How venture rounds work: from first check to exit

Every startup that takes outside money passes through the same legal gate before anything else. The company must sell its securities either under a registration or under an SEC-listed exemption¹. The stages, the paper and the exits all sit on that one rule.

To keep the mechanics concrete, this story follows Lantern, a made-up software company, from its first check to a sale. Lantern’s figures are round numbers the editors chose, and every table built on them is marked as our own arithmetic. The page belongs to fundraising mechanics and is education, not a recommendation to raise money.

The rule underneath every round

Every offer and sale of securities must be registered under the Securities Act of 1933 or rely on an exemption from registration^{1, 5}. That sounds abstract until you see how little the market’s vocabulary matters to it.

The industry names rounds by investor type or letter, but the federal securities laws do not differentiate in the same way.⁵

Whether Lantern’s first outside check is called friends and family, angel, seed or Series A, the company still has to fit the deal inside an offering exemption if it wants to avoid registering it⁴. The category that counts is the exemption, and the one used most often is Rule 506(b) of Regulation D⁵.

Friends and family, then angels

Lantern’s founders start where most founders do: their own savings, then people who already know them⁴. Because the relationship is close, the founders should spell out the risks, including what happens if the company fails⁴. These deals join at pre-seed or seed and run the smallest of any stage, around $10,000 to $50,000, as loans, convertible debt or equity⁴. The pre-seed round is the earliest infusion of capital, used to launch the company, build a prototype and look for early product-market fit¹¹.

Angels come next. They are high-net-worth individuals investing their own money directly in emerging businesses, and they tend to syndicate, pooling $200,000 to $400,000 per deal. In 2024 they put over $17.9 billion into early-stage companies⁴. Equity crowdfunding is also emerging as an option at this stage¹².

The seed round: notes, SAFEs and the first priced deal

Seed is often the first formal equity round with an institutional lead, and it takes one of two shapes. It can be priced, with investors buying preferred stock at a valuation the lead sets. Or it can be a convertible note or a simple agreement for future equity that converts later¹¹. A company this young is hard to value, so founders at this point usually want to postpone that argument, and the second shape lets them.

Convertible notes

A convertible note is a loan that can convert into a different security³. Seed investors use it often because a young company is hard to value and the note puts that argument off. Typically the note converts from debt into preferred stock automatically when the next funding round closes, or on other agreed conditions³.

SAFEs

A SAFE is a short contract. The investor funds the startup now in exchange for the right to shares later, and the SAFE converts automatically when the startup raises a priced round⁹. Until that trigger the holder owns no part of the company, and unlike a note a SAFE usually carries no valuation at issue, so the company defers that arithmetic³.

On Y Combinator’s standard form one term is usually left to negotiate: the valuation cap, the highest valuation at which the SAFE converts into shares⁹. The ownership the company sells equals the investment divided by the cap. Y Combinator’s example is a $1M raise for 15% ownership, which gives a post-money cap of $1M ÷ 15% = ~$6.7M⁹. The discount is the second lever. With a 20% discount, SAFE investors pay 20% less than the new investors do in the priced round⁹. The post-money SAFE has been the Y Combinator standard since 2018⁹.

SAFE or note: where the arithmetic differs

The difference that matters is debt. A convertible note is debt: interest accrues and the note has a maturity date set for repayment or forced conversion⁹. A SAFE is not debt, has no interest or maturity date, and is therefore simpler, faster and cheaper to sign⁹. The conversion math follows from that. A note converts what the investor lent plus the interest that built up, while a SAFE converts only what went in. Discounts are commonly 10–20%¹⁷.

Say a friend lends Lantern (our made-up company) $100,000 on a note at 8% simple interest, and a year later the next round prices shares at $1.00 with a 20% discount for the note holder.

Our arithmetic: Lantern’s note at conversion (discount rule from⁹)

When a cap and a discount both apply

Many SAFEs carry both, and whichever calculation is most advantageous to the investor applies¹⁶. The cap becomes a price per share, the Safe Price, which is the valuation cap divided by the Company Capitalization¹⁶. The investor then takes the lower of that price and the discounted round price, because a lower price buys more shares.

Suppose Lantern had raised $500,000 on a SAFE with a $9M cap and a 20% discount instead. We hold capitalization at 10,000,000 shares to keep the arithmetic readable. A real conversion also counts the SAFEs, the options and the pool, so read the result as a sketch. The table runs that one SAFE through a modest round and a hot one.

Our arithmetic: one SAFE, two rounds (cap and discount rule from¹⁶)

A modest round makes the discount do the work, and a hot round makes the cap do it.

How a round runs, step by step

Seed money buys time. When Lantern is ready for a bigger, priced round, a lead investor sets the pace: usually the best-known or most aggressive venture firm in the round, or the one writing the largest check¹¹. From there the round follows a familiar sequence.

