September 26, 2020 Informative 375

Startup Funding Rounds

Phase 1 – Starting the Company

  • Pre-seed/friends and family funding: The usual step before angel funding or VCs, where the founder or founders just have a set of skills and an idea to begin their company, and either themselves or close friends and family fund it.
  • Incorporation/Corporation: Allows the founders and the investor to agree on the terms of ownership and decision-making. It provides a layer of protection, for example, in case the company gets sued. A Delaware C-Corporation is the most standard type of legal structure you can use, and most investors in the US will want that.
  • Shares: This is what corporations are made of. Company ownership is represented in an integer number of shares. People own a given amount of shares of the business, which therefore represents a percentage of the total shares the company has issued.
  • Valuation: This is how much the business is worth. If the startup just has an idea or a code, the valuation is an agreement on something that feels fair to the investor and the founders.
  • Vesting: An agreement that says that each founder will only own their assigned shares after a certain period of time.

Phase 2 – Seed Round

  • Seed funding/capital/round: The first funding (outside friends and family) a startup obtains to create its business and make it grow enough. Angel investors, accelerators, incubators, and even some venture capital firms could act here.
  • Angel investor: A -very rich- individual, usually outside of the friends and family circles, who normally funds a startup in the early stages.
  • Convertible notes: If founders and investors have no way of agreeing in valuation, they can use a convertible note to hold off on the decision of how much the business is worth. With a convertible note, investors can come in, the company can grow, and the conversion to stock occurs later. A convertible note works much like a loan, except that it’s designed to be paid back in stock instead of cash. They are also known as bridge funding.
  • Stock option pool: In the startup world, it’s quite common to offer shares of stock to the first employees in the company; this is done with a stock option pool. It is a defined amount of shares that are ‘set aside’ to be issued to employees. The shares on the stock option pool are not given to employees because of tax purposes.

Phase 3 – Series A Funding

  • Series A Funding: After gaining enough traction, a startup can go to a venture capital firm and apply for a Series A round. This normally involves negotiations in terms of the company’s valuation and the position of the investors in the board of directors.
  • Board: The board of directors has control over crucial company aspects. It abides by the company bylaws, which is a sort of rulebook. The board makes most company decisions with a simple majority.
  • Preferred shares: Investors will also want to protect themselves in case the company goes down. If things don’t go right, it might file for bankruptcy or it might be acquired/absorbed for a small amount. In that case, investors might request that if that happens, they get paid first. Special rules like that make what we call ‘preferred stock.’
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