409A Valuation for Series C Funded Startups
In this article, we will discuss Series C funding and the role of 409A valuation for Series C funded startups.
With startups springing up across the globe, innovation and entrepreneurship are taking on new heights. With unique business models and market opportunities, these startups are shaping the future of business. With a diverse range of viewpoints and investing strategies, the Series C funding round is considered one of the most crucial milestones in the life of a startup. As such, 409A valuation is a financial metric that determines the fair market value of common stock for various purposes, including investment reference and employee stock compensation. In this article, we will discuss Series C funding and the role of 409A valuation for Series C funded startups.
Series C funded startups
You may be wondering why the term “Series C” is used to refer to a startup. Well, Series C funding is the fourth round of financing wherein the startup earns a significant infusion of cash, anywhere between $20-$50 million. Bringing in substantial funding, Series C funded startups are those which have typically attained the level of maturity and industry acceptance that is necessary for them to start this next phase of development. In short, the term “Series C” refers to the funding consideration for a startup.
While the startups that successfully secure Series C funding are known as Series C funded startups. It is important to note that the Series C funding round is largely driven by factors such as the maturity of a startup, the ability to generate cash flow, and the competitive position of a startup in its respective industry. Among others, these factors determine the likelihood of a successful Series C funding round. As a result, Series C funded startups are generally more mature and competitive than Series A startups as well as Series B funded startups.
What are Series C funded startups?
Series C funding is the common term for the fourth round of financing that is performed by a startup. This financing round is more critical than previous rounds as it contains the highest amount of capital compared to the other rounds. This means that the company will have access to significantly more resources to fund its operations and growth. Series C funded startups are usually high-value, fast-growing, seed-stage businesses that have demonstrated both a market need as well as the ability to execute on their business model.
As such, they are deemed more likely to succeed in the future and are thus rewarded with high amounts of capital. In this way, Series C funded startups differ from other types of companies that seek funding. Thus, Series C funded startups are characterized by the fact that their owners and investors will have high expectations with respect to their future performance.
When to raise Series C funding for your startup?
The Series C funding round of financing allows a startup to develop key product features or marketing efforts, enter into new markets or expand its physical distribution networks. As a result of the money raised in this round, companies become more stable and further develop their growth potential.
This type of funding will allow the startup to move on to more advanced stages. As a result, the startup can reach the point where it can generate enough cash flow as well as attain the necessary level of brand recognition. Following are a few of the major reasons why startups are encouraged to seek Series C funding:
- When you are ready to sell preferred shares – When a startup has been around for a while, it typically becomes more stable regarding the cash flow it produces and its growth rate. In addition, startups that have already been through multiple rounds of financing are generally well-established businesses. In this regard, if a startup is willing to sell preferred shares, it is time for them to raise Series C funding. In many ways, Series C funding will provide the startup with the liquidity they require to raise more money when they are ready to sell preferred shares.
- When you have passed the development stage – The first three rounds of financing generally focus on research and development. In other words, owners and investors pay close attention to the value and potential of the business model. As a result, they invest in the startup in order to advance its development process. However, if a startup’s potential is proven and its business model’s development stage is complete, considering Series C funding is appropriate.
- To further expansion of your company – Before a startup considers raising Series C funding, it needs to be at a stage where its growth potential is significant. As such, when a startup has reached a stage of development where it can expand its operations, it needs to consider raising Series C funding. Basically, if a startup wants to enter new markets or increase the range of products and services it offers, it should raise Series C funding.
- Acquisition and IPO potential – In many cases, a startup will consider raising Series C funding in order to be acquired by a larger company or to go public. As a result, they will earn more money and gain greater exposure in the industry. This practice is often followed by startups that have already proven the potential for success and growth. It is at this point that a startup can build a long-term strategy in order to generate enough value to be acquired or to present itself as a favorable IPO candidate.
Challenges in raising Series C funding
As a result of the high levels of capital, the Series C funding round of financing is often seen as a highly competitive round of financing. Consequently, the challenges faced by startups while raising Series C funding include:
- Since the Series C funding round is considered the most significant round of financing, many startups are faced with high expectations from investors. In addition, investors expect these startups to demonstrate a great degree of maturity and growth.
- The allocation of capital is no longer as basic as in previous financing rounds. The amount of capital is usually high in Series C funding. This means that startups are in control of a large amount of capital that they need to use wisely. Founders should know the fact that the allocation of capital is a complex process, especially when it comes to Series C funding.
- In order to succeed in the Series C funding round of financing, startups will need to choose the right investors for their businesses. This will allow them to obtain the necessary level of support. Thus, finding the ideal investor for the business may take a lot of time.
