Startup Funding Rounds Explained

Startup Funding Rounds Explained

Raising funds for a new business venture through various types of funding is unquestionably one of the most important roles of every CEO, which is why we have gathered key details on all startup funding rounds to answer any concerns you may have with regards to venture capital funding rounds. The funding process will undoubtedly be an ongoing process at every stage of your company’s development and is critical to its profitable growth. As such, its importance cannot be overstated, and many important questions will inevitably arise – How much pre seed should I use? How many rounds of funding for startups are there? How many rounds of funding before an IPO is done? What are the available types of funding? These questions rank among the most common our attorneys are frequently asked to answer, and the sooner you are able to address these issues as they pertain to your specific situation, the faster you will be able to accelerate your business venture and take it to the next level. Further, the research for potential investors will be far easier and meetings will run more smoothly as you develop the confidence to perfect your pitch and negotiate deals.

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In order to describe the main types of funding, we must first define what startup funding rounds are. Every separate occasion on which a company is raising money – whether by selling equity, issuing a convertible note, or convertible equity, such as a SAFE – is broadly defined as a venture round. Compared to venture capital funding rounds, a priced round defines a direct transaction from an investor for a fixed portion of ownership in the company (i.e., shares). This is where the name of the round comes from, since a clear price per share is established at this point. Priced rounds are most commonly used by founders for financing the business venture for a milestone of 12 to 24 months. Priced rounds are directly tied to investors and, more importantly, to the lead investor. Depending on how many rounds of funding for startups are expected to occur later on, the role of the lead investor could end up being crucial. The “lead” has the obligation to not only commit to financing a round, but also to establish the rules for all of the next investors and startup funding rounds. It is a standard practice for the lead investor to be welcomed on the board of the company as part of the deal to reward his/her commitment.  

Types of Funding 

This funding article will primarily focus on the types of funding for startups. Although not strictly standardized, there are a fair number of labels that are widely used and recognized with regards to startup funding rounds. However, differences in terminology may exist, especially across industries. 

Startup types of funding

Friends and Family Rounds 

A discussion of startup funding rounds would not be complete without addressing the very first round – i.e., the friends and family round, which is commonly referred to as “friends, family, and fools”. This round is on the opposite spectrum of venture capital funding rounds, as it consists solely of individuals with a personal connection to or relationship with the company’s founder(s). In most cases, when startup founders are considering how many rounds of funding before IPO are assessed, they do count the friends and family round as a separate and full round, given that 80% of the initial funding for the average startup comes from friends, family, and personal savings. This first round is thus not to be underestimated in terms of significance and will be considered its own, fully recognized funding round. 

Angel Rounds 

A significant number of startups depend on a round of financing from angel investors. Founders are frequently contemplating “How much pre seed should I use?”, which is difficult to estimate or accurately predict, but angel investors frequently tend to fund both pre seed and seed rounds as part of a syndicate. Friends and family rounds are often called first money rounds. If you are lucky, you may even have found angel investors who are willing and able to support your company even further to Series A round funding. 

How much pre seed should I use? 

Once the first money rounds are closed out, the next steps are the institutional rounds, beginning with the pre seed rounds. When it comes to the widely asked question of “how much pre seed should I use?”, the answer is typically found anywhere between $50K and $500K, but can oftentimes exceed $1M. It is therefore understandable why many startup founders become fixated on the question of “how much pre seed should I use?”. Considering the fact pre seed rounds generally occur before the marketable and salable product is finished, determining the appropriate amount of pre seed funding before the product development stage has even been fully completed may present a considerable challenge. 

Seed Rounds

The venture capital funding rounds officially start with the seed rounds, although experts do not agree on whether or not the friends and family, angel rounds, and pre-seed rounds should be considered as a part of the seed rounds in general. The amount of the investments in the actual seed phase is larger, with an average of $1.4M. As such, corresponding post-money valuations can range anywhere between $4.5M–$9.8M. Even if there are no strict limitations on the size of the investment, some VC firms would expect the startup company to have made demonstrable progress on the salable product, traction, or product-market fit. However, other VC firms will not specifically require such progress to have been made at this stage.

Growth Rounds

Series A Round Funding 

The types of funding after the seed stage are labeled in alphabetical order, which helps explain the series A funding meaning. This specific funding round is the “moment of truth” for startups, as only half of the seeded companies successfully carry out a Series A round funding. Additionally, this is the first round in which investors start to rely on the actual product and often want to see some tangible results in this regard. Of course, with every subsequent funding round, the money raised becomes a larger and larger sum, with post-money valuations ranging from $6.1M up to $30M and the median investment being $6.1M. The Series A round is arguably one of the most crucial startup funding rounds since it is a clear indicator of a company’s growth and pre-determined product-market fit. In sum, when we are trying to have series funding rounds explained, the key point regarding Series A round funding is the transition from selling your value proposition to showing some proof of concept to the investors. 

