What is a Shareholders Agreement? And Why do They Matter?
Shareholders' agreements are key to shielding companies and shareholders alike from risk. But why do they matter so much? And what should they include?Learn More
May 30, 2022
As a business, there will invariably come a time when an injection of cash might be needed. As you look to scale your labour of love, you might be wondering, what's the deal with Series A, Series B, and Series C investment? In this blog, we break down Series A investment in detail, from tackling investor desires to preparing the ultimate pitch deck for your Series A round.
So, let's start!
With so much jargon around Series A funding, it can be difficult to know which terms apply to a company depending on its lifecycle. So, without further ado, let's start with a terminology break down.
Series A fundraising refers to a company's first significant formal fundraising and involves an investment of usually between £1 million - £10 million. In fact, some companies are now raising in excess of £10 million under Series A staying in “stealth mode” while they look to the future to command a higher value later at “Series B funding” stage.
At Series B funding stage the company has advanced further, therefore usually having a higher valuation meaning investors are usually more willing to pay a higher price per share). This type of fundraising is usually when a company is still in start-up stage rather than its future scale-up stage.
The “A" in Series A refers to the class of shares in the company usually issued to an investor - "A" Ordinary shares.
Well, they are the most common class of shares created by a company when starting out. Ordinary shares entitle the holder to have rights to vote, to dividends and to participate in the capital on the winding up of a company. Ordinary shares are a new class of shares issued to investors which have different rights to those of the holders of the Ordinary shares depending on what has been agreed as part of the negotiation.
Usually, a company is likely to be at Series A stage when it plans to continue its phase of growth. The reason for the investment may be for a specific purpose (like attracting particular talent or reaching a milestone in product development) as well as with a view to attracting future investment.
Series A investment is similar to Seed investment, in that it involves equity investment (i.e. through issuing shares in the company). This is because, like seed funding, a company at this stage is likely to have previously raised investment more informally, e.g. through friends, family or crowdfunding. What differentiates Series A from seed funding is that it involves a more formal process for external funding, as often Venture Capital investors (VCs) are involved.
So, you're embarking on your Series A investment round. What is a potential investor going to be looking for?
No shocks here, but, of course, the nature of investment is that an investor is looking to make a serious return. However, money isn't everything; VC investors are generally more interested in quality than quantity in the companies that they choose to invest in. Smaller portfolios for VC investors can effectively generate bigger returns for the funds they manage, by enabling them to provide better support and engagement with founders and leaders.
At this stage, venture capitalists don't expect founders to be an absolute business or management whizz but there needs to be something about the founder, the team and the business that piques the interest of the VCs - essentially, what makes it stand out and why!
In terms of product-market fit, this doesn't have to be completely concrete, but VC investors will expect the product to be in the latter stages of development.
A venture capital firm will undertake due diligence on the company and this can be quite a lengthy process especially as this will most likely be the first formal investment. However, this is totally normal! Investing in early stages companies is risky business for a venture capital firm and so they need to be comfortable with all aspects of the business - including its financials, risks, competitors and legals to ensure that there is nothing that would prevent the business from achieving its goals and purpose.
Below we tackle the process for Series A investment, from timescales to valuations.
How long the process takes, from finding VCs to engage with the process to completion of the investment, will depend on the level of due diligence and the negotiation of the key transaction documents. However, as a ballpark figure, a company should plan for this to reasonably take at least six months.
The founder/s may already have experience of pitching their business to angel clubs or putting together a crowdfunding pitch. With VC pitches, they want to know about the team, product, market and key metrics. Therefore, for this stage, a pitch deck will likely need to be prepared to present to potential investors and this should include important details about the business, including how much money it wants to raise, what it is proposing to do with the money, financials, the market opportunities and its competitors. It's also a good idea to include any example case studies of successes and good press that the company has received.
