What is Series A Financing?
Series A financing refers to an investment in a privately-held, start-up company after it has shown progress in building its business model and demonstrates the potential to grow and generate revenue. Initially, start-up companies rely on small investors for seed capital to begin operations. Seed capital can come from the entrepreneurs and founders of the company (a.k.a. friends and family), angel investors, and other small investors seeking to get in on the ground floor of a potentially exciting new opportunity. Crowd-sourcing is another way for angel investors to access investment opportunities in start-ups.
The main difference between seed capital and Series A funding is the amount of money involved and what form of ownership or participation the investor receives. Seed capital will usually be in smaller amounts, e.g. tens or hundreds of thousands of dollars, while Series A financing is typically in the millions of dollars. Series A financing comes from well-established venture capital (VC) and private equity (PE) firms, such as D.E. Shaw and Kleiner, Perkins, which manage multi-billion-dollar portfolios of multiple investments in start-up and early development companies.
The Basics of Series A Financing
After a start-up, let’s call it XYZ, has established itself with a viable product or business model, it may still lack sufficient revenue, if any, to expand. It will then reach-out to, or be approached by, VC or PE firms for additional funding. XYZ will then provide the potential Series A investors with detailed information on their business model and projections for future growth and revenue. Typically, the funds sought would be used to proceed with expansions plans (hire additional personnel, programmers, sales and support staff, new office space, and the like). The funds can also be used to pay out initial seed/angel Investors.
The potential Series A investors will then perform their due diligence (basically reviewing the business model and financial projections to see if they make sense) and then form a decision about whether to invest or not. Remember, this is a high-risk enterprise, as many start-ups don’t make it. If they decide to invest, then it gets down to the nitty-gritty: how much to invest, what will they get in return, and other conditions covering the investment.
In exchange for their investment, typical Series A investors will receive common or preferred stock of the company, deferred stock, or deferred debt, or some combination of those. The entire investment is premised on the valuation of the company, how much it is worth, and how that valuation may change over time. Most Series A investors are looking for significant returns on their money, with 200-300% not uncommon objectives over a several year period.
- Series A financing follows initial seed capital and generally involves investments in the tens of millions of dollars.
- Series A financing becomes available after a privately-held, start-up company has demonstrated a viable business model with strong growth potential.
- Series A financing allows start-up companies to expand their operations, hire more staff, buy equipment and pursue its growth objectives.
- Series A financiers are usually large venture capital or private equity firms.
- Series A financiers typically gain a large or controlling interest in the start-up company.
An Example of Series A Financing
XYZ has developed a novel software that allows investors to link their accounts, make payments, investments, and move their assets between financial institutions, all on their mobile device. Several VC funds show interest and invite XYZ to discuss their current financial condition, detailed business model, projected revenues, and all other pertinent corporate and financial data.
The VC firms then pore over the data to see how reasonable it is, ultimately seeking to determine a future valuation for the company. Their conclusion is that XYZ will be worth $100 million in a three-year time-frame, but they are only willing to invest $20 million in XYZ. But because the company is not currently generating profits, the VC company is able to negotiate for a larger share of ownership, say 50%. If XYZ is successful and meets the projections of a $100 million valuation, the VC’s $20 million-dollar investment will now be worth $50 million, a return of 250% over three years.
Depending on the amount of an investment, Series A investors will also likely gain seats on the board of XYZ to allow them to more closely monitor the company’s progress and management. Subsequent rounds of financing, known as Series B or Series C, may follow down the road, where each of those investors must re-evaluate the value of company.
They will likely receive different terms than the Series A investors, as presumably the company has proven to be a more attractive investment, and they are buying into a more established enterprise. The final step in raising capital would be for XYZ to ‘go public’ through an IPO (initial public offering), allowing individuals to buy XYZ's stock on public exchanges. Series A (B & C) investors are also then able to cash out if they wish to.
But keep in mind, if XYZ fails, the VC/PE’s investment will likely be worthless.