Series A Funding for Start-ups – The things you need to know

Ruchi Gandhi

15 Jun, 2020

To augment its operations and sales revenue, each start-up needs to fuel in ample amount of funds into the business. If proper care is not taken at the seed/beginning stage of a start-up, it may have to face the repercussions throughout its lifecycle. One of the most important aspects is to raise finance from authentic sources, to have a fair dilution of equity, and to gravitate leading investors towards your business.

What is Series A Funding?

Series A stage of funding for start-ups is also referred to as the early traction stage. This is the stage where the start-up’s products or services are placed on and introduced in the market. Key performance metrics like customer base, sales, app downloads, etc. become relevant at this point.

Series preferred stock is the first round of stock offered to the venture capital investor by a portfolio company during the seed or early-stage round. A typical series A funding round is usually between $2 million and $10 million, purchasing the company’s stake from 10 per cent to 30 per cent.

It is usually expected that the money raised during a series round will remain and capitalize on the business for six months to 2 years as it develops its products, performs initial marketing and branding, hires its initial staff and otherwise undertakes early-stage business operations.

Throughout this stage, funds are raised to further increase the user base, product offerings, extend to new geographies, etc. The most popular sources of funding used by entrepreneurs at this point, i.e., Series A funding are venture capital funds, debt from banks and NBFCs, and venture debt funds. The primary source is through venture capitalists.

Venture capitalists usually finance new and rapidly growing companies, purchase equity securities, assist in the development of new products or services, and add value to the company through active participation. They take care of pooled money from many other investors and place them in a strategically managed fund.

Commonly followed sources

As there are no public exchanges listing their shares, private companies encounter venture capital firms and other private equity investors in a variety of ways. These include warm referrals from reliable sources of the investors and other company contacts; investor conferences and demo days where businesses are directly pitching to investor groups.

Also, with equity crowdfunding becoming more common, start-up firms are increasingly raising part of their Series round through online platforms like Onevest or Seed Invest in the USA and Seedrs in the UK, VC-Circle, Private Circle, Lets Venture, and Tracxn Labs, etc. in India. Such blended rounds include, alongside offline venture capital investors, a mix of angel investors, strategic investors, and clients.

What is a simple procedure of obtaining finance from VCs?

The steps involved in raising finance from a venture capitalist during a Series A round of funding are as follows:

• One of the most important decisions is to select an appropriate legal framework for any company. Generally, limited liability partnership (LLP) and private limited company are preferred entity structures for start-ups in India.

• The next step is to execute a business plan. For your business, this is a comprehensive thing that would include your market analysis, progress to date, financial projections, customer goals, offers, tactics, facilities, operating processes, culture, the amount of investment required and for what purposes.

It must show how investors’ money will contribute to the success of the start-up company. You will be taken seriously by any investor if they are convinced of your revenue projections, organizational strategies, funding goals, business processes, and their returns.

• The start-up needs to assess why it is necessary to raise the funding, and the correct amount to be raised. The company will create a milestone-based strategy with consistent expectations for what the company wants to do in the next 2, 4, and 10 years.

When the business plan is drawn up, translating the business goals into numbers is important. Hence, a detailed budget sheet  or fund-raising plan is needed to be prepared by a start-up.

• The next step is to find the right investors for your start-up. Targeting the right set of investors requires researching their past market investments and talking to entrepreneurs who have successfully raised equity funding.

• Pitching the investors in the right way is indispensable for the success of fund-raising. A pitch deck is a comprehensive overview of the start-up that explains all essential facets of the company.

It enables prospective investors to understand whether the concept addresses a real opportunity, whether the business case is strong, whether the team is well-rounded, competent and committed, and the traction the team has been able to achieve to date.

• The next step is to perfect your pitch by gathering your business plan, investor pitch deck, and other relevant documents and convince investors as to why your business is a worthwhile investment.

• It is imperative that entrepreneurs get adequate legal advice when negotiating investment terms of the deal and investors’ rights.

An intention document detailing the structure and conditions of the transaction is called the term sheet. It sets out the terms and conditions of a tentative business agreement and the details of the investment terms and collateral.

• The investor and start-up will typically enter into a non-binding agreement based on the start-up’s preliminary valuation generally followed by financial, legal and technological due diligence on the start-up as demanded by the investors.

Before concluding an investment deal, angel networks and VCs look at the company’s preceding financial activities and employee credentials and their history.

This is intended to ensure that the company’s statements regarding growth /development and market statistics can be checked as well as to ensure that the investor can detect any questionable practices beforehand.

• If due diligence has been performed to the satisfaction of the investor, then the investment process involves the execution of fundamentally appropriate transaction documents between the investors and the start-ups.