Series B Rounds 

The Series B funding meaning  goes beyond that of Series A funding meaning. Once the company has a clear proof of product-market fit on a larger scale – not just an indication – then the startup has two options: expansion or collaboration with competitors. By the time the company reaches this stage of the startup funding rounds, it will most likely have hired executives and found a way to generate revenue and achieve profitability. However, Series B is all about acquiring funds to grow in a specific niche or expand with new products or new markets, thereby taking the company to the next level. 

Mega Rounds 

Types of funding vary dramatically, and not all types are implemented by every startup. This is particularly true with the mega rounds, which are types of funding that raise over $100M. For this reason, mega rounds are far less common, as they require not only a product that convinces investors to invest such a large sum, but also investors who have the capacity of such a significant amount of funds – the combination of which is exceedingly rare. 

Bridge Rounds 

Startup funding rounds are nowhere near an exact science, as funding a startup founder’s dream or novel idea does not necessarily translate to a financially rewarding investment in the highly volatile world of business. Many business ideas simply will fail to resonate with potential consumers, which is why a considerable percentage of startups do not make a smooth transition through all startup funding rounds. Discrepancies between the market or the product-market fit could result in additional types of funding rounds, which are defined as bridge rounds. For example, a bridge round between the seed round and the series A round funding is known as “second seed” or “seed+”. The need for bridge rounds could arise from a failure to meet the required milestone to initiate the next funding round, or may simply be at the discretion of the founders. Regardless, bridge rounds are a clear example of why there is no clear cut answer to the question of how many rounds of funding for startups are needed, as startup funding rounds are just as individualized as the startup itself. 

Inside and Outside Rounds 

These types of funding solely depend on the type of investors who are providing the new funds. For example, a round primarily funded by investors who have already invested in previous rounds is called an “inside round,” whereas a round in which new investors are coming to the table is labeled an “outside round.” If a company is undergoing a massive expansion or is struggling to reach a particular milestone, an outside round might be the best decision for an injection of fresh capital. 

Party Rounds 

The so-called “party rounds” are among the startup funding rounds that are generally not preferred by founders. A party round simply means the majority of the investors who took part in it invested a smaller amount. This results in a large number of investors, but a similar total sum of investment, which is more difficult for founders to manage and is more restrictive when it comes to each individual investor’s commitment towards the success of the startup. 

Up Round, Down Round, and Flat Round

These three types of funding rounds simply reflect a comparison between the previous round and the current one, where an up round reflects a higher valuation, a down round reflects a lower valuation, and a flat round registers an equal valuation. Specifically, up rounds describe the scenario in which the pre-money valuation increases, which is generally a desirable type of funding round because it indicates investors’ confidence in the company’s business model. In contrast, if the pre-money valuation decreases, it is considered to be a down round, which is generally considered a negative indicator. A down round can reduce not only returns, but also the equity position of the company’s founders, as investors are signaling decreased confidence in the company’s business model. As such, down rounds are among the least desirable startup funding rounds, as it may indicate significant issues within the company.  

How many rounds of funding for startups are needed to ensure success? 

Having gone through the aforementioned types of funding and highlighting the various startup funding rounds, you should be able to determine which specific startup funding rounds are needed for your specific startup. You might decide to create a strategy with bridge rounds. Alternatively, you might decide to try the traditional method and go through every stage, including family and friends, pre-seed, seed, Series A, and Series B funding, meaning. In this event, there are no strict requirements or a fixed procedure which you need to follow. However, you should always be sure you have attracted the right type of investors and that you are able to transform your dream into quantifiable metrics that can demonstrate the viability of your idea, while considering the different types of funding within the different venture capital funding rounds. 

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Disclaimer: This blog article is provided by Pandev Law, LLC for general educational and informational purposes only. Although this article discusses general legal issues, it does not constitute legal advice nor does it establish an attorney-client relationship. No reader should act or refrain from acting on the basis of any information presented in this article, or elsewhere on this website, without seeking the advice of appropriate legal counsel, or other professional counsel, licensed in the relevant jurisdiction. Pandev Law, LLC expressly disclaims any and all liability with respect to any actions taken, or not taken, based on any content of this article or website. This blog article may constitute attorney advertising. Prior results do not guarantee a similar outcome.

Adrian Pandev

As the principal attorney at Pandev Law, I have helped hundreds of foreign individuals and companies successfully navigate their journey to the United States. Previously, I served as Trial Attorney at the U.S. Department of Justice. Now, I represent foreign investors, founders, and high-net-worth-individuals in business, immigration, and wealth planning matters. I am an early proponent of blockchain technology and serve as strategic advisor to blockchain startups and cryptocurrency investors. Selected to the Super Lawyers New York Rising Starslist 2019-2021. Follow me on Twitter, LinkedIn, or Instagram.

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