Mar 19 2021

Funding rounds for Startups. How do they work?

Currently, the Funding rounds for Startups have become one of the most popular alternative financing mechanisms and it is in the agenda of the Startup entrepreneurial world, through which many projects have managed to take off.

This type of financing mechanism is nothing more than the process by which the entrepreneurs of a Startup get the financial support necessary to materialize their idea thanks to the participation of investors.

As startup lawyers we can help you with anything related to such matter. On this post we will explain you everthing thar you need to know about the Funding rounds for startups.

What are the the Funding rounds for Startups?

The key element of the Financing Rounds is the raising of capital without having to resort to traditional methods of bank financing, obtaining that capital through more specialized investors. The financing can be obtained from investors both in the business world in general and in the technology sector in which Startups operate.

Among other reasons, this type of financing was born due to the growing difficulty faced by many entrepreneurs in finding bank financing for Startups. This fact has led to a proliferation of so-called “business angels”.

Through the financing rounds, the possibility is opened for new partners to acquire a part of the share capital of the Startup due to the financial outlay carried out by investors, which is usually coupled with the desire to be part of the business development and obtain well part of your control.

Thanks to the financing rounds, the Startups find an agile and attractive mechanism by which they can attract investors and capital and thus begin to operate with their project, expand their services, expand in the market or manage pay obligations through restructuring of liabilities or debts.

Characteristics of the financing rounds, types and operation

Depending on the objective and the moment in which the financing round is planned, it will have a series of characteristics that define it. In this regard, Startups require different types of investments depending on their needs and growth.

The different types of funding rounds are:

The pre-seed and seed round.
Series A round.
Series B round.
Series C round.

Pre-seed and seed round

The pre-seed round is the first round of the financing, and can even be defined as a preliminary round. Through this round, the raising of capital is aimed at raising the foundations of the idea and the business structure, the so-called Minimum Viable Product to be able to start an activity.

In this type of financing round, the so-called three Fs (Family, Fools, and Friends) are usually used and the objective is to obtain sufficient funds to achieve the initial viability of the project and that start their journey until they reach a profitability threshold that allows them to target the next financing rounds.

It is also important to have the support in this phase of institutions such as Startup Accelerators that provide advice and mentoring to polish the project and Startup incubators aimed at finding entrepreneurs to connect them with the business and investment world. In both cases, the contribution of training, direction and visibility to the project is obtained, matters that are extremely necessary in the first phases of the project.

The amounts of money that are handled in the seed rounds are usually small, generally less than 100,000 Euros. When the Startup reaches that Minimum Viable Product by managing to operate in the market, the seed round is reached in which to raise capital with the aim of defining and making a Startup project profitable that has clear objectives and demonstrated viability.

The objective of this round is to attract business angels, as well as equity crowdfunding and Venture capital platforms, providing financing and in many cases getting involved in the project offering entrepreneurs added value in the form of business know-how.

Round Series A

The Series A Round is the first of the rounds aimed at the growth of the Startup. The objective of this financing round is the organic development of the Startup and the business base.

This round of financing seeks to expand the available capital to scale the business as quickly as possible, while being staffed by hiring employees.

When this round is reached, the initial idea of the Startup is already a consolidated reality and its structure is sufficiently defined to be clear about where the money needs to be invested and what human capital will be needed. The objective of the investors at this point is the commitment to the Startup to sell their shares in the future, seeking the return on the investment.

Currently, in this phase, they seek to attract interesting amounts of financing, looking for a capital from 500,000 Euros to over 5 million Euros.

Round Series B

The Series B Round goes with the expansion phase of the Startup and it seeks to take the next step in expanding the business. The objective of this round of financing is to increase the value of the Startup through the expansion and scalability of the business model, fostering an investment-expansion tandem.

The economic amounts that are managed at this level of investment goes from 5 to over 20 million Euros.

Round Series C

Finally, Rounds C-Z are all the followed ones once the Startup has established itself in the market and functions as one more company. In these rounds, the capital is raised for different objectives, like new projects, expansion to other markets, acquisitions or transformation of the Startup to go on the stock market.

The capital that is raised in these rounds will depend on the objective that justifies them, but they are usually similar to those of Round B or even higher.

Venture capital investment funds and even financial investment entities usually participate in these last investment rounds, the profile of the investor is more specialized, with greater financial muscle to contribute large economic amounts and also, with enough information to calculate growth and the return on your investment.

Legal aspects to consider

On the basis that the financing rounds are an alternative financing mechanism and, therefore, economic-business; the legal aspects to be taken into account will be aimed at adequately articulating the synergies between the founders of the Startup and investors, so that the round of financing and investment in the Startup is attractive to investors and the founders maintain after each round of financing as much control and power over your own business as possible

For that purpose, investors and entrepreneurs find in the partners’ agreement the appropriate instrument by which set the details of the negotiation and the multiple aspects and particular issues of a financing round.

The partners’ agreement will function as a framework agreement by which the investment rounds will take place, stipulating in it the roles of each party, how the administration of the Startup will function from now on and the determination of actions to be taken in the different planned scenarios against a capital increase.

On this basis, in each investment round a Letter of Investment Intent or Term Sheet will have to be drawn up, this will set, on the one hand, the economic terms and, on the other hand, the legal terms of the financing round.

Regarding the economic terms, they can be summarized by reflecting in the Letter of Intent how much capital will be invested by each party and how the percentage of the shares will be distributed.

On the other hand, and with respect to the legal terms included in the Investment Letter of Intent, these will be interrelated with the partners´ agreement, since from each financing round, new actors will appear in the Startup taking the shape of investors with which will be agreed, among others:

Economic rights

It is necessary to regulate the current and future scenarios for the purchase-sale of shares. As well as it is necessary for entrepreneurs to address the inclusion of anti-dilution clauses to maintain control of the Startup, maintaining a minimum percentage of the company all the time.

Political rights

The appearance of new investors can affect the organization and management of the Startup. For this reason, the structuring of certain roles for the administration of the company and its bodies such as the Board of Members and the Board of Directors must be structured.

Mainly, both the participation in the organic structure of the Startup and the operating conditions of the entrepreneurs will be addressed, including issues related to permanence, exclusivity and non-competition to ensure the dedication and maintenance of the Startup for a minimum time.

Likewise, it should be foreseen how the future decision-making and information flows about commercial and financial results will be in the Startup.

Declarations and guarantees

The objective of this type of clause is to provide transparency about the past of the Startup and its current status at a legal and economic level, in case any type of claim or responsibility arises over the Startup, originated in previous moments to the financing round.

These clauses are used as a safeguard mechanism for both investors and entrepreneurs in case of having to face litigation or any type of extrajudicial claims, for economic reasons or due to liability derived from the activity.

If you have an idea and you need resources to finance it, you should consider this option. We believe in enterprising people and we are committed to offering a specialized service, based on our experience and expertise in the sector. We can provide you valuable information about financing rounds so that your project can be carried out.

LETSLAW

At Letslaw we have specialized professionals who can give you specific answers that meet your needs.
Contact us and receive advice from our lawyers capable of offering adequate advice on the best formula to organize and tackle a financing round for your Startup.