Venture Vernacular: VC Overview & Market Updates

Venture capital ("VC") represents a crucial source of funding for entrepreneurs gearing up for their company's next phase of growth. Transitioning from bootstrapped to VC-funded requires a grasp of capital raising alternatives, industry jargon, and current market conditions.

Market Update

A recent report on VC trends highlights that during the first three quarters of 2023, VC deals in the U.S. raised more than $32.1 billion across 2,209 transactions.[1] Globally, VC activity reached a substantial $193.6 billion.[2] Notably, early-stage deals constituted 61% of all VC activity in the U.S. in 2023Q3, while late-stage deals dipped to a mere 7%, marking their lowest level since 2019.[3] VC funds made up 30% of the investor share of global VC funding, with corporations and corporate venture capital ("CVC") contributing 17%.[4] Angel investors held a 10% share, while asset and investment management firms accounted for 9%. Private equity ("PE") represented 7% of the investor share, and incubators/accelerators rounded out the landscape with 5%.[5] In 2023, the market witnessed the emergence of 12 new unicorns, five of which are U.S.-based, bringing the total number of unicorns to 1,221.[6] Notably, mega rounds have made a resurgence, with U.S. companies completing 65 mega rounds and raising an impressive $15.8 billion.[7]

Local Spotlight: Philadelphia VC VC funding in Philadelphia rose to $1.1 billion in the third quarter of 2023 almost double the total funding raised in the first half of 2022.[8] Makatuu, an internet company currently in stealth mode, raised $554 million in an undisclosed funding stage.[9]

Types of Investors

Companies raise money from a variety of investors and programs. Click the arrows to read a brief overview of each investor type.

Incubators

Incubators can play an important role in supporting entrepreneurs during the nascent stages of their ventures, helping with development and refinement of startup concepts.[10] It is important to note that not all incubators provide opportunities for entrepreneurs to secure early-stage capital.[11] Incubators may grant entrepreneurs access to a range of resources, including workspace, legal consultations, networking, and mentoring, often for a period of one to five years.[12]

Accelerators

Entrepreneurs with a tried and tested business model at an early stage can tap into the valuable resources and mentorship offered by accelerators.[13] Accelerators programs are intensive, bootcamp-style initiatives typically lasting for two to six months.[14] Unlike incubators, accelerators commonly acquire a stake in a startup, typically ranging from five to ten percent ownership, in exchange for their services and a capital infusion.[15]

Angel Investors

Angel investors typically engage in early-stage funding, often participating in seed-stage and Series A rounds.[16] Generally, an angel investor is a high-net-worth individual who invests their personal capital in startups or other growth companies.[17] Angel investors frequently play an active role in startups, serving as directors or board members and contributing their valuable industry and business knowledge to the companies they support.[18]

Venture Capital Funds

VC funds play a pivotal role in supporting startups across various stages of growth. Many VC funds invest in multiple rounds of their portfolio companies.[19] The Investment Advisers Act of 1940 defines a VC fund as a private fund that pursues a venture capital strategy, restricts redemption rights, allocates 80% of its fund’s capital contributions to qualifying investments, and limits leverage use.[20] Generally, VC funds take an active mentoring role with the startups they invest in, often securing seats on the board of directors.[21] Startups benefit from a series of value-add services from VC funds, including guidance on strategy, introductions to other investors and customers, and guidance on operations and administrative matters.[22]

Corporate Venture Capital

CVC is typically characterized by investments made by large corporations into promising external startups without the involvement of an external fund managed by a third party.[23] CVC investments are made after careful consideration of the investing company's objectives, aiming to strike a balance between strategic and financial goals.[24]

PE Funds & Hedge Funds

PE funds and hedge funds also invest in startups. Like a VC fund, PE and hedge funds are pooled investment vehicles.[25] PE funds typically focus on long-term investment opportunities.[26] In contrast, hedge funds enjoy greater flexibility to explore riskier investments, a latitude granted by their regulatory framework and their base of wealthier investors.[27]

Types of Transactions & Structures

The various kinds of investors discussed above participate in diverse capital raising rounds, exchanging capital for different types of consideration. Regardless of type of structure or transaction, the deal must fit within a regulatory exemption outlined by the federal securities laws to avoid having to register the offering.[28] Click the arrows to read a brief overview of each transaction or structure type.

Seed Rounds

A seed round involves the raising of capital from sources such as friends, family, angel investors, or funds that specialize in early-stage companies.[29] During seed rounds, convertible notes and Simple Agreements for Future Equity (SAFEs) are commonly used as instruments to exchange for seed capital.[30] The funds secured in seed rounds are typically allocated for purposes such as product development and market research.[31]

SAFEs

SAFEs are contracts between a startup and an investor in which a startup promises to give a future stake in the startup if a certain triggering event occurs, such as a financing or acquisition.[32]

Series Rounds

Raising money from investors in a series of funding rounds after a seed round.[33] Investors are often VC funds, which provide capital in exchange for preferred stock.[34]

Early-Stage Rounds

Series A and B funding rounds are considered early-stage.[35] Series A capital is allocated to building an initial customer base and proof-of-concept.[36] Series B funding is traditionally used on scaling the business and expanding customer base.[37]

