Venture Investment Alphabet

Here on “Megamind” we often write about startups and their financing, in connection with which some users may have justified terminological questions. In almost every article about investing in startups, you can read the phrase: "SuperMegaStartup attracted $ dofig million at stage A" . Of course, for many this phrase is quite self-explanatory and natural, but when it comes to letters B, C, D and further, many begin to swim, at best, working off with common phrases. In this article I will try to clarify and eliminate this annoying flaw.

In general, venture investment is bidirectional. On the one hand, it involves the attraction of third-party capital for the development, improvement, launch and expansion of the company. On the other hand, a high-risk investment is expected in order to obtain super profits. The process of venture financing, as a rule, is carried out in stages, and the structure of the process is quite flexible and does not imply the mandatory implementation of all classified investment rounds.

According to the accepted terminology, the following stages of venture financing are distinguished:

Sowing stage (seed round)

“Sowing” is the first stage of venture financing. At this level, as a rule, relatively modest amounts of capital are provided to inventors or entrepreneurs to finance the early development of a new product or service. Funds at this level can be used to pay for preliminary operations for product development, market research, the formation of a team of managers and the development of a business plan.

Sowing capital, being in some form a form of securities, involves the purchase by an investor of a part of a new business. The term "sowing" appeared by analogy and describes the earliest investments intended to "support the pants" of a business until it can generate its own cash flows or until further investments are initiated. The capital of this level includes options for using the funds of friends, family, business angels and crowdfunding.
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Initial financing is the most risky, since the investor does not see the materialized product and has only the preconditions for the implementation of the financing project.

In the United States, the seed capital invested by a professional venture company usually does not exceed $ 1 million.

Sowing venture funds also participate in later investment rounds along with other players who finance business development and expansion costs.

Angelic Round

We owe the emergence of this term to William Wetzel, a professor at the University of New Hampshire, who in 1978 published a study in which he described venture capitalists, by analogy with the sponsors of Broadway theatrical productions.

This level of funding is sometimes combined with seed, if seed investments were received from business angels. Accordingly, the description of seed investments placed above regarding venture capitalists is valid for this round of financing. If the angelic round is separated from the seed, at this level investments are offered instead of ordinary shares of the company.

The peculiarity of angel investing is that, in addition to money, assistance is offered in the organization, management and proper distribution of these funds. Many angels have such undocumented capabilities, compared with which their investment of money can be a petty service.

Liter rounds of investment

Series “A” is, as a rule, the first significant round of venture financing. The name reflects the exchange of preferred shares for investment funds. The capital raised is spent on income growth and profit generation, expansion and financing. Investment series "A" are required for early development and growth. Most often during this period competitors become more active, and there is also the possibility of capturing a significant part of the market.

Preferred shares of this round are distributed to participants of sowing and early investments. These shares are often converted into ordinary shares in cases of a sale of the company or an IPO.

The “A” series is traditionally an important stage in financing startups. A typical round of this series attracts funds in the amount of $ 2 to $ 10 million for 10-30 percent of the company's shares. The capital raised at this time is intended for the company's capitalization for a period of 6 months to 2 years, while the company develops its product, carries out primary marketing and branding, hires its first employees, and also completes business operations that were not completed in the early stages.

Venture funds and private persons most often become the sources of capital of the “A” series, and the intersection of investors with entrepreneurs occurs through various conferences and demo days, since young companies are not public and information about them is not published in financial publications.

For the sake of justice, it is worth noting that all rounds of investments are most often mixed investments, including funds from angel, institutional and private investors, as well as collected on crowdfunding platforms.

The structure of the investment series "A" involves the expenditure of smaller investment packages to attract and conduct large investments, financial costs to service new investors, as well as analysis and audit by institutional investors. Thus, companies that need operating funds and are not prepared for large venture capital investments are trying to attract angelic capital. At this stage, attracting large investment packages is not only unreasonable, but also almost destructive for a fledgling business.

Typically, A-series investments in the technology sector are widely reported in the business press, blogs, industry reports and other media. In other industries, this round of venture capital investments occurs in a similar way, on the same legal and financial grounds, differing mainly in specific industry terminology.

Depending on the needs and capabilities of the company, the “A” series can move the company to the point where it can operate with its own cash flows.

The “B” series assumes investments spent on business development and growth. Most often this refers to the transfer of the company's business model to new markets.

In general, all lettered investment rounds are completely different only in the type of securities offered; in terms of functions and cost structure, rounds may have similar characteristics. Accordingly, the letter of the round are different and paper. So the first round of financing of the company includes the issuance of privileged papers of the A series, the second round - the papers of the B series, and so on. Most startups do not go beyond the investment series "C" or "D". Papers of each series have a different value.

When the goals of the investment round cannot be achieved, the company moves on to the next one, but investors should be aware that late rounds are less profitable. Entrepreneurs, in turn, need to remember about the possibility of diluting the company's capital and loss of control.

Also, later series may indicate that the company is not developing as expected. In this case, investors may worry that the company has spent too many rounds of raising funds, considering it a sign of stagnation.

Series "A", "B", ... Sometimes companies need additional funds at the current stage of investment. In order not to start a new round, entrepreneurs are trying to recapitalize the company on the same conditions.

It happens that they also distinguish the “AA”, “BB” series ... Today, investments in these rounds are usually allocated as preliminary ones before the corresponding rounds in the letter. The AA series is sometimes even called seed investments, which in my opinion does not at all reflect its essence. The AA series is used to support less capital-intensive business growth and is distinguished by simplified procedures and low legal costs, which, in turn, cannot but attract early investors and founders.

Some allocate more intermediate rounds of investment, but their realization is a rather rare and controversial event. These rounds involve the attraction of funds that provide an increased investment return, but with the lowest priority of repayment.

The topic of the venture today is one of the most sought after and interesting, as it is experiencing another rebirth. At the same time, there is a certain difficulty in studying the processes of the venture capital market, which consists in the absence of a single theoretical and methodological approach to venture capital investment.

Since the venture capital market was born and developed most extensively in the United States, we are forced to put up with the existing terminology. It is characteristic that the American venture capital investment system differs from both the European and ours, and is based on a continuous funding cycle (the main task of the venture capital market is the accumulation of funds and their placement). From the American point of view, high-risk capital is invested in the concept of venture capital at the “seed” and “initial” stages of development. The European approach (as well as the Russian one) complements venture capital with investments in the later stages of development. Also, the peculiarity of domestic venture capitalism is the formation of venture capital funds and direct investments for a specific project, often promoted by the state. In this case, in the American version, direct investment is not at all included in the concept of venture capital.

According to Dow Jones VentureSource research, described on the Vedomosti website , American venture capitalists are more generous than European: if seed investments are about the same on both sides of the Atlantic, then in the next round of investments, start-ups in the US are about twice as large as in Europe not to mention the subsequent rounds.

Why these difficulties with the division of investment packages and the distribution of funds? Isn’t it easier to invest at full speed at once?

No, not easier. Have you ever tried to swallow a watermelon whole? So here, a young company needs a gradual investment to transform its business processes. Each investment package should arrive no earlier and no later than necessary, otherwise there is a great risk of ruining the company.