Series C

What is a Series C?

Series C (third institutional funding round) denotes the equity round with which a company with an established market position and substantial revenue finances its further growth. The capital serves, for example, international expansion, acquisitions or the preparation of a company sale or stock market flotation (exit). In English it is also called Series C funding or Series C round. Follow-on rounds are called Series D, E and so on and follow the same logic.

The Series C follows on from the Series B. The investor group becomes broader: alongside venture capital firms, growth investors take part who otherwise tend to finance mature companies. In a GmbH (German limited liability company), the round continues to be implemented through a capital increase. If an IPO is planned, the company must first change to a legal form suitable for listing. As a rule, this is done by a change of legal form (Formwechsel) into a stock corporation (Aktiengesellschaft, AG) under Sections 190 et seq. of the German Reorganisation Act (UmwG). The Series C contracts therefore often already regulate the cooperation of all shareholders in this step.

Maturity and key figures in a Series C

Series C investors value the company less on its potential than on its predictability. What is expected is reliable revenue, a credible path to profitability or already positive results, and an organisation that works without the constant involvement of the founders. The focus is on:

• Size and predictability: revenue level, growth rate, share of contractually secured revenue and the accuracy of earlier plans.
• Profitability: gross margin, profit margin and the point at which operating profit turns positive. A common rule of thumb is that growth rate and profit margin together should reach at least 40% (Rule of 40).
• Capital efficiency: development of free cash flow, that is, the cash surplus after investments, and the question of whether the company reaches break-even with the round.
• Market position: share in the core segments, pricing power and distance from competitors.

Requirements for corporate governance also rise. If the company is no longer a small corporation by balance sheet total, revenue and headcount (Section 267 of the German Commercial Code, HGB), its annual financial statements must be audited by a statutory auditor under Section 316 (1) HGB. Investors expect a complete management team with an experienced finance head, an internal control system and reporting that matches that of a larger company in scope and speed.

Use of funds, round size and valuation

Series C capital typically finances entry into further regions, acquisitions of competitors or complementary providers (buy-and-build), additional product areas and a strengthening of the balance sheet before an exit. In addition there is the rising need for working capital, that is, funds tied up in ongoing business, for example in inventories and receivables. The round often contains a secondary component through which early shareholders and employees sell part of their shares.

Series C rounds in the German-speaking market often range between EUR 30 million and EUR 100 million; larger rounds are the exception. The valuation relies more heavily than in earlier rounds on revenue and earnings multiples of listed comparable companies and on transactions in the same industry. Such multiples first yield the value of the operating business (enterprise value). The pre-money valuation as the value of the shares follows from this only after deduction of financial debt and addition of liquid funds (equity bridge). Because companies at this stage have often taken up bank loans or venture debt, this step is no longer merely a formality.

Investors and structure of the round

Types of investor

Typical investors are venture capital firms with late-stage funds, growth funds and private equity firms that take minority holdings. Crossover investors, who invest both in unlisted and in listed companies, sovereign wealth funds, large family offices and strategic investors also take part. They bring different return targets and different requirements for reporting and exit perspective than early-stage investors.

Structure and documentation

• Preferential rights: The new liquidation preference, that is, priority in the distribution of sale proceeds, often ranks ahead of the earlier ones. A high valuation is sometimes secured through additional structure, for example a higher preference multiple. A further means is the IPO ratchet (after initial public offering): if the IPO takes place below a fixed price, the investor receives additional shares.
• Exit provisions: minimum proceeds below which a drag-along obligation cannot be enforced against the new investors, time windows for an exit and rights in case it does not happen.
• Stock-market-related provisions: duties to cooperate in the change of legal form, the lapse of preferential rights on an IPO and holding periods afterwards (lock-up).
• Regulatory clearances: If an investor reaches 25% of the capital or the voting rights, a concentration under Section 37 (1) no. 3 of the German Act against Restraints of Competition (GWB) may exist, which must be notified if the turnover thresholds are met. For foreign investors, above all from outside the EU, a state review of the direct investment (investment screening) may be added.

Due diligence in a Series C

The review by the investors (due diligence) in a Series C approaches the review before a company purchase in depth and scope. Financial due diligence examines the quality of earnings. This includes one-off effects, adjustments (adjusted EBITDA, earnings before interest, taxes, depreciation and amortisation excluding special items) and the reconciliation from earnings to cash flow.

The tax review addresses transfer pricing, VAT abroad and the payroll tax treatment of employee participation. Legally, change of control clauses, competition and data protection law and the compliance system are in the foreground. For a planned stock market listing, there is the additional question of how quickly consolidated financial statements, controls and reporting can be switched to the requirements of the capital market. This includes international accounting under IFRS (International Financial Reporting Standards).

