Funding Round Nomenclature Reconciliation – Series A or Seed?

Over the past few years, the way we describe funds and funding rounds has become a bit ambiguous.  I believe that this has been caused by what Fred Wilson calls Two Venture Capital Industries diverging from each other.  In my opinion, most miscommunications can be avoided if we just use the same words to describe things.  I really don’t care what the words are, as long as we can all agree on the meaning.

Specifically, I’d like to focus on the word “Series” as a way to define a round of financing. Depending on who you talk to this word is way “overloaded.”  Some funds use it to describe the size of their fund, while other investors may use it to define a range of how much they invest in each company and lawyers use it to define a class of stock.  For instance, when I purchase shares in a company, I’m usually purchasing shares in successive “series” of rounds; Each round defined using the next subsequent letter in the alphabet.  So, if an angel purchases $50k worth of equity in a startup, the equity is usually labeled “Series A Preferred Shares” and the next round the angel invests would be labeled “Series B Preferred Shares.”  Despite that the proper definition of the term “Series” is a legal definition of a round of stock, everyone else would consider the angel’s $50K investment a “seed” round and the following investment, the company’s “A” round.  Culturally, “Series” is used to describe the *stage* of company that a fund invests in, which I think trumps the legal definition.

As you’ve heard over and over, Internet companies are more capital efficient then they were five years ago, which in my opinion, is the fundamental cause of this ambiguity. I believe that the name of each stage (Seed, Series A/B/C/D, Mezz, PE, IPO etc.) should be a function of the risk associated with the investment.  For example: If I grow my company organically for 2 years, and it’s now generating revenues of $10M/year, then the first money I take will probably be from “Series B Investors.” It’s a function of price and risk tolerance.   Keeping all these things in mind, here’s what I propose the rough definitions of the stages should be for Internet investing:

• Seed – Test an idea with the market; See if it sticks. Angels, Super-Angels, Seed Accelerators usually invest $10k-$100k in lots of deals, which means lots of failed tests, but an increasingly higher hit rate at the same time.  If technology and user risk (ie: can they build it and do people want it?) is eliminated, then the company qualifies for the next level.
• Series A – Invest in successfully tested ideas from the seed stage, pressure-test the previously identified user acquisition channels, and refine the user experience. Today, series A investors typically invest $250k-$2m.  If market risk (ie: can you grow it?) is eliminated, then they qualify for the next level.
• Series B+ – Once the site/app is built, customers are using it, revenues are flowing, user acquisition channels have been quantified, it’s time to put the pedal to the medal and grow!  This requires capital, but selling equity may not be the founders first choice if they have other options.
• Factoring – Banks love to lend money to companies based on receivables.  The smartest companies I know borrow as much as they can against these uncollected sales contracts in order to put as much money to work as quickly as they can.
• Private Equity - You might want to acquire another company, or buy equity held by an exiting management team. (Note: There are lots of reasons why you might raise money from a PE firm, but not the scope of this post)
• IPO – A lot of CEOs forget that an IPO is a way to raise money.  Obviously, it provides liquidation for their stock, but if that’s the only thing that you’re after, there are other ways to achieve it.

I was debating this with a colleague of mine today, and his argument was that there’s a an entire “culture” built around the term, and to just accept that it’s flawed. – Maybe I should, but hopefully at least we’ll be talking the same language.