By Venture Planning Associates. 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.

Venture Financing Funnel

Venture Financing: Key Documents

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

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

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.

 

Venture Capital Basics: Recommendations to Entrepreneurs

Venture Financing Stages

Private Placements

Private Placement Memorandum

Criteria for Selection of Prospective Investors

Types of Financing & Debt vs. Equity

 

Venture Financing

Complete "A to Z" Smart & Fast guide

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Understand the Venture Financing Chain

Understand the requirements of Venture Capital Investors

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Venture Map to Financing

The Funding Round Chart

Preparing a Venture Proposal

Venture Planning Chart, Definitions, and Concepts

Venture Planning Checklist

Investment Opportunity Selection by Investors

What Every Investor Wants To Know

Investment Evaluation Criteria

How Investors Read a Business Plan

Investor's Questions To Be Answered by the Business Plan

Business Plan DOs and DON'Ts

Alternative Financing: VC is Not the Only Way

Dealing with Banks