Worked example: Series C with capital increase and share purchase

A GmbH with 200,000 shares on a fully diluted basis, that is, including virtual shares and other commitments, completes a Series C of EUR 40 million. EUR 30 million flows into the company as a capital increase, at a price of EUR 500 per new share. With a further EUR 10 million, the investor buys shares from early business angels, which carry no liquidation preference, at a discount of 20%, at EUR 400 per share.

• Pre-money valuation: 200,000 × EUR 500 = EUR 100 million
• New shares: EUR 30 million / EUR 500 = 60,000, of which EUR 1 nominal value per share goes into share capital and EUR 499 of additional payment into the capital reserve, together EUR 60,000 of share capital and EUR 29.94 million of reserve
• Post-money valuation: 260,000 × EUR 500 = EUR 130 million
• Existing shares purchased: EUR 10 million / EUR 400 = 25,000
• Investor's percentage: (60,000 + 25,000) / 260,000 = about 32.69%, of which about 23.08% from the capital increase
• Previous shareholders: (200,000 minus 25,000) / 260,000 = about 67.31%
• Inflow of funds: EUR 30 million to the company, EUR 10 million to the selling business angels

The secondary component raises the investor's percentage but brings the company no liquidity. What is decisive for the valuation is the price of the new shares. The lower price of the existing shares is not usually understood as a new valuation but should be expressly justified in the term sheet by the absence of preferential rights. The transfer of the existing shares requires notarial authentication under Section 15 (3) of the German Limited Liability Companies Act (GmbHG).

Distinctions: Series B, pre-IPO round, trade sale and secondary sale

• Series B: finances scaling of a proven model. The Series C presupposes an established market position and is directed more at profitability and exit perspective.
• Pre-IPO round: the last private round immediately before an IPO, often with crossover investors and detailed provisions on the IPO.
• Trade sale: the sale of the company to a strategic buyer with a change of control. A Series C, by contrast, is a minority holding, even if it can prepare such a sale.
• Secondary sale: the sale of existing shares, which can take place as part of a Series C or on its own.

Common mistakes

• Valuation bought through structure. A high nominal valuation with senior preference, increased multiple or IPO ratchet can be less favourable for the existing shareholders than a lower valuation without these rights. This becomes visible only in a waterfall analysis.
• Capital market readiness tackled too late. Change of legal form, switching accounting and internal controls need lead time and cannot be pushed into the weeks before an IPO.
• Fragmented shareholder structure. Many small holders make resolutions, authentications and a later sale harder; consolidating through a pooling agreement or a joint holding company is easier before the round than after.
• Clearances not planned. Merger control or investment screening can delay completion by weeks or months if they are recognised only after authentication.
• Secondary component without clear rules. Open questions on the circle of sellers, price and allocation lead to conflicts among the existing shareholders and delay the round.

Frequently asked questions

Is the Series C the last round before the exit?

Not necessarily. Many companies complete further rounds before a sale or IPO is possible. The Series C is, however, often the first round whose terms are expressly geared towards an exit within a foreseeable period.

Must the GmbH be converted into an AG before a Series C?

No. The change of legal form is necessary only for an IPO. Some companies carry it out earlier so as not to place the changeover in the IPO preparation phase.

What is a crossover investor?

An investor that invests both in unlisted and in listed companies. Its participation in a late round is regarded as an indication of possible IPO readiness, because it values the company by capital market standards.

How does a Series C affect the preferences of earlier rounds?

With a senior preference, the new investors are served first on a sale. This matters above all at moderate proceeds; at high proceeds the ranking loses significance, because the investors then choose their pro rata share anyway.

How large is a Series C round?

In the German-speaking market often EUR 30 million to EUR 100 million; larger rounds are the exception. Part of the amount often goes to the purchase of existing shares of early shareholders and brings the company no capital.

The Roemer Capital view

Roemer Capital accompanies Series C rounds up to a round size of EUR 100 million. Two calculations are at the centre: the distribution of proceeds across all preference layers at different sale prices, and the valuation that a later buyer or the capital market must support. Only both together show whether the round works out for the existing shareholders. A high nominal valuation that is achievable only through additional preferential rights is expressly compared by Roemer Capital with a lower valuation without those rights.

Because a Series C often prepares a sale, Roemer Capital builds the data room, the financial model with a base case, a cautious case and an optimistic case, and adjusted earnings figures so that they also withstand a later sale process. The change of legal form, the merger control and the investment screening are implemented by the company's law firm; Roemer Capital coordinates the timetable and the parties.