inherently risky, and startups will often have little or no financial track record or results to speak of. This prevents traditional sources of capital, such as banks, being accessed.
The cash raised during a seed round varies enormously, from tens of thousands to millions, and this very much depends on factors such as experience of the founders and the scale of the opportunity.
3. Series A: When a company has used its seed funding, developed its offer and refined its business model, it may opt for a series A fundraising round.
During series A fundraising rounds, investors aren’t looking for a ‘good idea’, they want a startup that has a strong strategy and a growth plan in order to take advantage of an opportunity and produce profits. Valuations of startups at the series A stage are generally in the millions of pounds.
To attract funding at this stage the company should be able to demonstrate to investors that it can be successful and profitable in the future. Typical investors at this time are venture capital firms. Startups may also try to attract investment through crowdfunding as part of a wider series A investment plan. This might be a deliberate structure or may be used to make up a shortfall if they fail to attract all the investment needed.
4. Series B: This round of funding is about taking the startup to the next level. Seed and series A funding is designed to establish the startup and secure a market share, series B funding is then used to scale the opportunity.
Series B funding can be used by a startup to meet many different costs associated with growth. Including business development, advertising, marketing and expanding the workforce. In terms of process, series B is similar to series A, but the investors may be slightly different, with some venture capital firms specialising in later-stage investments.
5. Series C: If a startup decides to access series C funding, it’s likely they are already enjoying some success. A company going through series C may want to develop new products, break into new markets or even acquire a competitor.
At this stage the purpose of investment is essentially to fund the scaling of opportunity. For example, an established business successfully operating in the UK, may be able to demonstrate an opportunity in mainland Europe using market research. At this point the business may turn to series C funding in order to achieve this growth.
As the startup moves through its growth cycle and finds more success, it becomes less risky. As the risk profile falls, more investment opportunities are available. At series C, hedge funds, private equity firms and investment banks often have an appetite for this level of risk. The reason for the lower risk is that the business will now have a financial history and experience of operating in at least one marketplace.
6. (Series D and beyond): Typically, funding rounds end at series C. Some companies though will go through series D and E rounds. There are a couple of reasons why a company may pursue these later funding rounds. Such as them not achieving all of their business goals following series C and raising capital for an expected initial public offering.
Now we’ve explored the categorisation of fundraising rounds, we can look at Series A in more detail.
Series A funding is the process of investing in a privately held startup. At the series A round, the startup will be able to demonstrate some growth and progress in building and developing its business model. There should also be a clear path to further growth and revenue generation, having already accessed seed capital in order to meet these goals.
The difference between seed funding and series A funding rounds is typically the amount of money involved. The ownership structures of the startups following investment is also different. Seed rounds, generally speaking, raise tens or hundreds of thousands of pounds of investment. Series A funding is typically in the millions of pounds.
The investment during series A comes from venture capital and private equity firms. These institutional investors manage portfolios of businesses and have the necessary expertise and experience to help startups achieve their growth goals.
When is the time right for series A? Once a startup has established itself. This could be by offering a product or service that’s viable. At this point it may already have a market for the product or service, or it may be able to prove a market exists through sufficient market research or pre-orders. Once a startup reaches this point they have everything they need to have a successful operation, but they need to scale up to make the most of the opportunity. It’s at this point a startup will reach out to series A investors.
The investment that it attracts during series A will be used to fund the growth and expansion plans of the business. This could be anything from talent acquisition to leasing an office.
Series A investors will not accept unlimited risk. Due diligence is an important part of the process and investors may be very demanding in order to achieve a deal that meets their risk appetite. In return for their investment, they will receive some form of equity stake in the startup. Series A investors will be looking for huge returns, possibly as high as 300%.
Part of the dialogue and process of series A fundraising is the valuation of the startup. Valuations at this point are still difficult and can vary wildly depending on the metrics or valuation methodology applied. The founders are likely to value the startup differently to investors and a common sense middle ground has to be reached. Part of this will be founders using the available financial data and metrics to convince investors, both of the size of the opportunity and the ability of the startup team to grasp it.
