8. Pre-Seed Through A and Beyond: What are all those investment rounds?

I see a lot of confusion among founders about all the different terms used for funding, and what they all mean. They wonder if they are ready for a seed round, or what they need to accomplish before going for an A round.

A round is a single funding effort, usually for a planned amount of money with consistent terms for all the investors. For example, everyone investing in a C round would be getting basically the same deal. Ideally all of the money for a round is raised within a few months after it is started or “opened”, at which point it “closes”. Of course, things are never quite that simple, and many rounds last for many months and may have multiple closings. Sometimes I see the terms “round” and “series” used interchangeably, but “series” more accurately applies to a class of stock with specific seniority, terms, preferences, and rights.

I break the various rounds into five categories.

• Friends and Family

• Angel and pre-seed

• Seed

• A round

• B, C, D, and later rounds

There has been a significant migration in the definition of these rounds. At one time, a seed round provided seed capital, the first money in to a business to let it start to sprout from an idea. These days the “seed round” may be the second or third phase of investment in a business. Today, pre-seed is more like what used to be called seed, and seed, is more like the old A rounds, and so forth. Generally, each round type tends to migrate to later in the lifecycle of the startup and to involve larger investments with higher expectations.

When describing rounds, I will give typical numbers and characteristics for each, but nothing is set in stone and there will always be odd outliers and exceptional cases.

Friends and Family

The Friends and Family round is exactly what it sounds like. This is money from people who are investing because they want to help, rather than because they are making a rational investment decision. An idea for a business is the only requirement for friends and family rounds.

However, unless you have unusually wealth friends and relatives, the amounts are likely to be small. Typically this round will raise a total of $50k to $150k with many investments being $5k or less. At this point, the company valuation is around $500k to $1m

Angel & Pre-seed

Angel and/or Pre-seed rounds are the first investments from disinterested parties. Angel investors are typically high net worth individuals investing for their own benefit. They are motivated by the potential returns, but also for the pleasure of helping entrepreneurs and dabbling in the startup world. Pre-seed investments often come from specialized pre-seed funds. I lump these two types together because the terms are often used interchangeably, and both angels and pre-seed funds are frequently investing in the same round. The funds raised in these rounds typically range from $100k to $2m on a valuation of $1-5m.

At this point the investor is looking for more than just an idea. They want to see a completed prototype or a finished product with some indications of traction.

Seed

Institutional investors and super-angels (extremely high net worth individuals) dominate seed rounds. At this stage the company is raising from $500k to $5m at a valuation of $3m - $30m (averaging $12m). For this the investor expects to see significant traction and a finished viable product. Over 50% of companies with successful seed rounds have revenue. The average company is three years old before reaching the seed round.

A Round

The classic Venture Capital investors appear starting at the A round. This round is usually 100% institutional, although there may be some follow-on investment from earlier investors if they negotiated that right. A rounds typically raise between $3m and $30m at an average valuation of $20m or more. Investors expect the company to have achieved clear product market fit and show rapid growth.

B Round and Beyond

Later VC rounds (B,C, D, and onward) provide the capital for continued hyper-growth. Here the investments can be in the hundreds of millions of dollars at valuations reaching to billions. Here be unicorns. Uber went through multiple G rounds before going public.

Stock vs. Convertible

Investment rounds can also be divided into stock or priced vs. convertible. A priced round is an investment at a specific valuation with detailed terms in return for some kind of stock in the company. Convertible investments will convert into stock at some future time in conjunction with a later investment, typically at a discount to the price paid by the later investors. Because of the potentially big uncertainty in actual valuation at conversion, many of these structures place a cap on the maximum valuation at conversion. Convertible rounds are frequently used in early rounds or in between later rounds. Most convertible investments are either structured as convertible debt (legally loans), or as SAFEs which were developed by the accelerator Y Combinator.

In each round, most investors expect that all the investors in that round will end up collectively owning 20-25% of the company. Later rounds of investment dilute the ownership of the early investors, so the seed investors might end up only owning 10% of the business after the A round.

Knowing where you fit before trying to raise money will greatly improve your chances by helping you target the right group of investors, ask for an appropriate valuation, and know what the business need to have achieved.

Good luck getting those funds and growing your business!

Till next time … Ciao!