If you want to grow your business, you’ll need access to capital. While money from friends and family can help get you off the ground, eventually you’ll want to consider outside investors. Here, we’ll cover the basics of Series A financing, an essential tool that helps startups accomplish their goals.
What Is a Series A Financing?
A company’s Series A financing is usually its second round of fundraising. The first round is often called a “seed” round, where founders raise money from friends, family, and angel investors. After the company demonstrates proof of concept, it might seek additional capital through a Series A.
Series A financings are typically led by venture capital investors — individuals and companies with a higher risk tolerance than your average retail investor or mutual fund. Each deal is different, but most Series A rounds raise between $5 million and $10 million.
The name “Series A” doesn’t have any legal significance — it’s just a helpful marker for where a company is in its capital raising journey. Some companies might start with a Series A, while others might have three rounds (with names like pre-seed, seed, and pre-A) before they decide to crown a round with the title of “Series A.” It’s all up to you.
Why Raise Money in a Series A?
Startups often raise money through a Series A financing because they need more capital to grow at a faster rate. Imagine your company has a popular new running shoe but can’t keep up with demand. Your products are flying off the shelves and you need to increase your manufacturing capacity — now!
Partnering with a venture capital company can inject much-needed funds into your business, allowing you to scale more quickly. Venture capitalists will often fund companies that traditional banks deem too risky. Plus, venture capital firms often have deep industry experience and financial wisdom, acting as advisors to new companies.
How Does a Series A Financing Work?
In a Series A financing, inventors buy a portion of your company at a certain valuation. For example, Venture Capital, Inc. might decide to purchase 20% of your company at a valuation of $20 million. In this example, your company would receive a $4 million cash infusion ($20 million multiplied by 20%). In some cases, the venture capital firm might negotiate the deal as the “lead” investor, with other investors jumping in on the same terms.
What Documents Are There in a Series A?
Now, let’s get into the nitty-gritty. While each deal is different, we’ll cover the primary documents present in most Series A startup financings. If you’re looking for someone to guide you through the process, reach out for help.
Preferred Stock Purchase Agreement
In most Series A financings, the investors buy preferred stock. Unlike traditional common stock — the kind most retail investors buy in the stock market — preferred stock comes with all sorts of special rights and preferences. Investors want extra protection to make up for the fact that they’re taking a big risk by funding a baby company.
Preferred stock may come with some (or all) of the following features:
- Board representation. Preferred holders might get a seat or two on the startup’s board of directors.
- Liquidation preference. In a sale or liquidation of the company, preferred holders might get the right to receive proceeds from the sale before holders of common stock.
- Conversion rights: Holders of preferred stock may be able to convert their shares into common stock whenever they want, or at certain events like another round of financing or an initial public offering.
- Dividends: Common holders can’t receive dividends until preferred holders receive an equal distribution.
- Veto rights: Preferred holders might get veto rights over any major company decisions, such as taking on debt or selling more equity.
- Price protection: If the company raises money at a lower valuation later, the Series A preferred holders get a downward adjustment to the price of their shares.
- Right of first refusal (ROFR): If other shareholders want to sell their shares, the preferred holders get the right to buy the shares before they’re offered to other investors.
- Co-sale rights: If a preferred holder doesn’t exercise its ROFR, they get the right to piggyback on the selling shareholder’s sale, selling on the same terms.
- Drag-along rights: If a certain percentage of shareholders want to sell, all shareholders are forced to participate in the sale.
- Inspection rights: Preferred holders often get the right to inspect the company’s books and records to make sure there’s no funny business going on.
Restated Formation Documents
Usually, the company will need to update its formation documents to account for the issue of new preferred shares. Examples of formation documents include articles of incorporation and bylaws (for corporations) and certificates of formation and operating agreements (for LLCs).
Investors’ Rights Agreement
The investors’ rights agreement typically contains provisions related to lock-up requirements (preventing founders from selling their shares for a certain amount of time), board matters (including indemnification), inspection rights, management rights, confidentiality provisions, and all sorts of other fun stuff.
Right of First Refusal and Co-Sale Agreement
This agreement makes the ROFR and co-sale rights official. As discussed above, the Series A preferred holders often get the right to buy shares before outside investors.
Voting Agreements
In voting agreements, shareholders often agree on how to vote their shares. For example, founders might commit to elect a venture capital firm member to the company’s board.
Legal Mumbo Jumbo
Series A financings also require all sorts of fun paperwork that you probably don’t want to think about (I’ll take care of it). Examples include legal opinions, board consents, and closing certificates.
Thinking of Raising Money for Your Business?
If your company is thinking of going out and raising money, I’m here to help. Reach out today to learn more about how my firm (with 50+ years of experience) and I can help you grow (and protect) your business.