While many people think of "venture" as one distinct asset class, there are stark differences for investors depending on what round of funding they are participating in. At Vincent, we only invest in later-stage pre-IPO companies, but it can be instructive to understand what other stages are like to evaluate their potential risks and rewards.
Source: University Lab Partners
This first stage is usually referred to as the “friends and family” round, as this is so early in the process that it is unlikely any third parties will be interested. Established founders can generally skip this stage, but a first time founder will need some amount of funding to see if their idea is even viable. At this point the company is still more of an idea than an actuality and often may only have a prototype. Pre-seed companies are usually still researching a market and going about the first few iterations of building a product to address a problem. Founders use this time to prepare for an actual round of funding and this stage can potentially last for a long time. As an investor, you will usually only have access to this early-stage if you have a personal relationship with a founder.
This is the first real funding round, and tends to be when “angel” investors get involved, providing capital in exchange for equity in the company. In some cases, when companies may not want to provide a valuation right away, investors are given convertible notes, where a debt instrument converts into equity in a subsequent funding round. In other cases, the raise is done with a SAFE (simple agreement for future equity) which also promises future equity - the goal for investors in all scenarios is to end up with equity. Many of the opportunities on crowdfunding platforms come in this stage, and this is also the stage that most startups never get past. The fundraise is typically so a company can develop a minimal viable product (MVP). Seed-stage companies usually have a product that is incipient and is finding some traction, and the funding is meant to enable them to continue validating their hypotheses about the market. The seed round is often relatively small and can be supplemented by early-stage venture funds, but typically only if the founders have a track record of success. Because seed rounds are relatively small, this is the best chance to receive a substantial amount of equity at a lower price point. Seed investments are a high-risk, high-reward investment and are best suited for investors who can afford to make a number of different bets and lose their entire investment if the company never gets off the ground. In every subsequent stage, the risk becomes lower, but so does the potential reward.
This is usually the first round in which venture capital funds are prominently involved, and while angel investors are still sometimes involved, it is to a far lower degree than in a seed round. There are still crowdfunding opportunities for companies raising their Series A, but investors should not expect to receive much equity for their dollar at this point, as Series A raises are generally for several million dollars or more. A company will typically only raise a Series A if they can do so at a higher valuation than it had in its seed round. A “down round”, where the valuation has decreased, is something companies avoid unless it is their only option for survival. Companies generally don’t raise a Series A until they have an existing product on the market and are ready to grow the company. The company is not necessarily profitable, but has begun to generate revenue and show a clear path towards profitability. The purpose of this round is to convert an MVP into a real product and to fund the initial growth of the company. Series A companies have usually found “product-market fit” and are raising capital to reach many more customers and a higher level of revenue.
Series B, Series C and beyond
By this point, a company has already successfully raised a seed round and a Series A, and in order to continue fundraising will have to show that the business is viable. The company will have likely been around for several years and have substantial revenue and a clear strategy for growth. This round is largely to fund that growth, either by expanding the company’s headcount or footprint, and reducing barriers to expansion. It may also fund the expansion of product lines or possibly even acquisitions of small companies. Generally, these rounds are considered “late-stage” venture and funded by venture capital funds, private equity firms, and even hedge funds, banks and existing companies that might be interested in a future acquisition. There are also bridge rounds and different stages that may not fit cleanly into this framework, but by this point it is not likely a retail investor will be able to access individual late-stage rounds. The best bet for exposure to late-stage startups is to invest in a VC fund itself or to buy pre-IPO shares on a secondary market. Stage B and beyond are growth rounds for businesses with significant revenue on the path to attempt to dominate one or more market segments.
Once a company gets to a certain point in its development, generally when they have reached a billion dollar-plus valuation, they are close to either an IPO or are a prime acquisition target. At this point they may raise additional rounds in preparation, and some companies keep going to Series E, F, G, etc. but generally the investors in these rounds are exclusively VC firms.
This is almost always going to come in the form of an IPO or an acquisition. It is at this point that investors can finally get paid for their shares in the company. For prominent later stage companies, there also may be chances for investors to sell their shares on the secondary market pre-exit.