Series B

What is a Series B?

Series B (second institutional funding round) denotes the equity round with which a company, after the Series A, expands a business model proven in the market on a larger scale. Whereas the Series A finances proof of market acceptance, the Series B serves to expand sales, organisation and markets many times over (scaling). Press reports also speak of Series B financing or, in English, Series B funding.

In a GmbH (German limited liability company), this round is also implemented through a capital increase. The investors receive shares of a further share class, that is, shares with their own preferential rights, which must be coordinated with the rights from the Series A. The parties involved are usually a new lead investor who leads the round, the existing investors, the founders and further shareholders. The shareholders' agreement, the contract of the shareholders among themselves, is usually restated. Because it is a contract, all contracting parties must in principle take part, unless it provides for amendment by majority resolution. An amendment to the articles of association requires a majority of three quarters of the votes cast and notarial authentication (Section 53 (2) of the German Limited Liability Companies Act, GmbHG).

Key figures for a Series B

A Series B presupposes that growth can be repeated with a justifiable use of funds. The focus is on the efficiency with which capital is converted into recurring revenue. The following key figures are in common use:

• Payback period of customer acquisition (CAC payback): the number of months until a new customer has earned back the cost of acquiring them (customer acquisition cost, CAC). The yardstick is their contribution margin, that is, their revenue less directly attributable costs.
• Ratio of customer value to acquisition cost (LTV/CAC): the contribution margin expected over the whole customer relationship (lifetime value, LTV) in relation to the acquisition cost. A benchmark of at least 3 to 1 is common.
• Revenue retention (net revenue retention): the revenue of existing customers after twelve months in relation to the starting revenue, including expansions and churn. Values above 100% mean that the customer base grows even without new customers.
• Capital efficiency (burn multiple): the net cash outflow of a period divided by the recurring revenue added. The lower the value, the less capital an additional euro of recurring revenue costs; values above 2 are often viewed critically.
• Sales efficiency (magic number): the increase in recurring revenue in a quarter, annualised and divided by the sales and marketing costs of the previous quarter.

In addition there are requirements for the organisation: a second management level, reliable monthly closings, planning whose deviations can be explained, and processes that can carry a rapidly growing workforce. There are no binding revenue thresholds. A company with high growth and weak efficiency often has a harder time in a Series B than one with moderate growth and good efficiency.

Use of funds and size of a Series B

Series B capital flows into scaling what was tested in the Series A. This includes expanding the sales organisation, entering further countries, additional products for existing customers, platform and infrastructure and, in part, first acquisitions. Round sizes in the German-speaking market often lie between EUR 15 million and EUR 50 million. The range is wide and depends on growth, the capital needs of the business model and market conditions.

In internationalisation, funding planning is closely tied to the legal structure: subsidiaries or branches abroad, employment relationships under foreign law, VAT and transfer pricing. Investors expect these costs to be included in the financial model and not to appear only after market entry.

Investors and documentation

Types of investor

The Series B is often led by a new lead investor who invests larger amounts per company than early-stage investors. These include growth funds, venture capital firms with multi-stage funds, corporate venture capital and international investors. The Series A investors usually take part proportionately through their subscription rights, that is, their right to take over new shares in line with their percentage. From the perspective of the other participants, a new, independent lead confirms the valuation from outside.

Relationship to the rights of earlier rounds

Because the Series B creates a further share class, the parties negotiate above all the relationship of the new rights to the existing ones:

• Ranking of preferences: The new liquidation preference ranks either ahead of the earlier ones (senior) or equally with them (pari passu). With equal ranking, proceeds that do not cover all preferences are distributed proportionately.
• Anti-dilution protection: If the price per share of the Series B is below that of the Series A (down round), the Series A investors receive additional shares depending on the clause. The new round therefore regulates whether and to what extent this protection is triggered.
• Consent rights: The question of which investor group can block which measure is often reorganised, usually through a majority of all investors rather than individual vetoes per round.
• Participation obligation: Clauses under which investors lose preferential rights if they do not take part in later rounds (pay-to-play) occur mainly in difficult market phases.
• Sale of existing shares: Part of the round can be structured as a sale of existing shares by founders or early investors (secondary sale). The purchase price then goes to the sellers, not to the company.

Focus of the review

The review by the investors (due diligence) is deeper and more number-based in a Series B than in a Series A:

• Cohorts and revenue quality: development of individual customer vintages, dependence on large customers, price development and share of recurring revenue.
• Sales organisation: productivity of sales staff, ramp-up times and accuracy of revenue forecasts.
• Finance function: monthly closings, reconciliation of plan and actual, tax position and quality of reporting to the shareholders.
• Technology and data protection: scalability of the platform, IT security, implementation of the General Data Protection Regulation (GDPR) and dependence on third-party providers.
• Legal: material contracts with termination and change of control clauses, employment law for a growing workforce and the company law history.

