Starting a successful new business requires a great idea, a great strategy, a great team, and, often, a lot of capital. After entrepreneurs have invested their own money and requested investments from family and friends, it is usually necessary to begin fundraising with investors. After initial funding with a seed round, most companies move on to a series of funding rounds, beginning with Series A.

Series A represents a significant step in the growth of a company, as it is often the first time the company must demonstrate a thorough understanding of securities laws, fundraising, shareholder rights, and the business side of venture capital. Founders should work closely with experienced Series A funding lawyers to have a successful round, which sets the tone for all future fundraising.

What Is Series A Funding?

Seed funding is often obtained from angel investors or other investors who specialize in early-stage, speculative funding. Series A funding is often the first financing round in which a company offers equity to venture capitalists. It is often the first significant infusion of capital into a company and establishes the framework for all investor relations, fundraising rounds, and future equity financing. Mistakes or omissions during Series A often cause exponential problems as the company scales up.

The Purpose of Series A Financing

Generally speaking, a company seeks Series A financing when it has a product and is earning some revenue (or is very close to earning revenue). The purpose of Series A funding is to obtain the capital necessary to reach profitability.

When seeking Series A financing, founders must demonstrate that:

• They know the market and how their product fits into the market
• They have used prior capital and investment funds effectively
• They have proof of concept for their business model
• They have an effective strategy for reaching their market
• They have a specific plan for company growth
• They have a quality leadership team who can execute that plan
• They understand the investor’s potential risk

Every startup is unique, and not all new ventures will have all of those elements established to the same extent during their Series A fundraising round. Most venture capitalists understand that the business is still in an early stage, and some elements of the growth plan and marketing strategy will need to evolve over time. However, it is critical to understand the expectations of your early-stage investors and work to their standards.

What Is the Difference Between Series A Financing and Series B Financing?

Generally speaking, by the time a company seeks Series B funding, it has proven its strategy and marketing plan and simply needs enough capital to scale its operations. Companies may not yet be profitable by the time they seek Series B funding, but they need to demonstrate that they have everything in place to get there.

Subsequent funding rounds (Series C, Series D, etc) are typically focused on more and more specific efforts toward profitability: financing is raised to scale the business model, expand the user base, improve the product, etc.

Does it Matter Which Round My Financing Round Is Labeled?

As a rule, how you label your financing round does not matter in terms of the amount of capital raised and how you will use the money.

However, many investors have different expectations from founders at a seed round vs. a Series A round vs. a Series B round. In some cases, they may have very different expectations of what these rounds will look like, how the company will be positioned, and what its valuation should be. If you have questions about how best to organize your fundraising rounds to match the expectations of your potential investors, it is a good idea to consult with a startup attorney in your area.

Important Series A Documents and Provisions

Typically Preferred Stock is sold to investors in a Series A fundraising, which grants investors certain rights and requires compliance with SEC regulations. Before seeking Series A funding, a startup should have completed all the steps necessary to undergo due diligence, which includes investor review of corporate records, financial documents, business plans, intellectual property assets, legal and regulatory compliance, etc.

Here are the necessary documents for Series A venture capital funding:

Term Sheet

The term sheet is usually a nonbinding document that describes the terms of the final investment agreements. The term sheet typically outlines key investment terms such as the amount of capital being invested, the valuation of the company, and investor rights, including liquidation preferences, board composition, anti-dilution provisions, among others. The term sheet clarifies and formalizes the investor’s offer. Although the term sheet is non-binding, it provides a backup document in the event of a later disagreement or dispute. The term sheet also typically includes certain binding non-disclosure and confidentiality clauses.

Investor Suitability Questionnaire

The investor suitability questionnaire is used to determine whether an investor is “accredited,” according to the SEC. Working with accredited investors provides exemptions from certain SEC regulations and allows investment in private companies.

Amended Certificate of Incorporation

Because most Series A investors will receive preferred stock, the company is often required to file an amended and restated Certificate of Incorporation, which reflects the change in share classes and the associated rights and privileges of the investors.

Investors Rights Agreement

The Investors’ Rights Agreement (IRA) documents the specific rights and obligations of investors, as well as the obligation of the company toward its investors. It generally includes provisions like:

• Registration rights. Registration rights govern how or when investors are allowed to sell their shares to the public. The most common registration rights are “piggyback” rights, which give the investor the right to join a sale initiated by the company. Registration rights typically also include specific lockup and transfer restrictions limiting how and when shares can be sold.
• Information rights. The information rights provision gives investors access to financial and corporate information. This typically takes the form of annual or quarterly financial statements and capitalization (cap) tables, budget and business plans, and similar documents, allowing investors to monitor company performance. The information rights clause may grant certain investors the right to review certain information on request or to appoint a board observer.
• Pre-emptive rights. These rights include right of refusal/right of first offer and other provisions that allow investors to avoid dilution and maintain the value of their equity.
• Voting rights. The IRA specifies investors’ voting rights, including the terms under which shareholders may pool their votes.
• Other provisions. The IRA may include other provisions that are important to investors, such as an agreement to maintain certain insurances, obtain approval for key actions, or other factors that protect investors’ interests.

Shareholder and Board Written Consents

The shareholder and the board must issue written consent to signify their approval of key transactions, such as a Series A funding round, as well as any amendments to shareholder or investor rights.

Preferred Stock Investment Agreement or Stock Purchase Agreement

The stock purchase agreement is the legally binding agreement between the company and the investor. It specifies the purchase price, representations and warranties, indemnification, closing conditions, and other stipulations agreed upon by both parties.

Entrepreneurs and founders must work closely with experienced Series A funding lawyers to understand the details of all these contracts. While it may seem that the investor, because they have the capital, can control the terms of the deal, founders often have more control than they think. An experienced startup lawyer can help entrepreneurs understand how to make Series A funding agreements that are most beneficial to them and where they can push back. It is also critical for founders and directors to understand how to implement and abide by the terms of all the Series A agreements. Finally, the services of an attorney will be necessary to ensure that all contracts, agreements, and capital raised during Series A are correctly documented and filed with the relevant reporting agencies and authorities.

Need a Series A Funding Lawyer?

Series A financing sets the tone and the base terms for all the subsequent funding activities of a company. Mistakes at this stage become magnified over time, and successes at this stage lay the groundwork for more successful fundraising in the future. It is the key time when your company establishes its reputation among venture capitalists, and missteps can be hard to overcome. Work with a Series A funding lawyer who is as invested in your success as you are.

At the Fridman Law Firm, we are dedicated to supporting entrepreneurs and innovators and know how to guide companies through the complex fundraising process. For more information about how to have a successful Series A funding round, contact us today or call 212-262-9823.