Going the rounds – from seed to exit




To get to the finish line, startups need funding to help them evolve through their lifecycles. This means more than just one round, with each kicking up different dynamics to the one before. According to a funding report from Tech.eu, European technology startups raised around €16.2bn in 2016. And the funding ecosystem in Europe continues to grow. In 2016, the number of deals was up by 32 percent over 2015 and investment volume up by nearly 12 percent.

The last five years have seen larger growth in Europe in terms of capital investment. The top countries by investment volume in 2016 were the UK, Israel, France, Germany and Sweden. But with so many rounds to go through and so many types of investors, there are dozens of material legal and commercial considerations companies need to think about in order to navigate all stages in their business from seed to Series A, B, C and beyond.

Each stage of the company is different from the next and each funding round serves a purpose for the company in parallel with the company’s growth objectives.

Seed and angel

You have to start somewhere and for most start-ups, that is at the seed and angel round.

At this early or conceptual stage, things are still relatively simple for the company and the founders. Everyone’s focus is on getting the business established and the product or service at the proof-of-concept stage. The company has friends and family money, maybe some angel investors and possibly some early stage incubators. The founder or co-founders still retain a significant majority equity stake and still run the show in terms of governance and decisionmaking. There are not many employees so there is usually no need for an option scheme and any obligations to investors are relatively small.

At this stage, the best thing a startup can do is use standardised convertible financing documents like convertible notes.  Simple Agreement for Future Equity (SAFEs) from Y Combinator, Advanced Subscription Agreement (ASAs) and Keep It Simple Security (KISS) from 500 Startups.  The investors provide funding and agree to get issued shares in the company’s next round of financing, at a discount to the next round and/or with a valuation cap. This avoids having to value the business at a time when it is not appropriate. Also, the documents are much simpler and therefore a convertible round gets done much quicker.

Series A

At the Series A stage, a company has launched and the rollout of their product or service has gained traction and demonstrated potential for growth. Typically, the company has its first taste of institutional involvement and everyone’s focus is on supporting the development of the product or service and growing the customer base.

A new incoming investor will want to have a role in the governance and decisionmaking of the company and its specific needs. This alone will add to a company’s overall workload and can be a distraction if not managed efficiently. The incoming investor will usually want more rights than those given to seed and angel investors, such as a seat on the board of directors, preferred shares with a liquidation preference and anti-dilution rights, a greater degree of information to be disclosed and consent rights.

At the Series A stage, there are some new things to think about. First, while the founders have been diluted somewhat, they still most likely hold a majority of the shares. Second, founders will probably be asked by the incoming investor to build an option pool to incentivise growth of the employee base. The option pool will tend to represent 10 to 20 percent of the equity of a company, diluting the founders down even further. Third, founders will also likely be asked to sign up to a lock-up period on share transfers and a reverse vesting period for their shares, as investors will look to ensure the founders remain part of the business for a certain period of time (typically at least three or four years). Lastly, investment documents will likely now be full form and contain the usual provisions (pre-emption rights on new issues of shares and share transfers, drag along, co-sale and tag along, etc.)

The best way to win at the Series A is to choose investors wisely, use model documents, plan realistically to reach the next stage, try to avoid bridge financing and do not get too creative – future investors will look at this round as setting a precedent.

Series B – the growth round

Also known as the growth round, at a Series B the company has traction in the marketplace and has a business model and a plan to grow the product or service in its current market and into larger markets. Funding size will typically be single or even double digit millions and funds are typically allocated to expansion and to develop marketing, sales and general infrastructure.

Founders may find themselves in the minority to the growing investor base but overall, focus switches from founders to team. When the Series B comes around, both the founders and the existing investors may find they need to cede more control to new investors. Founders may end up in the minority and older investors who have not continued to participate pro rata may have to give up some rights and take more of a back seat in decisionmaking as their shareholdings get diluted.

Those same investors may start to have slightly different ideas about the future and be thinking about the path to exit, which can sometimes be contrary to new incoming growth investors who want longer periods of growth. This can lead to some secondary activity (older investors selling their shares to willing buyers or new investors).

