Series A, Series huh? Primer on venture capital funding
Venture funding is not for the faint of heart, or for those in a hurry for return. Forbes says 90 percent of startups are bound for failure; venture firms aim to throw many seeds on fertile ground in hopes a few will take off and become the “unicorn” companies valued at $1 billion or more a decade or more into the future. Experts recommend only risking a small portion of your investment portfolio on startup funds.
In fact, the Securities and Exchange Commission requires sellers of non-registered securities—read private equity, hedge funds and venture capital funds—to sell only to accredited investors. Those are investors with an income of $200,000 or higher ($300,000 for a married couple) for at least two years and with a reasonable expectation of that income continuing in the current year—or, an individual with a net worth of more than $1 million excluding the value of their primary residence.
Still all in? Read on for a guide to venture capital terminology.
What are the different venture capital funding rounds?
Most founders raise money to take a company from back-of-the-napkin to matured more than once at various stages of need and size of investment.
Pre-seed: This is money most often raised to get an idea off the ground, for initial costs and plans. Often from founders themselves or friends and family, often not for equity.
Seed: Usually the first official raise of funds. Often funds R&D—and the people behind it—for determining business direction. Also often involves investments in exchange for equity.
Series A: Funding sought to take a going company with some discernible product, usually to enable hiring, execution of strategy and development. Most often raised from venture capital, this is the first series of preferred stock. According to Fundz, the median Series A raise in the U.S. by mid-2021 is around $8 million. These companies are usually already valued in the tens of millions.
Series B: Goal is to scale a company to the next level. Usually a larger round—in mid-2020 the mean Series B raise in the U.S. was $33 million.
What are angel investors?
Angel investors are single high net worth individuals who invest time, money or both to get a company off the ground in its very earliest stages, often in exchange for equity in a company. They often provide very favorable terms to companies as their interest lies more in a company’s success than in high profits.
Investors in venture funds can also be committed to the mission of the particular fund. Some funds are very mission-driven, seeking to boost, for example, enviro-tech startups, socio-economically underserved populations or geographic areas—while providing a return.
Do they ever get tax incentives?
There are no specific federal tax breaks currently for venture investing. Many states do offer those incentives for different types of early stage funding investment. Ohio, for instance, offers a personal income tax credit of up to 10 percent of cash investments in Ohio-based small businesses.
What’s the return on a typical VC investment?
Venture firms all shoot for the sky, but any individual investment could also tank completely. The goal of individual investments is a successful exit, meaning a sale of the company for a large profit.
Most firms/funds, however, have targets or track records over a set period of years over all investments. The National Bureau of Economic Research has said a 25 percent return on a venture capital investment is the average.
What about VC vs. private equity?
Private equity (PE) refers to ownership of companies that are not publicly traded. High net worth individuals and firms invest in privately held companies or in public companies with the intent to take them private, and many are older companies long in business.
Venture funding refers to money in newer, startup-type companies, which PE may not necessarily be.
While both venture and PE funds may be interested in high-growth potential investment, and both have a high tolerance for risk, PE firms often prefer to focus on obtaining majority ownership and then “fixing” or streamlining businesses for growth, while venture funds aim to grow companies through minority investment of funds and expertise, and often attracting other outside capital.
How are company valuations determined?
Potential investors want to know the value, and potential value, of what they want to buy into.
There are several ways to calculate that, including market capitalization—multiplying a public company’s share price by its total number of shares outstanding—looking at multiples of a company’s revenues or earnings, or simply looking at the value of a company’s assets minus its liabilities (book value).
But that’s tricky for a new entity with no or little cash flow. Investors then may look at what similar companies are actually selling for, such as, say, five times that company’s sales, and then apply a similar formula— that’s called the “market multiple.”
Or they will look at the stage of the company’s development and the human, intellectual and physical infrastructure it has in place, and apply various known calculations often used in the industry to score the company’s worth.
Cynthia Bent Findlay is a freelance writer.