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Bill McCready
Stages of Venture Capital and Business Finance from Seed Capital
to IPO
Each phase of a business’ or project’s 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
Seed 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. 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
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.
For more detailed information or assistance contact us at the
address below.
Venture Planning Associates, Inc., http://www.ventureplan.com
Tel. 858.457.3434 / efax 425-955-7531
capital@ventureplan.com
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