Startup funding explained: Series A, Series B, Series C

Seed funding refers to any money a startup raises from external entities — like angels, friends, and incubators. In return for funding, these external entities will want equity in the company. This equity is determined by the investors and is considered the pre-money valuation. In 2020, the median pre-money valuation seed round was $6 million. Most founders can expect to give away at least 10 percent of their startup during the initial seed round. Startups without any cash flow or customers will likely give up more equity.

After the initial round of seed funding, many startups grow (or fail) without any further investments. Startups give away a chunk of their equity, and they get some quick cash. But what happens when they need more money to promote growth? Some businesses can thrive on $100,000. Others may need a couple million to even make a tiny splash in their market.

Startups will get seeded before they participate in seeding rounds. Initial seed money can come from a variety of places. Friends and family are obvious sources, but other common seed and pre-seed sources include:

• Startup accelerators are fast-paced mentorship programs that also act as funding funnels. Generally, these services connect you with mentors and other startups, and they play a part in helping you get funding (either directly or indirectly).
• Startup incubators are also mentorship programs. But unlike startup accelerators, startup incubators work with early-stage startups and focus on more long-term growth.
• Angels are individuals with a high personal wealth that support early-stage startups in return for equity.

Once a startup is seeded, it can participate in Series funding rounds to generate additional funding.

Series A is the next round of funding after the seed funding. By this point, a startup probably has a working product or service. And it likely has a few employees. Startups can raise an additional round of funding in return for preferred stock. Remember, a startup and any angels it worked with are the current holders of that startup’s stock. When a startup starts Series A, it will sell off more stock in return for extra cash (usually between 10 and 30 percent). Around 1 in 3 startups that make it past the seeding round will successfully raise Series A.

Startups need a Series A valuation before trying to secure any funds. This arduous process will look at the market size, risk, revenue, customer base, team quality, and proof of concept in detail. Investors will want to know that a business has both a great idea and an idea that can generate revenue. Many startups are not generating a net profit before Series A. But most are generating some form of revenue. Series A funding can provide a huge chunk of revenue to a startup. In 2020, the median Series A funding round was $10 million.

Series A funding exists in its own economic ecosystem. Traditional funding levers often look at net profits and market conditions as the primary factors for investment. Angels, accelerators, and venture firms are often more interested in the founder’s history, the quality of the team, and the overall market size. While revenue and growth are still important, Series A funders are willing to take more risks than traditional private equity firms. It may make sense to pull in analysts and consultants to help you position your startup in a way that attracts these unique (and risk-ready) investors.

Most Series A funding is expected to last 12 to 18 months. If a company still needs funds after this period to dominate its market, it can go through Series B funding. By the point a startup gets to Series B funding, it’s already successful. However, this success isn’t necessarily measured in profits. Many Series B companies are still at a net negative profit. But they almost always have revenue coming in, and they were seen as successfully spending Series A capital. In fact, the median Series B startup has a pre-money valuation of $40 million.

Series B funding is mostly used for scale — not development. Most venture firms expect a startup to be developed, revenue-drenched, and growth-ready. There’s a reason the median capital raised in Series B is around $25 million. Most companies sailing towards Series B are proven.

After Series B, many companies move on to Series C. Unlike the funding rounds above, Series C is only awarded to successful startups. These funds are often used to expand market reach or M&A activities. Most startups consider Series C to be the final round of funding. While it’s possible to undertake later rounds of funding, they’re typically used to help organizations push toward an IPO

Once you get to Series C funding, your investor range broadens. You can expect hedge funds, private equity firms, and investment banks to get involved in this round of funding. You have revenue (usually net), growth, a huge customer base, and a kick-butt team. Thus, your valuation will be tied to more concrete data. At this round, those visionary-type metrics (team experience, ideas, and R&D dreams) are less important. Investors want to see the books and make a valuation based on profits.

DigitalOcean provides startups with the resources they need to grow rapidly. Our global startup program Hatch is focused on providing founders with the speed, flexibility, and power they need to scale their digital infrastructure. Sign up to learn how we can help you scale your startup.