Understanding the Venture Capital Stages

Successful venture capital funding is a process of reducing perceived risk to the lowest possible level. The funding source has fiduciary responsibility to its investors (business angels and venture capitalists). The requirements of funds vary with the life cycle stage of the enterprise and terms of investing. Many VC firms are very strict about providing money to potentially big businesses. Others are only in the market to fund companies preparing to go public with an IPO. Let’s look at the stages of venture capital financing properly.

1. Early stage

An early stage company is one that is not yet ready to position its product or service on the market. A company in this stage may need seed capital or start-up capital in amounts ranging from $25,000 to $250,000. This stage of financing is fraught with extremely high risk. The new technology and innovations being attempted have equal chance of success and failure. The capital is usually provided by business angels and is characterized by the following sub stages:

• Seed Capital. The business is still in the idea stage. Seed-stage financings are often comparatively modest amounts of capital provided to inventors or entrepreneurs to finance the early development of a new product or service. Cash infusions are directed toward feasibility studies, R&D, product development and testing, market research, building a management team and developing a business plan.

• Start-up Capital. Companies are able to begin operations but are not yet at the stage of commercial manufacturing and sales. Investors support product development and initial marketing push of the companies which have been recently organized to distribute your product in the market. Generally, such firms have already assembled key management, prepared a business plan and made market studies. At this stage, the business is seeing its first revenues but has yet to show a profit. This is often where the enterprise brings in its first "outside" investors. The risk tends to be lower relative to seed capital situation.

2. Expansion

Expansion capital is for businesses already in or ready to start production today. The amounts that venture capitalists usually invest in expansion companies range from $500,000 to $5 million. There are usually four stages to expansion capital:

• First stage capital is provided to companies that have completed the product development stage and require further funds to initiate commercial manufacturing and sales but may not be generating profits. Most first-stage companies have a product or service in testing or pilot production. The time horizon to realization is up to 6 years.

• Second stage. The funds are usually provided for companies in production and generating revenue, but not yet making a profit. Second stage capital helps to grow receivables, inventory, payables, physical plant expansion, product improvement and marketing. But the company may not yet be profitable.

• Third stage / Mezzanine financing. The capital at this stage helps businesses perform major expansion and perhaps even develop and introduce new products or renew advertising efforts. It is characterized by a developed product on the market, a full management team in place, sales revenue are generated from one or more products, but the surplus generated is insufficient to meet the firm’s needs. The company is near break-even.

• Fourth stage / Bridge financing. The business expands high yields, capital growth and good profitability. It has reputed market position and an established formal organization structure. Companies in this stage are in need of capital to help smooth the way to a potential IPO. It is repaid with proceeds of the IPO, and used to restructure previous equity positions. The company demonstrates significant revenue growth.