Preferred Stock: Where “F” in a Class Can Equal Success
If you pay any attention to TechCrunch or Venturebeat, you’ll see stories titled “Startup Raises $X Million in Y-round Financing.” When the “Y” in story is a large number, do not assume that the startup company is tanking. Instead, the startup could be gaining momentum and approaching positive cash flow…but just needs one more round to get over the top.
Rounds of financing are tied to classes of preferred stock. You can name the preferred stock rounds whatever you like, but the norm is to follow the alphabet. For example:
1st round = Series A
2nd round = Series B
3rd round = Series C
26th round = Series Z
If a startup raises its rounds of financing at increasingly higher company valuations, each new class of preferred stock will represent an increase in price. This means that value is being created and progress is being realized at the startup. Thus, a startup may be going through a sixth-round financing (or Series F) simply because the startup needs more time or money than it anticipated.
About the Author
Ryan Roberts is a startup lawyer and represents technology companies through all phases of the startup process, including incorporation, seed & venture financings, and exit transactions. Click here to learn more about his practice.
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True, companies often survive through an E-, F- or later round, but as you know, Common usually gets wiped out after the 3rd or maybe the 4th round. Even if they're not completely wiped out, Common is under such a large preference stack that they might as well be.
The fact that startups last through these later rounds is mostly the result of a perverse incentive the VCs have (they're playing with other people's money and they get 20% of any upside so hope is always around the corner).
I agree. And we'll probably see a lot of that (common taking big hits) given the lower valuations going around.