Overall, investors in the B Round tend to take centre stage in a number of ways: (i) the involvement of multiple investors raises issue of which investors should have a say over what the company does; (ii) the angels will be optimistic about the company but will likely not have the ability to participate any further, so will become diluted; (iii) the Series B typically features more than one investor, usually two or more with one leading the round and putting in the most money; and (iv) at least two and possibly three board seats will be taken by investors.

Companies should keep an eye on key things such as any rights that were offered to investors at the previous stage – rights which will likely be requested by new investors in this round and which existing investors may not want to give up. Investment documents will become more complex as investors’ rights are layered on top of one another and vesting/lock-up periods for founders might be reset or pushed out a little further. And, multiple investors with different investment strategies also mean different expectations and time horizons.

The most important elements for founders at this stage are to enlist a strong lead investor and limit the number of investors that can come to the table.  Also, be wary of giving greater rights to new investors (such as a participating liquidation preference), as this sets a bad precedent going forward and existing investors might also ask for it. A company often considers venture debt as alternative financing rather than doing this round too early (when bargaining power might not be optimal).

Series C – the conquering round

By the time a company gets to a Series C round, it has a successful business (generally profitable or at least break even or with significant users and revenue potential anticipated) that is attracting significant attention and revenue. The company is unrecognisable from its startup persona and because the risk is much lower than when the company started, new investors come calling. At this stage, several investors may exercise most of the control and possibly enough to encourage or force the original founder to step back from the business in favour of more seasoned specialists to scale the business globally. Often, investment at Series C is for a specific purpose, such as expansion into further territories or acquiring complementary businesses.

When it comes to investors in a Series C, the diversity of the investors is very clear. Time horizons come into focus and some investors begin to push hard for exit, even drafting provisions into the document that talk about appointing bankers to seek exit opportunities. Early stage investors seeking secondaries and investment documents can be complex and may require a lot of attention from the company.

In general, there are three key things for a company to watch for at this stage. First, as with Series B, limit the number of investors that have consent rights and try to limit this to a percentage of all investor shares, rather than separate class votes of all preferred shares.  Second, investors may seek participating multiple liquidation preferences because of higher valuations, and this should be avoided. Third, investors may seek drag-along vetos, which should either be avoided or capped at a certain valuation.

Series D exit and beyond

If a company has made it to this unicorn stage, they have grown and nurtured a startup into a fully-fledged company. Both the company and its investors are focused on preparing for and agreeing the terms of an exit. Broadly speaking, everyone is aligned though some may have items they wish to negotiate when it comes to receiving exit proceeds or their potential liability. The founders are now most likely fully vested and any residual transfer restrictions should fall away on exit.

The things a company should watch for in a Series D are similar to those issues encountered in a Series C. However, investment documents need to be very clear in terms of which parties need to approve any potential sale or IPO, and founders must avoid getting dragged into a sale. It is important to ensure those terms are completely clear.

Overall, round by round, issues tend to gradually multiply as the rounds progress and additional investors come on board, each with slightly different strategies to the last round. Alternatively, as a company heads towards exit, issues begin to diminish. Depending on the terms of the exit, not all investors will be aligned here either.

As you would expect, as the rounds progress, investment documents increase in complexity. It is important not to get too complicated in the early stages and not to give away too many rights too early, since new investors will always want what older investors had, and more. Consistent legal counsel through the company’s lifecycle helps minimise any potential situations of conflict.

For a founder, their dual role as shareholder and manager will be dictated at an earlier stage via vesting periods on shares  and lock-ups on share transfer. But that will gradually diminish as the company gets bigger and investors look at bringing in more seasoned management to steer the company to an exit. In the later stages, there will be an increasing focus on exit and the terms of that exit and the decision making at the later rounds (C & D) has been set through every round of investment so far.

Going the rounds for every startup will be a little different depending on the type of investors and founders involved, but sticking to some basic guidelines will make the process advantageous for everyone involved, through every stage of their business.


Tina Baker is a partner andco-founder at JAG Shaw Baker. She can be contacted by email: tina.baker@jagshawbaker.com.

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Tina Baker

JAG Shaw Baker

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