- As a result of the high amount of money allocated in this round, startups will have to endure a significant dilution of their ownership. In other words, they will have to give up a large portion of their equity. The amount of ownership that startups will need to give up depends on the amount of capital they receive.
How to get Series C funding for your startup?
There are a number of ways to get Series C funding for your startup. However, the most common methods include private equity funding, corporate venture capital, and angel investor financing. In order to raise Series C funding, the first step would be to prepare a pitch deck that includes information on the company’s background, a detailed plan for expansion, financial forecasts, valuation, and other key information.
Further, market research should be conducted in order to find the right investors for the business. Lastly, it is important to present company information in the most appealing manner possible. Thus, in order to get Series C funding for your startup, you will need to consider a number of key elements.
Do 409A valuation require in Series C funded startups?
Before a startup considers raising Series C funding, founders or management team should ensure that they have a 409A valuation. The role of 409A valuation in Series C funding is to help determine a startup’s fair market value of common stock. This is because it provides a benchmark, and investors will know exactly what they are investing in.
Therefore, it is advisable to use a 409A valuation as a fundamental aspect of raising Series C funding. Typically, the need for 409A depends on the specific circumstances and requirements of the investor. For instance, venture capitalists are always required to have a 409A valuation. As a result, be sure to conduct proper research and plan accordingly.
How does 409A valuation work in Series C-funded startups?
Now that you know that 409A valuation is a necessity before you raise Series C funding, it is time to learn how it works. Following are some of the key elements to consider when getting a 409A valuation:
- Calculate enterprise value – The first thing that you need to do is to calculate your enterprise value. It is the market value of your company that is calculated by subtracting the market capitalization from debt. In other words, enterprise value is the total worth of the business in terms of financing.
- Backsolve approach – The backsolve approach is used to estimate the value of the common stock. It is calculated by using the most recent price paid by the investor for preferred shares. As such, the backsolve method is used for startups that have complex capital structures.
- Calculate the value of the common stock – A startup’s common stock can be calculated using various methods under 409A valuation. The Internal Revenue Service provisions allow you to choose from four acceptable methods to determine the value of the common stock. It is essential to adhere to the rules and regulations.
- Apply DLOM – The discount for lack of marketability or DLOM is a reduction from the fair market value. As a matter of fact, the shares of private companies are not listed on a public exchange. In such cases, the use of DLOM is used in the calculation of 409A valuations.
409a valuation case study for Series C funding round
Let’s say there is a company, called Streama, an online live-streaming platform for businesses offering webinars. With gaining a large majority of the market share in the company, the Board wishes to move into different markets with its service, and become the dominant player within the industry. With this, they raised a Series C round to expand the company’s reach.
The company then decided to take on its initial investment in the form of a seed funding round, from angel investors. The total amount of the funding was $90,000,000 to support the company and expand its services. With this investment, the share price buy-in was $15.00 per share. Here is a look at the cap table post-funding:
Increase ESOP from 2,500,000 to 3,166,666 to maintain a 10% ESOP for employees and for increased options for incoming ESOP holders in the coming 12 months.
For a 409a valuation for Series C funded startups, as their funding round set the valuation of the company for angels to invest in, this too set the share price for their stock.
Therefore, we can base off this scenario to conduct a backsolve approach based on their cap table. In order to conduct this analysis, payout “Tranches” would be set up according to the amount paid back to investors, in this case on their $90,000,000 investment. After this, the remaining amounts would be split according to their ownership percentage.
In this case, 100% of the payout up to $137,100,000 would be paid to the stakeholders who invested in the company, to get back their investment. The remaining 9 tranches are according to breakpoints calculated by each equity holder. These tranches would then be put through a stock option pricing model (OPM) to attribute values to each equity class.
According to this cap table and the inputs, the common share price would be $5.35 after the DLOM, shown as:
Common Share price: $5.35
This share price would reflect around 35.64% value after DLOM of the seed funding round of $15. This is an example on how to get a 409a valuation for Series C funded startups, and find the common share value to be used for future use, such as stock option exercise pricing.
Need a 409A valuation to raise series C funding?
In conclusion, 409A valuation for Series C funded startups is necessary for a variety of reasons. The backing of a 409A valuation can act as proof of the facts presented in the pitch deck because it gives a fair idea of the company. While raising Series C funding requires other considerations as well, including the valuation of the company, financial projections, and more. Get an accurate 409A valuation from Eqvista for your business. With years of experience and qualified team members, Eqvista is your business’s most reliable and affordable option. To learn more about our 409A valuation services, get in touch with us today!