Building a new product to release to the market is a difficult task and one that all founders must take, but developing a viable product is only a part of the uphill battle.
Building a startup that has the ability to scale to a fully functioning business is often the more time-consuming and difficult part of the battle.
For many startups to make the climb from the bottom to an industry leader, they typically seek multiple rounds of investing to gain the capital required to scale up to the next business level. Many investors when looking to invest in a startup are looking for good ideas but mainly choose to invest in startups with a promising business model, idea, and team.
When creating a startup, it can be confusing to understand the vernacular and terminology utilized by those in the business world—especially if the founder does not have a business background.
Funding Rounds, Venture Capital, Angel Investors, Equity, and Valuation are all terms that are frequently utilized and are critical to understand. It’s easy for novice founders to be overwhelmed—not only do they have to make a product, but they also have to learn how to start and run a business.
While there is a learning curve for many founders, learning the terminology and lingo will help tremendously in creating a successful startup. Below is a description of the different funding categorizations and a comparison between Series A and Series B funding stages.
With this knowledge, a startup can have a better understanding of their position within the startup life cycle and make better business decisions accordingly.
How are series funding categorized?
A common misconception is that the term “startup” is a one-size-fits-all definition for businesses in their early stage.
In reality, a startup can encompass many types of businesses at very different stages. A startup can range from a business that has nothing but an idea, all the way to a business with salaried employees and a product actively being sold to the masses. Because of this vague classification, startups utilize the funding categorization to gain a better understanding of where in the startup timeline a business is today.
Each series denotes the progression of a company as well as the typical reasons for investment needs. The order of funding rounds is as follows:
Seed and angel investor stages are the earliest stage of funding and tend to be a relatively low total capital requirement to satisfy the funding stage.
Series A startups are those that have the very beginnings of a business with a customer base, proof of concept, etc.
Series B funding is typically for startups that are looking to increase production or sales. With a solid basis that the startup product is desirable, Series B funding is typically needed to scale up production and to reach more customers.
Series C funding is typically reserved for those startups that have reached the point of a successful private business and are looking to further optimize before going public.
What is seed funding?
Seed funding is the earliest an investor can back a startup. The seed funding stage typically will get backed by an angel investor. These angel investors are typically entrepreneurs that utilize their own wealth to invest in startups.
The main reason the seed stage is dominated by angel investors is that investment firms like venture capital firms have to worry about more than one person when investing. A venture capital firm works by having limited partners that all chip in to a massive fund that is then utilized to make investments to turn a profit.
Because there are more parties involved in the process, venture firms are typically more reserved when deciding to invest or not. There are exceptions like California-based venture firm M13 that actually offer funding from seed to Series A.
The main reason that there are reservations when investing in a seed startup is that there is more risk associated with startups that have yet to prove their worth.
While there are many reasons why startups fail, having an early-stage startup poses many risks that make investors more hesitant. With just an idea and a small number of real assets, a seed startup has no guarantees and could result in an investor losing their investment entirely. Founders that are able to instill confidence into an investor and prove that they are different from the rest will be able to get funded because they are minimizing the perceived risk.
During seed funding rounds, investors are typically able to negotiate more ownership of a startup than in later funding stages and this is the main incentive for those that decide to invest during the seed funding rounds. Valuations at the seed stage of funding also tend to be difficult to obtain or relatively low, which contributes to a higher equity to funding ratio.
The relationship between seed investors and an early-stage startup tends to be much stronger, which is ultimately advantageous for both parties because they have the best interests of each other in mind.
What is Series A?
Series A is the first and main acquisition of funding for a startup.
Series A funding rounds are typically created to scale a small team into a larger team that is capable of developing, producing, and selling at a higher rate. Series A startups typically have the underlying basis of an established startup including a founding team, a proof of concept, and a good track record of capital management from the previous round of funding.
The Series A funding round is typically utilized for hirings, equipment necessary for production, and other items needed to create a product at a viable rate.
With more of an established presence, this is typically where a venture capital will begin investing.
For many investing firms, the seed round is a period of sink or swim that can weed out weaker ideas and founding teams. The more advantageous firms are those that offer assistance from seed to series A like M13, because they look at founders and startups as people worth investing in rather than just a product with a certain profit margin.
Valuations tend to be given at the Series A funding stage as there are some key metrics that can be utilized to understand the worth of a startup more clearly. With a proof of concept, idea of money management with seed funding, and the progress of a startup, appraisers are better able to approximate the worth of a Series A startup over a startup in the seed funding stage.
Typically investments are achieved by the startup giving preferred stock holding of the private company to investors after a valuation. The amount of equity given per capital invested tends to be lower than the seed round, however, the amount is usually enough to lure investors in. Typically VCs and other investors will invest for a non-majority holding of the startup. This allows for future utilizations of equity by the founder and allows an investor to not be the sole decision-maker in business direction.
What is Series B?
Series B funding is typically the third wave of funding needed for a startup.
With two funding rounds already achieved, startups at Series B tend to have a good reputation with investment and money management. This is compounded by the fact that these startups have more physical assets and financial records, which increases their value.
Valuations for Series B funding rounds tend to be higher, which means that investors in Series B funding rounds get less equity for their capital simply because the company itself is worth more. Valuations at this stage are not only higher but they also tend to be far more accurate because they are able to rely more heavily on quantitative data sets rather than qualitative analysis of a startup.
During Series B funding, some previous investors will most likely assist with this funding round as it is to their advantage to continue the upward trajectory of the business.
The funding gained in the Series B round is typically utilized to scale up operations, moving a small business into a larger business bracket. Customer outreach, increasing productivity, increasing availability, and increasing reach are some of the items that Series B funding attempts to address.
Series B funding rounds are needed to scale and grow the startup into a viable business with a wide reach.
How are Series A and B fundings different?
Each funding stage is unique and carries its own set of challenges, but what are the main differences between Series A and Series B? There are a couple of ways in which Series A and B are different and this includes the funding amount, how far along a startup is, and the reasons behind the need for the funding round.
When comparing the capital requirements between the two stages, Series B funding will tend to cost more. Series A funding is seen as the first real acquisition of capital to make an idea come to life.
While this upfront cost is expensive for Series A funding, the goal of getting the product to more people is what makes Series B funding require more funding.
An easy way to think about it is to think about the difference between a small-town bakery and a bakery that distributes its baked goods nationally. Series A is what gets the local baking shop up and running while Series B funding is the amount it takes to scale the local bakery into one that can produce and ship nationally.
How are they similar?
The main similarity between Series A and Series B funding is that they both look to get a startup over a hurdle.
Whether that be through the initial scale-up or the scale-up that transitions the startup into a business with a wider reach, both funding rounds act as a way for a startup to transition to the next business stage.
Both funding stages typically look to angel investors and venture firms to acquire funding, and they both typically also give equity in the business for an investor to back the startup.
Overall, deciphering the difference between Series A and Series B funding stages all comes down to having an understanding of the funding stage process. Seed, Series A, Series B, and Series C constitute the funding stages of a startup and are key to understanding where a startup is at in the process.
Key milestones mark the differences between the funding stages. Building a team and a product is indicative of a seed round of funding. Series A is mainly accompanied by the purchasing of items necessary for initial production. Series B funding is the step normally taken to get a product to the masses and to scale production to a point that the business begins to see its first amount of profit.
Resources we love
The Top 12 Reasons Startups Fail [CBInsights]
Series A, B, C Funding: What It All Means and How It Works [Investopedia]
A VC Star Is Reimagining the Role of the Venture Capitalist [Forbes]