Worked example: efficiency key figures before a Series B

A software company raises its ARR from EUR 8 million to EUR 14 million within a year. In the same year, sales and marketing costs are EUR 6 million and net cash outflow is EUR 9 million. 200 new customers were won with an average of EUR 24,000 of ARR, and gross margin is 75%. Among existing customers, EUR 1.2 million of ARR was lost through churn, and expansions brought EUR 2.4 million.

• New ARR from new customers: 200 × EUR 24,000 = EUR 4.8 million
• Revenue retention: (8.0 + 2.4 minus 1.2) / 8.0 = 9.2 / 8.0 = 115%
• Check: 9.2 + 4.8 = EUR 14.0 million of ARR at year end
• Acquisition cost per new customer, simplified with all sales and marketing costs: EUR 6 million / 200 = EUR 30,000
• Contribution margin per new customer: EUR 24,000 × 75% = EUR 18,000 a year, that is, EUR 1,500 a month
• Payback period: EUR 30,000 / EUR 1,500 = 20 months
• Customer value at annual churn of 15% (1.2 of EUR 8.0 million): EUR 18,000 / 0.15 = EUR 120,000; LTV/CAC = 120,000 / 30,000 = 4 to 1
• Capital efficiency: EUR 9 million net cash outflow / EUR 6 million additional ARR = 1.5

Revenue retention and customer value speak for the model. An investor will, however, question the payback period of 20 months, because it ties up a lot of capital per new customer. Series B capital can be deployed more effectively above all if this period falls, for example through higher prices, shorter sales cycles or a larger share of expansion revenue.

Distinctions: Series A, Series B, Series C and venture debt

• Series A: finances proof that customers can be won repeatably. The Series B presupposes this proof and finances scaling.
• Series C: serves to expand an already strong market position, often with a view to profitability, acquisitions and a later sale or stock market flotation (exit).
• Venture debt: debt capital that is often taken up in addition to an equity round. It hardly dilutes but must bear interest and be repaid.

Common mistakes

• Growth without proof of efficiency. Anyone who presents only revenue growth, without evidencing acquisition costs, revenue retention and capital efficiency, leaves the interpretation of the figures to the investor.
• Finance function behind growth. If reliable monthly closings and explainable planning are missing, the review lengthens and forecasts lose credibility.
• Ranking of preferences underestimated. A senior preference for the new round can considerably reduce the share of earlier investors and the founders at moderate sale proceeds.
• Internationalisation without a structure budget. Costs for foreign companies, local staff and tax advice are missing from the financial model and shorten the runway.
• Share sale without coordination. A sale of founder shares that is not coordinated with the lead investor and existing investors can trigger pre-emption rights and call the round's price per share into question.

Frequently asked questions

When is the right time for a Series B?

When the milestones from the Series A have been reached and runway is still at least twelve months. In practice, around two years often lie between the two rounds.

How large is a Series B usually?

In the German-speaking market often EUR 15 million to EUR 50 million. The amount is sized by how much capital the company needs to reach the key figures of a Series C or break-even; part of the round can go to the purchase of existing shares.

Can founders sell shares in a Series B?

Yes, to a limited extent this is common, usually with the investors' consent and often at a price below that of the new shares. If a founder with a holding of at least 1% holds the shares as private assets, the gain is subject under Section 17 of the German Income Tax Act (EStG) to the partial income method (Teileinkünfteverfahren), under which 60% of the gain is taxable. For shares held by a corporation, 95% of the gain remains tax-free under Section 8b of the German Corporation Tax Act (KStG).

How much are existing shareholders diluted in a Series B?

Often by 10% to 20% on a fully diluted basis, that is, including all committed future shares. What is decisive is the ratio of round size to post-money valuation, plus any topping up of the employee pool.

Does the shareholders' agreement have to be renegotiated?

As a rule yes. The new lead investor accedes; preferences, consent rights and transfer rules are adjusted to the new class. Because all contracting parties must take part, coordination with the existing investors sensibly begins already in the term sheet phase.

Is venture debt an alternative to a Series B?

Rather a supplement. Venture debt can extend runway between two rounds or top up an equity round, but usually presupposes a recently completed equity round and predictable revenue.

The Roemer Capital view

In Series B mandates, Roemer Capital's focus is on the efficiency key figures, because in this round they determine valuation and investor group. Roemer Capital calculates customer value, acquisition costs, payback period and capital efficiency from the company's raw data and reconciles them with the financial model before investors do. Its benchmarks are an LTV/CAC ratio of at least 3 to 1 and a payback of acquisition costs in less than 12 months.

The second task is the structure. Roemer Capital models how new and existing preferences interact at different sale prices and coordinates the alignment with the existing investors. It prepares a sale of founder shares within the round economically; the tax structuring lies with the client's tax adviser.