Understanding equity funding for startups is crucial for the growth of your business. Even companies that launch with a great idea won’t be able to reach their full potential without proper funding. In order to secure the proper funding, you must first understand how the different financing rounds typically work. 

Each round of funding serves a different purpose, and the shares of stock issued to investors in each round will have different rights and responsibilities that you will negotiate with your investors. Every company is different and will have its own path as it navigates the process of raising capital, but a typical funding process is laid out below.

Frequently, the first round of funding comes from friends and family or angel investors. This stage is known as pre-Seed funding, and its purpose is to get your company off the ground and develop a minimum viable product (MVP). At this point, as a founder, your focus is obtaining exactly as much funding as you need (a difficult task) to get the company to the next stage so that you can avoid as much dilution as possible. Funding from a pre-Seed round will usually come in the form of a convertible note or a Simple Agreement for Future Equity (“SAFE”), and it’s fairly common for early-stage companies to have several of these funding rounds with increasing valuations.

The next round of funding is usually the first equity round, called the Series Seed round. At this point, you have determined the direction of your company, and you need the capital to build and develop your product and find product market fit. When a round is “priced”, you will negotiate an actual valuation of the company by assigning a negotiated price per share to the equity sold in that round. Also, with a priced round, you’ll have more obligations to your investors, as major investors will likely require a seat on your board of directors and other rights to affect the company’s trajectory. In priced rounds, the valuation, rights, and obligations of investors are negotiated in advance through a term sheet, which typically requires you to work with your attorney and advisors to find terms that work for you and your lead investor. 

Each funding round comes with its own challenges, and it’s important to understand what your goals are for your company.

After the Seed round, you will look to raise your Series A. At this point, investors will be more interested in how the company will generate revenue. Because the company will be growing quickly, you will almost always deal with venture capital firms to lead your Series A. In some cases, a company may call their first priced round a Series A raise, as the label associated with the round is technically arbitrary. That said, labels like Series A and Series B carry significance in the industry and signal a company’s stage of growth and development. 

If a company raises again, the next round is typically the Series B financing round. If you wish to raise money for your Series B, you will need to show investors that your company is expanding. Typically, a Series B is for companies that are developing a new line of products or simply cannot keep up with the demand from their customers and need a substantial injection of capital. Series B investors will be looking to invest significant amounts of money into the company after you’ve clearly demonstrated how you plan to expand. In some cases, a company may not need a Series B, depending on capital required for growth, realized revenue, and the long-term expectations for the business. 

Each funding round comes with its own challenges, and it’s important to understand what your goals are for your company. Working with the right investors and advisors can make all the difference. The right people will help you navigate through this process and get your company where you want it to go.

Tom Budnik is a startup and venture capital attorney based in Chicago, IL. He represents founders, startups, and venture capital funds in a wide variety of corporate transactions, including raising capital and navigating issues associated with rapidly-growing startups. He can be reached at tbudnik@founderslaw.com.