Learn the five most important terms of a Series A funding round

The next round of equity funding after the seed round is a Series A. Typically, a startup has demonstrated product-market fit and has some traction in the form of user growth and/or income. Series A funding is all about trying to scale the product and team to take the business to the next level.

There are many macro-economic and company-specific variables, but a Series A typically earns between $10 million and $20 million. The investor base is usually professional venture capitalists, although a few strategic angels may be involved.

Most Series A's in the United States are based on the National Venture Capital Association (NVCA) model documents. This standard set of documents is a good starting point for negotiations, but revisions are common. In the end, the total document set is hundreds of pages. It is important for founders to have an attorney familiar with NVCA documents to draft and negotiate on their behalf.

Founders don't need to know every paragraph of the document set. However, it is essential that they understand the term sheet. The Series A term sheet is a summary of the agreement. A founder who understands the term sheet can represent themselves in negotiations and communicate their wishes to their attorney.

Below are the five most important conditions of a Series A funding round.

The valuation is the value of the company agreed between the investor and the founder. Valuation is often the most disputed and negotiated term in the term sheet.

Valuation can be expressed in two ways: pre-money and post-money. Pre-monetary valuation refers to what the investor is valuing the company before the investment. On the other hand, the post-money valuation is the value that the investor places on the company after the round is over. To calculate the post-money valuation, simply take the pre-money valuation and add the amount collected in this round.

When an investor says, "I will invest $X at a valuation of $Y", that is usually the post-money valuation. At the same time, the founder often understands valuation as pre-money. As you will see below, the interpretation of the rating is important:

● $20 million for a $100 million post-money valuation would give investors 20% ownership of the company.

● With $20 million on a pre-investment valuation of $100 million, investors own 16.67% of the company.

To avoid ambiguity, founders should explicitly state that the valuation is pre-money or post-money. This demonstrates an understanding of basic terms and earns the respect of investors.

The liquidation preference determines how much preferred shareholders will be paid from the proceeds of an acquisition before other shareholders are paid. It is designed to ensure investors make money or at least break even on an acquisition. There are two main components in a liquidation preference:

● Participation: if and how the shareholder receives the money distributed to the shareholders after the payment of the preference.

● Preference: the money distributed to the shareholder before it is distributed to other classes of shareholders.

Let's start with preference. Preferences are expressed in terms of multiples of the money an investor has invested. For example, 1x means the preference goes to 100% of the invested amount, while 1.5x means 150%.

The most common liquidation preference in Series A funding is 1x. So if an investor invested $1 million in your company during a liquidation, they will be reimbursed $1 million before ordinary shareholders receive any money.

Next, let's look at participation. Once the preference is granted to the investor, the question becomes whether and how he will participate in the remainder of the distribution to shareholders. If an investor invested $1 million in your business with a 1x liquidation preference and you sold it for $21 million, the investor would receive $1 million first. But how will the other $20 million be distributed? It depends on the participation right of the investor. There are three...