This entails the execution of investment-related definitive agreements. These documents include the Shareholders’ agreement (SHA) and the Share Subscription Agreement (SSA).

Subsequent to the completion of these steps, the shares are issued, and capital is raised by start-ups.

Things to consider when raising a ‘Series A Funding’

If a start-up is looking to raise a Series A funding, it may be a good idea to get acquainted with what venture funds are looking for, in order to determine whether your company is ready for Series A. Most start-ups, even those that receive funding from an angel or seed-stage funding, or investments from accelerators/incubators, are unable to obtain follow-up funding. Why is Series A so difficult to fund?

For successfully obtaining a Series A funding, a start-up must take into consideration the following points:

• Be Series A Ready

If you are trying to raise a Series A funding, it may be a fair option to familiarize yourself with what venture capital firms are aiming for, to evaluate if your business is ready for Series A or not.

Promising unit economics, sales, proof of business model, structures ready to help efficient scaling, product/market alignment, strategy for consumer acquisition and growth, team quality, etc. are some of the main factors that are usually taken into account.

In order to figure out whether you are ready for Series A funding, it is prudent to examine where the business entity stands against all these metrics.

• Begin Early

Fund-raising is a time-consuming process in the current environment, so it is better to be realistic about the time frame. Make sure that you start the cycle at least 7-8 months prior to raising a Series A financing. There are two components to the deal process, pre-term sheet, and post-term sheet.

Underestimating the time needed eventually leads to desperation on the part of the company, and as a result, the finance plan will often need to be modified to involve switching attention towards the requirement to raise a bridge round to sustain the business.

• Leverage and strengthen your network

Seed financing is more plentiful and easier to collect as compared to Series A. Taking advantage of your network and developing real relationships before you launch your series A funding would make it easier for you to get potential meetings with investors. Contact your extended network and ask them to use their connections. These networks of second degree have powerful and favorable findings. It is always helpful to spread a word about your business via your network or through PR / marketing initiatives.

• Perfect your “Pitch”

The key is getting as many meetings as you can. Speak to other founders who raised Series A funding successfully and take their feedback for your pitch. First, visit the low-priority investors on your list. They will ask you specific questions and provide you with useful input that you can use in your presentation before meeting high priority investors on your list.

• Create a Fundraise Momentum

Approaching several venture funds at the same time is a smart idea for bringing a competitive element into the process. Try keeping your conversations with interested investors moving along, and as close to the same pace as possible. This may not be simple, but if you manage to organize effectively, you will be able to negotiate from a high negotiating power that usually leads to better valuation and terms of the deal. Further, this will result in landing up a term sheet from one or more VCs.

• Be aware of the “standard market practice”

Keep yourself up to date with the generally offered terms of a Series A deal. It is certainly possible that the first draft of your term sheet that you receive is not exactly “friendly to the founders.” However, the best line of defense and the most common explanation for discussing these deal terms is that they are not standard practice in the industry.

• Get the deal terms right

It is imperative that you ensure that the terms of your Series A deal are accurate and compatible with your business trajectory. The deal terms of Series A funding will serve as the basis for all future rounds. Some of the terms you signed up for in your Series A round are likely to move through subsequent stages of funding, i.e. Series B or Series C. Therefore, it is important to get them right for the first time itself.

• Engage a lawyer or Company Secretary

If you are raising venture capital, you need a lawyer who is specialized in financing venture capital. A lawyer, who has made such transactions multiple times, knows the complexities involved in structuring these rounds, particularly from the point of view of which conditions are relevant, what the “standard market practice” is, and when to stay firm and when to agree to the investor. This will allow you to quickly and more effectively close your investment papers.

• Keep paperwork in place

Shorten the closing time of your transaction by having all the paperwork in place for due diligence. Ensure that the legal documentation and compliance of the company are up-to-date and that the department has reviewed all documents relating to staff, preceding financials, corporate structure and formation, customer arrangements, intellectual property, etc. The paperwork should be organized and ready for review by a legal counsel/diligence team appointed by the investor.

• Raise 10-15% more than budgeted for

If you have access to capital and the terms of the deal, including dilution, are good, then collect 10-15% more than budgeted as business initiatives/operations do not always come into action as expected. Raise enough to help you to obtain a reasonable chance to hit your goals for the next fund-raising rounds so that you can concentrate all your energy on developing the company and expanding it in the right direction. Raising every round of funding post Series-A round becomes significantly difficult and is, therefore, a time-consuming process. Furthermore, there is a transaction cost every time you close an additional round.

Takeaway

Also, read: Funding Alternatives for Start-ups and Small Businesses: Start-up Finance