Funding Round Meaning: Everything You Need to Know
The funding round meaning refers to the rounds of funding that startups go through to raise capital.3 min read
Updated October 28, 2020:
The funding round meaning refers to the rounds of funding that startups go through to raise capital. The startup company will go through several rounds of valuation that will increase as a startup proves its increasing probability of success, customer base growth, and proof of concept.
During each funding round, valuation is independently evaluated. Typically, investors who contribute funds during initial rounds will want to contribute funds during subsequent rounds as well in order to maintain their shares in the company as it grows. Usually, each round of financing means the business accepts at least one investment from at least one investor within a specific time period.
Regardless of the funding round, one essential requirement is that both the business and the investor come to an agreement regarding how much is to be invested and on what terms. These agreements are included in a document called a term sheet. The terms and discussions around these terms can vary significantly from deal to deal. Since it is far more common for an investor to refuse to make an investment than for a company to refuse to accept an offer, this situation is known as a "buyer's market."
Types of Funding Rounds
There are several different types of funding rounds used to fund startups, which include:
- Seed round. The seed round is the first round of funding and typically occurs at the idea stage, or upon the development of a proof of concept or prototype. There should also be promising signs that demand exists for the type of product or service offered. Usually, seed funding rounds are minimal and the funds are used for research and development, market research, or expansion of the team. There are even seed accelerators (e.g. Y Combinator) that accept startup applicants, offer seed capital, and provide an opportunity for the company to demo its services or products to larger investors.
- Angel round. The angel round typically occurs when a business is initially launching, if not earlier. Businesses in this stage will often need an investment to cover the costs needed to run daily operations before a significant cash flow enters the picture.
- Sometimes, the seed round and angel round are not actually distinct rounds, but a hybrid of the two. Seed and angel rounds often include a significant amount of funding from family members and friends, as well as investments from angel investors who are involved with companies in their early stages of development. In many cases, investors will contribute small amounts of capital in exchange for equity. As the business will have a very limited track record, the risk is higher as compared to a more established business. The startup company's value will be determined based on the quality of the executive team, proof of concept, progress achieved with initial capital, market size, and the inherent risk of the endeavor.
- Series A round. As the company is most likely in the startup stage during this round, investing is still considered high risk. A Series A round of shares is typically offered (usually to company founders and employees) in exchange for funding.
- Series B round. During this stage, the company will likely have a higher valuation. As the company's track record grows, the financial risk decreases. As a result, the cost to invest is also higher. The valuation of the company is based on its performance in comparison to the overall industry, assets (such as intellectual property), and revenue predictions. Signs of growth during this stage should include an expanding customer base, increased revenue, and success of products and services. This round of funding is usually provided by private equity investors and venture capitalists.
- Series C round. When a business is preparing for rapid growth, a Series C round of funding may be required. Generally, this occurs when the company has proved its success within its market, increased its market share, scaled up, or developed new services or products, and wants to make acquisitions of competing companies.
- Bridge/mezzanine/pre-public round. A company might decide to go public once its services and products have gained sufficient traction. Funds may be raised for mergers and acquisitions, financing the process of preparing for an initial public offering, or price reductions and other steps to reduce competition.
If you need help understanding funding rounds, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.