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.
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
Seed Capital Funds
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.
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
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
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
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
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.