PCI

How are Privately Held Businesses's funded?

Series of Funding in a PHB

A, B, C, D, Etc.

A startup with a brilliant business idea is aiming to get its operations up and running. Over time, its customer base begins to grow, and the business begins to expand its overall operations and sales force.

If the company has been able to rise through the ranks and has become highly valued, their future expansion may include new offices, employees, and even an IPO.

If merely surviving off the generosity of friends, family, and founder's pockets, but incoming profits from sales will not suffice, then it is common to engage in external funding, known as "seed" or "angel investor" funding.

These types of investments are usually followed by Series A, B, C, and D external funding rounds, to continue financing the growth of a business.

These funding rounds give outside investors the opportunity to invest cash and/or time in a growing company in exchange for partial ownership, through equity.

Before beginning any round of funding, analysts undertake a valuation of the company in question. Valuations are derived from many different factors, such as management, proven track record, market size, and risk.

Key distinctions between funding rounds pertain to valuation of the business, its maturity level, and its growth prospects. These factors determine the reasons why the company is seeking new capital as well as the type of investors involved.

Survival Stage

Known as "pre-seed" funding, this first stage refers to the period in which a company's founders are getting their operations off the ground. The most common "pre-seed" funders are the founders, close friends, supporters, family.

Depending upon the nature of the company and the initial costs to set up and develop the business idea, this funding stage can happen very quickly or may take a long time.

Early Startup Stage
Seed Capital

Seed money represents the funds that a business raises. It helps finance the founding team that focuses on market research, product development, and initial sales efforts. These actions will determine what its actual products will be and who their target demographics are.

"Angel Investors" are the most common type of investors participating in seed funding. They tend to appreciate riskier ventures such as startups with little proven track record, and expect an equity stake in the company in exchange for their time, expertise, experience, and money investments.

Angel investors are willing to accept less favorable terms compared to others, since they like to invest in the entrepreneur starting the business rather than the viability of the business. They foster innovation and are therefore the opposite of the more predatory venture capitalists who use pooled money from a strategically managed fund.

Angel investors, also called seed investors are affluent individuals who inject not more than 10% of their portfolio in startups in exchange for ownership equity or convertible debt. Some of them invest through online crowd-funding platforms or build angel investor networks to pool capital together.

Since angel investors or business angels may lose their investments often, they look for acquisitions with a defined exit strategy or ones with a strong potential for IPO's.

Although angel investors want an effective internal rate of return of 20-30%, entrepreneurs with early-stage businesses may not find cheaper sources of financing such as banks willing to lend or invest.

This round may produce funds from $20,000 up to $2 million. A seed funding round is all that some founders feel is needed to successfully get their company off the ground and running. They may not need to engage in the next rounds of funding.

These companies are often valued between 3 and 6 million dollars. However, the majority of startups fail to make it beyond seed funding.

Development Stage
Series A Funding

Once a business has developed a user base, consistent revenue figures and other key performance indicators, that company may opt for Series A funding in order to further scale the product across different markets.

Often, seed startups have great ideas that generate a substantial amount of enthusiastic users, but the company management doesn’t know how to monetize this over the long term. Therefore, it is important to develop a business model whose forecasts can generate this long-term profit.

Typically, Series A rounds raise 2-15 million dollars in exchange for common or preferred stock, deferred stock, or deferred debt. More is raised if it involves a valuation of a high tech industry business.

Here, besides great ideas, private equity investors are also looking for a strong long term strategy and management team that turns that idea into a successful, money-making business. That is why firms going through Series A funding rounds need to be valued up to $15 million.

The first investors involved in the Series A round come from more traditional large venture capital firms, looking for 200-300% returns over several years.

They often take a large or controlling interest and become part of the political process, and lead the pack forward as an "anchor" investor. It is then easier to attract additional large investors for the next funding rounds.

Angel investors may now be bought out, but may also invest at this stage, but they tend to have much less influence in this funding round than they did in the earlier stage.

If a company successfully generated seed funding, but fails to find investors for a Series A funding, they may try to find funds through equity crowd-funding.

Later Stage
Series B Funding

Companies that have gone through seed and Series A funding rounds are well-established and have developed substantial user bases. They have proven to investors that they are prepared for success on a larger scale. Series B funding is used to meet these levels of demand.

Building a winning product and growing a team requires quality talent acquisition. Series B rounds tend to raise capital between $7 million and $10 million. Most Series B companies have valuations between $30 million and $60 million.

The difference with Series A is the adding of a new wave of venture capitalists that specialize in this later stage investing, but pay a higher price/share because the company's valuation went up in this stage.

These investors prefer to receive convertible preferred stock, because of its unique features not available in common stock, such as dividend accrual and anti-dilution. The latter protects an investor from equity percentage dilution, resulting from later issues of stock at a lower price than he/she originally paid, thus they receive more stock. Anti-dilution clauses are also known as preemptive rights or subscription rights.

In a contract with a full ratchet provision, the conversion price of the existing preferred shares is adjusted downwards to the price at which new shares are issued in later rounds. The weighted average provision uses the following formula to determine new conversion prices:

C2 = C1 x (A + B) / (A + C)

C2 = new conversion price
C1 = old conversion price
A = number of outstanding shares before new issue
B = total amount received for the new issue
C = number of new shares issued

A company may struggle to find more capital due to the protections granted to past private investors. They may waive their dilution protection to avoid this problem, because they will make much more money shepherding a startup PHB to a PTB, than protecting an ownership stake in a struggling PHB.

Series B funding comes from private equity investors, venture capitalists, institutional investors, credit investments, and crowd-funded equity. Latter investments provide a wider market from which businesses can receive capital.

These activities transact through an Internet finance platform operated by a crowd-funded Internet finance provider, who connects companies with investors at low costs to both, due to the low cost structures of these operations.

Scaling Stage
Series C Funding

Businesses that make it to Series C funding sessions are already quite successful. These companies look for additional funding in order to help them develop new products, expand into new markets, or acquire other companies.

In Series C rounds, investors inject capital into the meat of successful businesses, in order to at least double their investment. Series C funding is focused on scaling the company, growing as quickly and successfully as possible.

A way to scale a business is to acquire another company, possibly a competitor who currently possesses a fair market share and certain competitive advantages from which the business could benefit.

If the cultures seem to fit, a merger would be a synergistic partnership. Agglomeration or Series C funding could be used for this.

If the enterprise is thriving and thus becomes less risky, investors like hedge funds, investment banks, private equity firms, and secondary market groups will accompany the earlier investors. These investors expect to invest significant sums of money into companies as a means to secure the business's position as leader in their industry sector.

Although most companies end their external equity funding here, some may go on to Series D and even Series E rounds of funding. If however, companies gained over a hundred million dollars in funding through Series C rounds, they usually are prepared to continue to develop on a global scale.

Many of these companies utilize Series C funding to help boost their valuation in anticipation of an IPO. Their $100 million+ valuations are also founded on hard data rather than forecasts, as they have established strong customer bases and revenue streams, plus proven histories of growth.

Public Offering Stage (IPO)
Series D Funding

If they have not yet been able to achieve their intended goals, like an IPO, during Series C funding, they may continue with a Series D funding to finance the final push to such an IPO.

Summary

Company profiles differ with each case study but generally possess different risk profiles and maturity levels at each funding stage. Nevertheless, seed investors and Series A, B, and C investors all help to nurture ideas to come to fruition. Series funding enables investors to support entrepreneurs with the proper funds to carry out their dreams, perhaps cashing out together down the line in an IPO.

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