Building a successful startup almost always requires outside capital. Whether you need money to develop a product, hire a team, or scale into new markets, understanding the fundraising process and what investors expect at each stage is essential knowledge for any founder. Capital raises follow a fairly predictable progression, with each round building on the last and carrying its own terms, expectations, and dilution implications.
Friends, Family, and Founder Capital
At the earliest stage, most companies are financed by the founders themselves. Founder capital may take the form of cash contributions, personal loans, or “sweat equity” in exchange for stock. While this stage involves relatively simple documentation, it is critical to clearly record who contributed what, how equity is allocated, and whether any vesting arrangements apply. Early informality can create massive legal headaches later if disputes arise among the founders or when institutional investors begin reviewing the company’s records.
The next money in often comes from friends, family, or a small group of angel investors. Although these rounds are typically smaller and less formal, they still require careful attention to securities law compliance, investor disclosures, and the practical risk of taking money from individuals who may not understand the high-risk nature of startup economics.
The Pre-Seed Round
Increasingly, founders raise a distinct pre-seed round before a formal seed. A pre-seed is typically a small raise, often from dedicated pre-seed funds, angel investors, or startup accelerators, intended to carry the company from an idea to an early product, initial traction, or a first key hire. Like the seed round, discussed below, pre-seed financings are almost always completed on convertible instruments such as SAFEs or convertible notes rather than priced equity, because the company is usually too early to support a meaningful negotiated valuation.
The Seed Round
The seed round is usually a startup’s first true institutional raise. Because early-stage valuations are difficult to negotiate, seed rounds are frequently completed using convertible instruments, such as SAFEs (Simple Agreements for Future Equity) or convertible notes, rather than issuing priced equity. These instruments allow investors to provide capital now, which then converts into equity later during the first priced round.
Series A: The First Priced Round
The Series A is generally the startup’s first significant “priced” equity round led by an institutional venture capital firm. In this round, the company issues a new class of preferred stock based on a formally negotiated, per-share valuation.
A Series A involves robust due diligence and heavily negotiated investor rights. Investors will present a detailed term sheet covering valuation, liquidation preferences, anti-dilution protections, board composition, and protective provisions (veto rights over certain company actions). The resulting definitive documents, which typically include a Stock Purchase Agreement, an Amended and Restated Certificate of Incorporation, an Investors’ Rights Agreement, and a Voting Agreement, are complex and require experienced legal counsel on both sides. Founders who haven’t navigated a Series A before are often surprised by the scope of the process and the level of control they must concede.
Series B, C, and Later Rounds
Subsequent rounds follow a structure similar to the Series A. Each new round typically prices the company at a higher valuation (reflecting growth and reduced risk) and involves issuing a new, distinct series of preferred stock with its own specific rights and preferences. These new series are layered on top of prior rounds, making the capitalization table and liquidation waterfall increasingly complex.
Down Rounds and Anti-Dilution Protections
Not every round is an “up round.” If a company must raise capital at a valuation lower than its previous round, the consequences can be severe. This triggers anti-dilution provisions negotiated by earlier preferred stockholders, which automatically adjusts their conversion price to grant them additional shares. This mechanism protects early investors but can cause substantial, disproportionate dilution to the founders and employees holding common stock.
The Possible Exit
All of this fundraising ultimately builds toward a liquidity event, the point at which investors and founders convert their ownership into cash or marketable securities. The two most common exits are an acquisition, in which another company buys the startup, and an initial public offering (IPO), in which the company sells shares to the public on a stock exchange. Acquisitions are far more common than IPOs and range from modest to multi-billion-dollar transactions. When an exit occurs, the liquidation waterfall built up over successive rounds determines who gets paid and in what order: preferred stockholders typically recover their liquidation preferences first, with any remaining proceeds flowing to the common stockholders. This is why the terms negotiated in each prior round matter so much: they ultimately dictate how the proceeds of a successful exit are divided.
The Bottom Line
Each fundraising round is a negotiation that shapes your company’s governance, economics, and ultimate exit outcomes. Founders who understand the mechanics of each stage are better positioned to negotiate favorable terms, avoid common pitfalls, and maintain meaningful ownership.
KJK advises startups and founders at every stage of the capital-raising process, from structuring early SAFEs to negotiating Series A term sheets. If you’re preparing to raise capital and would like help navigating the process, please contact Andrew Wilber (AJW@kjk.com) or Emily Korthaus (ELS@kjk.com).
This is Part IV of our “Startups 101” series. Read Startups 101 — Part I: Choosing an Entity and State of Formation, Startups 101 — Part II: Protecting Confidential Information and Intellectual Property, and Startups 101 — Part III: How Much Stock Should Your Startup Issue?