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Stages of Firm Development and Venture Funding |
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by Ten3 East-West. See also slide presentation on the Venture Financing Chain
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Initial Funding | |
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Pre-seed Stage |
A relatively small amount of capital is provided to an investor or entrepreneur to prove a specific concept for a potentially profitable business opportunity that still has to be developed and proven. The funded work may involve product development (as opposed to "pure" research), but it rarely involves initial marketing. |
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Seed Stage |
Financing is provided to newly formed companies for use in completing product development and in initial marketing. These companies may be in the process of being organized or may have been in business a short time. In either case, products have yet to be sold commercially. Generally, such businesses have assembled key management, have prepared their initial business plan, and have conducted at least initial market studies. |
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Early Stage (First Stage) |
Financing is provided to companies that have expended their initial capital and now require funds to initiate commercial-scale manufacturing and sales. |
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Growth & Expansion Funding | |
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Second Stage |
Working capital is provided for the expansion of a company which is producing and shipping products and which needs to support growing accounts receivable and inventories. Although the company clearly has made progress, it may not yet be showing a profit at this stage. |
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Third Stage |
Funds are provided for the major expansion of a company which has increasing sales volume and which is breaking even or which has achieved initial profitability. Funds are utilized for further plant expansion, marketing, and working capital or for development of an improved product, a new technology, or an expanded product line. |
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Bridge Financing (also Later Stage or Expansion Stage ) |
The firm is mature and profitable, and often still expanding. Financing is provided for a company expected to "go public" within six months to a year. Often bridge financing is structured so that it can be repaid from the proceeds of a public offering. Bridge financing also can involve restructuring of major stockholder positions through secondary transactions. This is done if there are early investors who want to reduce or liquidate their positions. This also might be done following a management change so that the ownership of former management (and relatives or associates) can be purchased prior to the company's going public. |
Source: partially adapted from Blue Rock Capital
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VC Secrets: Stages of Venture Capital
By William F.(Bill) McCready, CEO/Founder, Venture Planning Associates, Inc. Used by permission.
Each phase of business or project development has different capital requirements. While most companies do not seek outside financing at every stage in their growth, early-stage financing, expansion financing, and acquisition/buyout financing exist for all stages.
Besides indicating the type
of investment they prefer, you will find that many Venture Capital firms also
specify the stage of financing needed. In general, the later the stage of the
company, the smaller the risk for the Venture Capital firm. Therefore, Venture
Capital firms that invest in later-stage companies must pay a higher valuation
for their equity positions. Typically, venture capital firms expect to achieve a
return on their investment in start-ups within four to seven years, and, in
established companies, within two to four years.
EARLY-STAGE
FINANCING
Early-stage financing is an initial infusion
of capital provided to entrepreneurs with little more than a concept. These
funds are used to conduct both market research and product development. Once
research and development are underway, and the core management team is in place,
start-up financing can be obtained to recruit a quality management team, to buy
additional equipment, and to begin a marketing campaign.
First-stage financing enables a company to
initiate a full-scale manufacturing and sales process to launch the product in
the market.
SEED CAPITAL FUNDS
Seed capital funds invest in the earliest
stage companies, and generally expect to have only about 20% succeed to a second
round of financing. This second round will usually be a hand-off to another
fund, or syndication of funds, that now takes the lead on this investment. As a
result, a Seed Capital Fund will almost always demand a very high percentage of
the business, do stage investments with milestones, and insist upon proactive
directors and officers of its choice.
EXPANSION FINANCING
Second-stage financing facilitates the
expansion of companies that are already selling product. At this stage, a
company may raise between $1 to $10 million to recruit more members to the
sales, marketing, and engineering teams. Because many of these companies are not
yet profitable, they often use the capital infusion to cover their negative cash
flow.
Third-stage or
mezzanine financing, if necessary, enables major expansion of the
company, including plant expansion, additional marketing, and the development of
additional product(s). At the time of this round, the company is usually at
break-even or profitable.
IPO (INITIAL PUBLIC
OFFERING)
The final step for a successful company is going public, referred to as
Initial Public Offering, or
IPO. Once a company goes public, the Venture
Capital firm realizes a great deal of value from its initial investment. For
example, if, over the course of several rounds of financing, the Venture Capital
firm has bought 40% of a company for $6 million, and if the company achieves a
public market capitalization of $150 million, then the value of the Venture
Capital firm's investment has grown to $60 million. This provides the firm with
a tenfold return on its investment.
ACQUISITION AND
BUYOUT FINANCING ACQUISITION
Acquisition financing provides the necessary
funds to acquire Another company. Management/leveraged buyout financing assists
management's purchase of a product line or business from another public or
private company. In buyout situations, a key area of consideration for the
Venture Capital firm is its confidence in the management team's ability to
assimilate the assets of the two merging entities.
EXIT THROUGH
BEING ACQUIRED
For many venture backed companies that do not look like a 'home run' or do not
look able to sustain their advantage on their own, they become the merger
candidate. There are many advantages to this exit strategy that are not
immediately obvious.
First, running a public versus a private company is completely different. You
may not be prepared for the changes necessary and may need to be replaced by a
new management team.
Second, there can be significant advantages and cost savings by doing a stock
swap with an already public company. Tax savings, liquidity and handing off the
burden of continued fund raising are just a few.