If the company hasn't already, a cap table will need to be prepared - which is essentially a table containing details of the current shareholders of the company (including the number and class of shares and their percentage shareholding). This table also needs to include any rights that have been granted to own shares in the company, for example, share options (or share option pools that have been created). Essentially, this table needs to be clear on every existing right and future right that could convert.
This can be an area where it's easy to miss something so it is definitely worth spending time on this to avoid any later issues with valuation and dilution (and certainly getting a second pair of eyes on this, at the very least). There are also software programmes that can assist with this.
It's also key to involve a tax advisor experienced in investment work (at the early stages) to ensure the best structure and valuation of the company is achieved in relation to the investment. This includes any advanced assurance that may need to be sought from HMRC, depending on the nature of the investor.
If not already, this is the time for the company to get its ducks in a row prior to the formal due diligence process.
Even though this process can feel quite lengthy, disclosure is a key part of the investment process and can also provide the company with protection further down the line. Here's what the company can do to get a head start:
It's really important to have a trusted team - both internally and externally (tax advisors - like Nuvem9 - accountants and lawyers are instrumental here). Not only will this help things to run as smoothly as possible but, crucially, to get ahead of any issues that an investor may find during the disclosure process. The company can then ensure that the internal team has the full details to hand and resolve any issues ahead of time. This will save the company time and money in the long run.
Nope, this isn't a room for a character in a certain sci-fi franchise, but it's where the due diligence information about the company is stored. Now this might just sound like a boring administrative piece but, importantly, there is likely to be commercially sensitive information being shared and therefore the company will want to ensure that this is held securely. Again, this is where the company's lawyer can add value and there is specific software out there that facilitates this, making the whole process of sharing documents that bit less painful.
Rather than waiting for the full due diligence questionnaire to land, the company's lawyer can help by providing a list of key documents that an investor is likely to ask for. This is a massive timesaving piece and helps get ahead of the game while offering the internal team breathing space to start collating things in the background.
A term sheet is an agreement setting out the key terms of what has been agreed for the investment, for example, the valuation and key protections and rights the investor wishes to have. Whilst the majority of the terms are non-binding legally, this is still an important document to focus on to crystallise those main terms. It's also a document that is negotiated, so it's really important to get this right.
This is another key stage where it can really make a difference to have some support from a lawyer or from someone who is experienced in investment. They can guide the company as to what is “market practice” so the business can be confident in discussing the investor's terms with them.
So, the pitch is successful - now what?! Well, number one congratulations! Number two - this is where the due diligence process begins. The investor will want to really focus in on the business plan and the company's financials to see if it's an investible proposition.
As this is still a relatively early stage in the company's lifecycle, the depth of the due diligence reflects the relative risk that an investor is going to potentially take on.
An investor will want to know how the company intends to spend their money (particularly if they are investing through EIS; the money invested must be spent within 2 years) and this extends to understanding whether current resources are adequate and will allow the business to grow.
As we mentioned above, this is essentially a lengthy document asking questions about all legal aspects of the company.
Part of preparing for this stage includes carrying out an audit of the company's register at Companies House and its statutory register's. Essentially, it's important to review significant decisions that the company has made to ensure that the required approval has been sought, documented and the relevant filings have been made at Companies House.
This is where the key documents are drafted and negotiated and usually include,
The articles will most likely require amendments to be made to reflect relevant protections for the company and the rights of the investor.
Having the right lawyers who are experienced in investment can make all the difference here, not only to get the right protections for the company but also to make this as painless and straightforward as possible.
All the documents have been agreed, signed and dated and the funds the company will receive in accordance with the agreements have been transferred. Now, for the exciting part - being able to move forward to the next phase of growth!
We are here to help with your funding round and are highly experienced in supporting companies secure external funding. Whether you're preparing for seed round investment or scaling to Series A financing, we ensure you're equipped with pragmatic expertise that maximises your potential.
From tackling angel investors and venture capitalists, to grappling with the due diligence stage right through to completion, we support startups and scaleups to attain sustainable growth. We guide founders and companies through the financing process and provide commercial and practical advice to make investment as seamless as possible!