The amount of equity given up in return for series A is unique to each deal. It can depend on many things, such as the number of founders and the equity stakes held by investors from the seed round. There may be other considerations to make, such as investors wanting an element of control over the direction of the business and certain guarantees that founders will remain in the business.
Series B funding is the second stage of funding that includes venture capitalists and private equity as potential investors.
Series B fundraising occurs when a startup has passed a number of milestones in its development and operation. Following on from series A, the business will be more established and will have advanced its business model, meaning it will attract a typically higher valuation.
This leads to investors paying a higher price for equity in a series B financing round, when compared to series A. The risk is generally lower at series B, as the company has had the time (and previous investment) in order to generate revenue through sales.
Investors also have more information available in order to perform their due diligence, such as the track record of the management team and how effectively it utilised the investment received in series A.
Where do series B investors come from? There are a variety of potential sources of investment at series B, (where the risk is lower). Startups may decide to approach their existing investors, which has several advantages. The convenience of established reporting processes, and the familiarity and existing knowledge within the relationship, can make the investment decision process easier to work through. Existing investors may also help during series B as it’s an advantage to them if the business continues on a high growth trajectory.
Other investors will be from private equity firms, venture capitalists and credit markets. As the fundraising rounds progress, the number of potential investors grows and startups will have a wider choice to approach than at series A. This allows startups to pursue the best capital structure and lines of finance that suit its business model.
Cash raised during series B can typically be used to scale up operations. Increasing the market opportunity, productivity and growing revenue.
What's the difference between Series A & Series B funding?
All of the funding rounds are different and have a unique set of characteristics.
The processes and challenges of series A and B funding rounds may appear subtly different, but actually the contrast can be stark.
One important difference is the context of the business when the decision to fundraise is made. At the time of a series A fundraising round, the startup will typically have used the initial seed capital in order to develop a viable business model. This business model will be presented to investors and must be convincing in order to attract financing. At series A, investors will want to see a strong potential of growth, underpinned by a product or service that can be taken to market and scaled in future.
At the time a startup will pursue series B funding, it would be expected that following earlier investment rounds, the company would be generating revenue from sales. The management team may come under extra scrutiny during series B too, the reason being that their time in positions of leadership is much longer and they have had to deploy previous investment in order to meet growth targets. If there’s a lack of success in following business strategy, investors at series B may ask for extra elements of control or some guarantees/controls, as they expect a company to follow a certain growth trajectory following their equity purchase.
Another important difference is the magnitude of the incoming investment. In series A funding the cash injection is typically in the millions of pounds. Series B funding however, can be in the tens of millions of pounds, and even more in some cases.
The two rounds are different in regard to how the cash will be put to work. In series A, a startup is positioned to develop and refine its offer and processes. During series B, the cash is needed to be able to scale up and reach a much wider market. The fundamental business is already in place at series B, with the barrier to reaching a wider market being the need for investment.
Investors also see an important difference between series A and series B. Series A investors know there’s a greater risk, and therefore they can pay a lower equity price. In return for parting with their cash they will expect high future returns. Series B investors are more risk averse. They understand the business at that point should be relatively settled, have an existing financial track record that can be scrutinised and be able to show how it plans to achieve growth in the future. The lower risk at series B means investors pay a higher price for equity.
Understanding the differences between series A and B comes down to understanding the fundraising categorisations, timings and objectives. Once you have an insight into seed funding and series A, B and C, you will also have a basic knowledge of where a startup is on its growth journey during these times.
The development of business strategy and the pursuit of growth provide milestones for businesses as they move through different funding rounds. Each round will be associated with achieving specific aims, and investors will part with their cash when convinced of the companies ability to achieve them.
Fundraising is a difficult time and there are lots of aspects to consider, from preparing financial documents and business plans, through to performing a valuation. Professional advisors can help with this process.
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