1. Introduction and offering. Investors and companies find each other through networks and warm referrals, because no public exchange lists these securities¹¹.
2. Term sheet. The parties agree the main terms and sign a term sheet as an expression of commitment¹¹.
3. Definitive documents. Lawyers negotiate and draft the contracts that carry out the deal¹¹.
4. Due diligence. The investors examine the financial statements, books and records, and every aspect of operations¹¹.
5. Closing. Investors fund and the company issues shares. Some deals come in tranches, with the rest of the money released when the company hits agreed milestones¹¹.

Diligence can end in homework: investors may require fixes before they agree, such as new employment contracts or vesting schedules for key executives. At closing the company gives representations and warranties about the accuracy of its disclosures, and any outstanding convertible notes may convert at or after the close¹¹.

Nobody drafts the documents from scratch. The NVCA Model Legal Documents are the industry-embraced starting point for venture financings, covering the Certificate of Incorporation, Stock Purchase Agreement, Investors’ Rights Agreement, Voting Agreement and Right of First Refusal and Co-Sale Agreement¹⁰. The updated set adds mechanics for tranched financings, and the NVCA itself calls each document a starting point only, to be tailored to the deal¹⁰.

Other securities on the cap table

A round is not the only way shares get issued. Startups also grant options and restricted stock to employees, and an LLC has membership interests instead of shares³. Options get their own treatment in the equity and finance team section, starting with startup stock options, including how the strike price is set. Debt can count as a security too, depending on its type³.

Series A funding: from pre-seed to the first priced round

A priced equity round is often called Series A, and each later round takes the next letter¹¹. It is the first institutional venture round meant to fund growth, and together with seed it makes up early-stage funding, which companies use to find product-market fit¹².

Valuations have not just recovered from the 2022-to-2023 correction; they have pushed past their 2021 highs¹³. The median pre-money valuation more than doubled relative to 2021 at pre-seed, seed and Series D+¹³. Treat that as a reading of the market from one report, as of June 30, 2026, and not as a target. The post-money valuation is usually the highest mark in the round and is not the price every investor pays¹³.

This is also where the paper changes character. In the stock purchase agreement, investors exchange money for newly created preferred stock¹¹. Founders usually hold common stock and outside investors hold preferred, and the two classes carry different voting and economic rights³. Because of regulatory requirements, most venture capital investments are structured as equity such as preferred stock⁴.

Pre-money, post-money and dilution: one round worked through

Every priced round starts with two valuations. A pre-money valuation is the value of the company immediately before it receives the investment, and a post-money valuation is the value immediately after⁹. The two differ by exactly the new money.

Y Combinator shows the link with a SAFE. A target of a $1M raise for 15% ownership gives a post-money cap of about $6.7M, which it writes as “$1M at $6.7M post / $5.7M pre”⁹. Raise less on that cap and you sell less: $500k on a $6.7M post-money cap is about 7.5%, and $1M is about 15%⁹.

Lantern’s Series A lead offers $2,000,000 at an $8,000,000 pre-money valuation. The question is what the lead owns afterwards and what the existing holders keep.

Our arithmetic: Lantern’s Series A (pre- and post-money definitions from⁹)

Nobody lost value in the swap. The people who held the company before gave up a fifth of the ownership in exchange for cash in the bank, and that give-up is dilution.

Early investors usually want to keep their stake in the next round. Pro rata rights let an investor put money into a future equity financing to keep their ownership percentage from shrinking⁹.

The option pool shuffle

An option pool is a block of shares reserved for future hires. When a round creates the pool at the same moment it brings in the investor, someone has to decide whose stake pays for it. Y Combinator’s SAFE draws the line like this: the post-money cap counts the options and pool that exist before the equity financing, and does not count the new or increased pool adopted as part of it⁹. In plain terms a pool created inside the round dilutes the people who held stock before it, and the new investor does not share the cost.

Now suppose Lantern’s lead asks for a 10% pool, sized on the post-money company and set up before the money goes in. The founders feel it immediately.

Our arithmetic: Lantern’s pool (pool rule from⁹)

What preferred stock gives investors

Four terms decide most of what an investor receives beyond shares, and the NVCA model Certificate of Incorporation and Voting Agreement show how each is written.

The first is the liquidation preference. Preferred holders are paid before any payment to common holders, in an amount per share equal to the greater of a multiple of the original issue price plus declared dividends, or what they would get had they converted to common¹⁴. In a sale at a low price, that can leave little or nothing for common holders. The second is participation. Where preferred is participating, holders take the multiple of the original issue price first and then share what remains pro rata with common as if converted¹⁴. The investor is paid twice, so more of a sale goes to preferred.

The third is anti-dilution protection. If the company later sells stock below the series’ conversion price, the conversion price is reduced by a formula¹⁴, and a down round shifts ownership toward the earlier investors. The fourth is governance: the holders of the preferred stock, as a separate class, elect a preferred director¹⁵. Investors taking part in governance is normal for VC funds, often as a seat on the board or advisory board⁴.

The preference at three sale prices

Say a fund put $10M into Lantern’s Series A for 25% of the company, in preferred stock with a 1x preference. Three exits are on the table: $5M, $30M and $60M. The table shows who gets what under each preference type.

