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Sunday, February 12, 2012

The Venture Capital Financing Process(Part Deux)

Venture capital (VC) funding is typically used by enterprises that are early-stage, high-risk, high-potential growth startup companies.  Many times they are already generating revenue for their product or service, even though they may not be profitable yet.

Round and round we go

In the venture capital game financing rounds typically have names that relate to the class of stock being sold:

    The seed round is where company insiders provide start-up capital.
    The Angel round is where early outside investors can buy common stock.

Under normal circumstances the company will have advanced its cause by the time of the next round.  As a result, each subsequent round of venture capital reflects a different valuation (i.e. if the company is prospering, the Series B round will value company stock higher than Series A, and Series C will have a higher stock price than Series B).

On the other hand, if the company is not prospering, it can still get subsequent Series-rounds of financing, but the valuation will be lower than the previous series: this is referred to as a “down round.”

These “down rounds” may also include “strategic investors” who participate in the round and also offer value in their area of expertise such as marketing or technology assistance.

After a “down round” where the company fails to meet established growth objectives they can essentially re-start under a new group of funders. These rounds are identified as series AA, BB, etc.

After that we get into the ‘Alphabet Soup Rounds’

The first of the Alphabet rounds is known as "A round" or "A round financing".  This is the first round of financing for a new business venture after the seed capital is received.  In most instances this will be the first time that company ownership is offered to outside investors.

By this point in time the company should be generating some revenue but is probably not yet profitable.  The investors at this stage are venture capital funds or angel investors who are willing to accept higher risk for the prospect of higher returns.

As the company grows and requires even more capital, each subsequent round of preferred stock issued to investors takes on the next letter in the alphabet.  This way investors know where they stand in the pecking order of claiming future profits.

At each stage, the company gets revalued.

The second round of financing for a company by private equity investors or venture capitalists is known as Series B.  This round usually takes place once certain milestones have been reached by the organization.

The third round of financing is called, guess what? Series C and usually represents an additional expansion stage for the company.  At this stage the company has proven successful in the market and has the potential for an even larger market.

Series Round D financing (along with series C) represent the final stages in the Early Financing cycle. Usually these are the final steps in the company’s growth cycle before the IPO (Initial Public Offering) or the sale of the company to another group of investors.

During the Series A, B, C, etc. rounds of financing, the company typically receives money from investors in exchange for preferred stock.  As a side note insiders, seed capital investors and angel investors usually receive common stock. Private equity investors generally prefer convertible preferred stock to common stock.

Holders of preferred stock have a greater claim to a company’s assets and earnings. In addition if a company is forced to liquidate in order to pay creditors and bondholders, common stock holders receive no money until after preferred shareholders are paid out.

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