If you’re fundraising for your startup, equity is one of the most important components. You have been successful with the seed round and after growing your business, you need to raise series A now.
You need to have enough capital to keep the business operational for a long time, especially if you plan to grow it in the future.
In other words, you should get as much equity as possible so that when things don’t work out and your company folds, you can at least recover some of your investments. The amount of equity that a founder should retain in Series A funding depends on various factors including the valuation and other nuances involved in running a business.
Read on to know more about what should be your target equity stake for a Series A funding round and how much risk you are willing to take with your personal finances and fledgling company.
How much risk are you willing to take?
One thing that should always be at the top of your list when determining the equity stake for your Series A funding is how much risk you are willing to take.
Generally speaking, if you would like to reduce your risks (or founders’ risks), you should be willing to give away more equity to investors and receive more money which can help your startup to grow faster or to have a longer runway.
If you are not comfortable with the amount of equity you should retain, you should perhaps reconsider going for a Series A funding round. After all, you’re investing the same amount of money that your backers are, so you need to be sure that there are enough reasons to back your company.
The general recommendation for Series A funding rounds is that the equity stake should be between 10-25% of the total funding amount.
This is a very wide range and will largely depend on the exact situation of your business, your personal preferences, the amount of funding you are raising, and other factors.
If you don’t like the equity stake that you get in your Series A funding round, you can always revisit the investors later and ask them to increase the amount.
What’s the recommended minimum equity stake for Series A funding?
Typically, venture capitalists expect you to retain at least 15% of the equity in your company. They usually don’t want to back the company if you are ready to give away all your shares for a mere money transfer.
In other words, exit does not make much sense at this stage nor for your investors neither for you since the business is growing and if you work hard, you can turn it into a successful business with much higher valuation in the future.
At the same time, most investors expect you to retain more equity in your Series A funding round so that they can earn higher returns on their investment.
Ideally, you need to find a sweet spot between a low amount of equity for a lower amount of funding and a high amount of equity for a higher amount of funding.
It’s important to keep in mind that a lower amount of equity in your company won’t increase the valuation much and might even reduce the valuation if your business takes off and becomes very successful in the future.
How do you determine valuation for Series A funding?
There are various valuation methods and techniques that you can use to determine the valuation for your Series A funding round (Source).
However, no single method or technique is universally correct. It all depends on the specifics of your business, its market size and growth potential, the competition in the industry, the stage of your company, your own valuation, the investment amount, the investors’ expectations, and other factors.
There is no standard approach for calculating Series A valuations. However, if you accept the valuation provided without conducting any due diligence, you may doom your company’s funding future. On the other hand, if the valuation is too high, you could be forced to undergo a down round at your Series B.
To avoid getting mired in calculations, it’s best to hire a professional valuation partner who can help you determine the valuation for your Series A funding round.
Venture investors generally prefer to back Seed and Series A rounds as they are relatively low-risk investments.
Factors that impact your Series A valuation
Venture capitalists value a company primarily on the basis of its future potential. They invest in startups not only to earn returns on their investment but also to fund new businesses with high growth potential and create jobs in the long run.
It’s important to understand that the valuation isn’t just about how much the company is worth today, but also how much it has the potential to be worth in the future.
Apart from the business fundamentals like revenue growth and profitability, venture capitalists look for other factors that could influence the valuation of their investments.
Some of the most important factors that could impact your Series A valuation include the following:
– Market Penetration: The value of a company is derived primarily from the growth prospects of the existing market. If the market for your products or services is already saturated or even saturated to some extent, then the value of your business will significantly impact by how much customers are willing to pay for it.
– Competition: A strong competitor in the same industry is one of the major factors that impact the valuation of a company. In many cases, the degree of competition in the market is the only thing that separates startups with similar revenue and profitability growth.
– Team: An experienced team and a strong technology might be important factors in the valuation of a company. With time, these factors could have a huge impact on the profitability of a business and could even become a competitive advantage for a few companies.
Other Factors to Consider When Determining the Equity Target for Series A
There are a few more factors that you should consider before making decision on equity targets for series A. The following factors can give you some leverage to negotiate the equity of founders and what can be given to investors.
– Your track record: Venture capitalists generally value startups that have already raised Series A funding rounds. Therefore, if you have already staked some money in your company and you want to raise a Series A round, the equity stake that you should retain in the round will largely depend on the amount of equity that you have in your previous funding round.
– The stage of your company: The valuation of a company is expected to increase significantly after Series A funding. This is the time when your business should be profitable and able to generate revenue and profit.
At this time, the valuation can increase to a significant extent because many investors will start valuing your company on the basis of future potential rather than the amount of money that you have already invested in it.
– The competition: Venture capitalists generally look for companies that have less or no competition in the same industry. This means that your competitors in the industry are another important factor that can impact your Series A valuation.
– Your personal net worth: The valuation is expected to increase significantly when the personal net worth of the person backing the company increases significantly. This will largely depend on the amount of funds that you have in your personal bank account.
Final Words
After your Series A funding round, your company will be well-capitalized and ready to take on any challenges that might come its way.
At this point, you should be able to determine the overall worth of your business and make informed decisions based on the figures.
When you are funding your startup, consider the amount of risk you are willing to take, the value that you want your company to be worth, and the amount of equity stake that you want to hold in your company.