Our arithmetic: three sales of Lantern (preference terms from¹⁴)

In the middle row the non-participating fund keeps its preference, because converting to common would pay it less. In the bottom row converting pays more, so it converts. The participating fund takes its preference first and then its share of what is left, so it collects more in every sale above the preference.

Broad-based weighted-average anti-dilution

In a down round the earlier investors’ conversion price falls in proportion to how many cheap shares were sold. The NVCA charter offers a broad-based weighted-average formula, and full ratchet as the alternative a term sheet may call for¹⁴. In the weighted-average version the conversion price after a lower-priced issue is CP2 = CP1 × (A + B) ÷ (A + C), where CP1 is the price in effect before, A is the common stock outstanding on a fully diluted basis, B is the number of shares the new money would have bought at CP1, and C is the number of shares actually issued¹⁴.

Two years later Lantern stumbles and has to raise at a lower price than the Series A paid. It sells 2,000,000 new shares at $0.50 for $1,000,000, and the Series A converts at $1.00 with 10,000,000 shares outstanding on that basis.

Our arithmetic: Lantern’s down round (formula from¹⁴)

The gap between those two share counts is why founders negotiate this term.

Who is allowed to invest

Many exemptions limit participation to accredited investors or restrict non-accredited ones⁷. For an individual, one route is financial: a net worth over $1 million excluding the primary residence, or income over $200,000 (or $300,000 with a spouse or partner) in each of the prior two years with the same expected this year⁷. Directors and executive officers of the company selling the securities also qualify⁷.

Under Rule 506(b) a company can raise an unlimited amount from an unlimited number of accredited investors, with two limits: no general solicitation, and no sales to more than 35 non-accredited investors in any 90-calendar day period². Rule 506(c) permits general solicitation where every purchaser is accredited and the issuer takes reasonable steps to verify it¹. Rule 504 allows up to $10 million of securities in a 12-month period¹.

After the first sale the company files a notice on Form D within 15 days, with no filing fee, and state regulators can still require their own notices and fees^{1, 2}. One ineligible purchaser can taint the round: if a company offers securities to even one person who does not meet the conditions, the entire offering may violate the Securities Act².

Round names you will meet

Venture rounds are named after the class of stock being sold¹¹. A letter with a prime mark, such as Series A’, is a small follow-on or bridge round folded into the one before, generally on the same terms. Series AA was once used for a new start after a crunch-down or down round. A pre-IPO round is a late-stage equity round that raises money ahead of a listing, and mezzanine rounds, bridge loans and other debt carry a company between venture rounds or up to its IPO¹¹.

Round count is itself a signal. Investors can worry when a company has raised too much in too many rounds, since it can look like delayed progress¹¹.

Stage by stage

Later rounds: Series B, C and growth capital

Once a company has found product-market fit it uses growth capital to scale, which typically means Series B, Series C and later rounds¹². Investors at this point may expect operational oversight, one or more board seats and a bigger say in strategy⁵.

VC funds invest across the life cycle, from Series A through the public offering, and many invest repeatedly in the same companies⁴. A fund is typically built to last at least ten years, with the first few years spent investing⁴. Venture investment grew from approximately $164 billion in 2023 to approximately $215 billion in 2024, and those investments are generally locked in until a liquidity event⁴. Bridge financing is funding a startup seeks between full VC rounds¹².

Before a later round the company weighs how much to raise, what securities to offer, how many board seats to give and which existing owners will be diluted⁵. An employee equity plan belongs on that list, because securities issued under it dilute owners as well⁵.

Exits: how the story ends

Securities of a private company can be resold to another investor only if the resale is registered or fits an exemption, such as the Rule 144 safe harbor⁶. That is why exits matter: they are how illiquid shares become cash.

For Lantern there are three endings. A public offering is one: a startup can list through an IPO, a merger with a special purpose acquisition company or a direct listing, and some investors’ shares may be subject to a lockup that delays selling⁶. To go public the company must file a registration statement and may not sell until the SEC staff declares it effective, after which the company is subject to Exchange Act reporting⁸. A sale is another: a startup can sell to another company or investor⁶. The third is the one nobody plans. If a company shuts down it sells its assets and returns what is left to shareholders in order of liquidation preference⁶, and that is where the preference clauses above do their work.

Common mistakes in reading a round

Five mistakes come up again and again. One is reading round names as law, when the securities laws care about which exemption the deal fits and not whether it is called seed or Series A^{4, 5}. Another is treating a SAFE as equity, although the holder owns nothing until a triggering event converts it³. A third is treating the term sheet as the finished deal, when the definitive documents carry many important details beyond the major deal terms¹¹. A fourth is copying model documents unchanged, although the NVCA calls them a starting point only¹⁰. The fifth is missing the notice filings: Form D is due within 15 days of the first sale, and states can add their own².

None of this replaces a securities lawyer. A lawyer applies these rules to a specific company, which this page cannot do.