VC Secrets: Stages of Venture Capital

Dear ,

As promised, here is your new issue of the Expert-zine.

VC Secrets: Stages of Venture Capital

  By William F.(Bill) McCready
  CEO/Founder, Venture Planning Associates, Inc.

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.

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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 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. 


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

At the time of this round, the company is usually at
break-even or profitable. 


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


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. 


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

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.

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Watch for the next issue: 

VC Secrets: What the Business Plan Books Don't Tell You
____________________________________________________________ / 

Teri McCready, Publisher
Tel. (858) 457.3434 / email: 
5370 Toscana Way               San Diego, CA 92122 USA 

Copyright 2000-2002, Venture Planning Associates, Inc.
ISSN: 1529-1316 

Everyone's an expert in something, but almost no one     
is an expert in everything!
     Teri McCready, Publisher, Expert-Zine

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Received on Saturday, 27 September 2003 00:36:56 UTC