The Series B and C Funding Rounds and SEC Requirements

Updated: Apr 23

Part 5 of a series about raising funds for startups: Series B and C rounds and SEC requirements for fundraising.

In the past, we’ve written about the five rounds of funding a startup goes through if it thrives. They are the family and friends round, the seed round, and the Series A round. As the final installment of our series on fundraising, we will consider the Series B and C rounds. We write about them together because they have similarities in how they are constructed.

Progression of Quirky Produce Inc. to Series B

For the Series A round, we used the example of Quirky Produce Inc., a Delaware c corporation formed to purchase and sell “ugly” produce, or in other words, misshapen vegetables that restaurants and grocers would not buy. Anaya and Liam, the owners of Quirky Produce, completed their Series A round. In exchange for $2,500,000 in equity, and after converting two SAFE notes into stock, Quirky Produce issued 5,780,000 shares of preferred stock valued at $0.50 per share.

At this point, Quirky Produce has become an established company. Anaya and Liam want to build the business. They plan to raise another $7,500,000 in a Series B round. Afterward, if the company continues to be successful, Anaya and Liam plan on a final round of fundraising, the Series C round, after which they dream of going public with their “ugly” produce idea.

The mechanisms for fundraising are much the same as for the Series A round. As with the Series A round, investors usually want to have preferred stock so that they will have a stable rate of return and be paid ahead of the common stockholders if for some reason Quirky Produce should fail. Investors also commonly want the preferred stock to be convertible into common stock. Anaya and Liam, as the founders of Quirky Produce, are the only common shareholders at this point. In the Series A round, they attracted three venture capital firms that now have preferred stock. Anaya and Liam return to that well for Series B and find that all three firms want in on the next round, at $2,500,000 each.

Securities Registration Exemptions

One of the things Anaya and Liam must do is either register their securities offering with the SEC or invoke an exemption to registration. They had to do this in their Series A round, too, but we focused on the importance of the capitalization table instead.

We’ve previously written about the various Securities Exchange Act exemptions in Regulation D. Anaya and Liam cannot use the Rule 504 exemption for their Series B round because they plan to raise more than $5,000,000 over a twelve-month period. Of the two Rule 506 exemptions, Anaya and Liam will reject Rule 506(c) because it requires them to take reasonable steps to make sure that the investors who claim to be “accredited” in fact are accredited. They settle on Rule 506(b).

Rule 506(b) allows for the sale of securities without registration provided that certain requirements are met. Among other requirements, general solicitation or advertising of the security is forbidden. There may be an unlimited number of “accredited investors,” but no more than thirty-five unaccredited investors who must be sophisticated investors.

Information Required by the SEC for Series Rounds

When a company offers securities exempt from registration with the SEC, it must file an SEC Form D with the SEC that provides some basic information about the prospective investment. The form asks for some background information such as the name of the company, the state in which organized, the type of entity, the company’s principal place of business, and so forth. But then we get to the heart of the form:

One of the sections is called “related persons.” These are the officers and directors of the corporation and any person who has been a promoter of the issuer over the prior five years. This information is important for a potential investor because investors want to know who they are dealing with in any round, no matter the series.
The particular exemption the company will claim.
Whether the offering is intended to last more than one year.
The types of securities the that will be offered. These securities can include equity, debt, warrant, pooled funds, and so forth.
Whether there is a minimum investment.
The number of unaccredited investors who already have invested, along with the total number of all prior investors.

All this information is intended to help prevent the types of widespread securities fraud and insider trading that resulted in the passage of the Securities Exchange Act of 1933, following Wall Street’s 1929 collapse.

Moving On With Series B

Form D must be filed for each new offering of securities not later than fifteen calendar days of the date of first sale of the securities. But Anaya and Liam are cautious, so they file their Form D with required attachments before actually accepting money from their investors and issuing them preferred stock. Then, they put the money to work, expanding Quirky Produce’s area of operations and anticipating an eventual Series C offering and then going public.

Read about Carpenter Wellington’s startup legal services for entrepreneurs.