Late-Stage Rounds

Funding that is used to fine-tune operations and prepare for an initial public offering (“IPO”) or other exit opportunity are considered late-stage funding rounds.[38] In recent years, companies have elected to stay private longer and the market sees Series D, Series E, and even Series F+ rounds, leading to mega-rounds and the unicorn phenomenon.[39]

Convertible Notes

A convertible note is a loan to a startup from and investor that can be converted into a different security.[40] The note typically begins a debt and converts into preferred stock upon the triggering of a funding round or other agreed upon condition.[41]

Preferred Stock

Preferred stock is an equity security, which represents an ownership interest in a startup and has preferential right over common shareholders.[42] Rights may include liquidation preferences, protection from dilution, rights to dividend, and limited voting rights.[43]

Venture Debt

Some companies offer venture debt as an alternative to traditional commercial bank lending.[44] Venture debt has fewer restrictions, including minimum capital requirements and regulation-imposed covenants.[45]

Liquidity Exits

While an IPO has been the gold standard of a liquidity or exit opportunity, exits can also take the form of a merger with a special purpose acquisition company, a direct listing, a reverse merger, or a traditional merger or acquisition.[46] In 2023Q3, 126 companies went public through an IPO.[47]

Of course, this is not an exhaustive list of terms an entrepreneur should familiarize themselves with as they consider their capital raising strategy. We will continue to explore venture capital and capital raising topics on the Forum for Entrepreneurship & Law.

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[1] CBInsights, a leading market intelligence platform on private companies and investor activities, releases a quarterly report including global data and analysis on dealmaking, funding, and exits by private market venture companies. CBInsights, The State of Venture Q3’23 1, 11-13 (Oct. 2023), available at https://www.cbinsights.com/research/report/venture-trends-q3-2023/ [herein CBInsight Report]. [2] Id. [3] Id. at 83. [4] Id. at 15. [5] Id. [6] Id. at 34-35. [7] Mega rounds are funding rounds that raise over $100 million. Id. at 20. [8] Id. at 136. [9] Top equity Philadelphia, including Makatuu’s July 2023 round, raised $773 million in 2023Q3. Id. at 138. Stealth mode is used to describe a startup that is developing a product or establishing a company in secret until a public launch. See Stealth mode, PCMag Encyclopedia, https://www.pcmag.com/encyclopedia/term/stealth-mode (last visited Oct. 23, 2023). [10] Catherine Cote, Startup Incubator vs. Accelerator: Which Is Right For You?, Harvard Bus. Sch., https://online.hbs.edu/blog/post/startup-incubator-vs-accelerator (last visited Oct. 23, 2023). [11] Id. [12] Id. [13] Id. [14] Id. [15] Id. [16] What are the differences in friends and family, angel investors, and venture capital funds?, U.S. Sec. & Exch. Comm’n, https://www.sec.gov/education/capitalraising/building-blocks/investor-types (last visited Oct. 23, 2023) [herein SEC Investor Differences]. [17] Id. [18] Id. [19] Id. [20] VC fund is defined in Rule 203(I)-1 of the Investment Advisers Act of 1940. 17 C.F.R. § 275.203(l)-1 (2023). In future blog posts, we will explore VC funds in depth. [21] SEC Investor Differences, supra note 14. [22] Id. [23] CVC also excludes investments into internal new ventures. Henry Chesbrough, Making Sense of Corporate Venture Capital, Harvard Bus. R. (Mar. 2002), available at: https://hbr.org/2002/03/making-sense-of-corporate-venture-capital. [24] Id. [25] Private Equity Funds, Investor.gov, https://www.investor.gov/introduction-investing/investing-basics/investment-products/private-investment-funds/private-equity (last visited on Oct. 23, 2023). [26] Id. [27] Hedge Funds, Investor.gov, https://www.investor.gov/introduction-investing/investing-basics/investment-products/private-investment-funds/hedge-funds (last visited on Oct. 23, 2023). [28] SEC Investor Differences, supra note 14. [29] Seed Round, U.S. Sec. & Exch. Comm’n, https://www.sec.gov/education/glossary/jargon-z#SeedR (last visited Oct. 23, 2023). [30] Id. [31] Id. [32] The SEC has cautioned investors about the use of SAFEs. Investor Bulletin: Be Cautious of SAFEs in Crowdfunding, U.S. Sec. & Exch. Comm’n, https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_safes (last visited Oct. 23, 2023). [33] Series Rounds, U.S. Sec. & Exch. Comm’n, https://www.sec.gov/education/glossary/jargon-z#SeriesR (last visited Oct. 23, 2023). [34] Id. [35] Id. [36] Id. [37] Id. [38] Id. [39] See e.g., Charles J. Johnson, Joseph McLaughlin & Anna T. Pinedo, Corporate Finance and the Securities Laws 3-7 (6th ed. 2023 & Supp. 2022). [40] Convertible Note, U.S. Sec. & Exch. Comm’n, https://www.sec.gov/education/glossary/jargon-z#CN (last visited Oct. 23, 2023). [41] Id. [42] Preferred Stock, U.S. Sec. & Exch. Comm’n, https://www.sec.gov/education/glossary/jargon-z#PS (last visited Oct. 23, 2023). [43] Id. [44] Learn About Venture Debt, Hercules Capital, https://www.htgc.com/about/ (last visited Oct. 23, 2023). [45] Id. [46] See e.g., Johnson, supra note 34, at 3-8. [47] CBInsight Report, supra note 1.