Alternative Investments - The Stages in Venture Capital Investing

Venture capital is a source of financing for new businesses. Venture capital funds pool investors' cash and loan it to startup firms and small businesses with perceived, long-term growth potential. This is a very important source of funding startups that do not have access to other capital and it typically entails high risk (and potentially high returns) for the investor.

Most venture capital comes from groups of wealthy investors, investment banks and other financial institutions that pool such investments or partnerships. This form of raising capital is popular among new companies, or ventures, with a limited operating history that cannot raise capital though a debt issue or equity offering. Often, venture firms will also provide start-ups with managerial or technical expertise. For entrepreneurs, venture capitalists are a vital source of financing, but the cash infusion often comes at a high price. Venture firms often take large equity positions in exchange for funding and may also require representation on the start-up's board.


The Stages in Venture Capital (VC) Investing
Angel investors
are most often individuals (friends, relations or entrepreneurs) who want to help other entrepreneurs get their businesses off the ground - and earn a high return on their investment. The term "angel" comes from the practice in the early 1900s of wealthy businessmen investing in Broadway productions. Usually they are the bridge from the self-funded stage of the business to the point that the business needs true venture capital. Angel funding usually ranges from $150,000 to $1.5 million. They typically offer expertise, experience and contacts in addition to money.

  1. Seed - The first stage of venture capital financing. 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. These early financings may be directed toward product development, market research, building a management team and developing a business plan.

    A genuine seed-stage company has usually not yet established commercial operations - a cash infusion to fund continued research and product development is essential. These early companies are typically quite difficult business opportunities to finance, often requiring capital for pre-startup R&D, product development and testing, or designing specialized equipment. An initial seed investment round made by a professional VC firm typically ranges from $250,000 to $1 million.

    Seed-stage VC funds will typically participate in later investment rounds with other equity players to finance business expansion costs such as sales and distribution, parts and inventory, hiring, training and marketing.
  2. Early Stage - For companies that are able to begin operations but are not yet at the stage of commercial manufacturing and sales, early stage financing supports a step-up in capabilities. At this point, new business can consume vast amounts of cash, while VC firms with a large number of early-stage companies in their portfolios can see costs quickly escalate.
    • Start-up - Supports product development and initial marketing. Start-up financing provides funds to companies for product development and initial marketing. This type of financing is usually provided to companies just organized or to those that have been in business just a short time but have not yet sold their product in the marketplace. 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.
    • First Stage - Capital is provided to initiate commercial manufacturing and sales. Most first-stage companies have been in business less than three years and have a product or service in testing or pilot production. In some cases, the product may be commercially available.
  3. Formative Stage - Financing includes seed stage and early stage.
  4. Later Stage - Capital provided after commercial manufacturing and sales but before any initial public offering. The product or service is in production and is commercially available. The company demonstrates significant revenue growth, but may or may not be showing a profit. It has usually been in business for more than three years.
    • Third Stage - Capital provided for major expansion such as physical plant expansion, product improvement and marketing.
    • Expansion Stage - Financing refers to the second and third stages.
    • Mezzanine (bridge) - Finances the step of going public and represents the bridge between expanding the company and the IPO
  5. Balanced-stage financing refers to all the stages, seed through mezzanine.
Venture Capital Investment Characteristics and NPV


Related Articles
  1. Investing

    A Look into the Exciting World of Venture Capital

    We look into the world of venture capital, where deep-pocketed investors gamble on funding the next big startup (or the next big flop).
  2. Entrepreneurship

    The Risk And Rewards Of Investing In Startups (GOOG)

    Investing in startups is a very risky business but can reward investors greatly if and when they do pay off.
  3. Entrepreneurship

    A Look Into The Secrets Of Venture Capitalism

    Venture capitalists own an equity stake in the start-up and have a say in the functioning of the company. Investments are generally made in early stages of a company with long term high growth ...
  4. Entrepreneurship

    How To Raise Seed Capital and Grow Your Startup

    To get a business off the ground, entrepreneurs need a clear understanding of how to strategically position themselves for VC firms and angel investors.
  5. Entrepreneurship

    Does Your Startup Need Venture Capital Money?

    Venture capital funding provides capital to grow a business. However, entrepreneurs will also lose some control over business decisions.
  6. Personal Finance

    How You Can Become A Venture Capital Associate

    Venture capital analysts are the junior members of the venture capital firm. They receive compensation that is typically higher than other finance analyst positions.
  7. Entrepreneurship

    Fed Raising Rates Affects Startup Funding

    With interest rates having nowhere else to go but up, the Fed’s impending interest rate raise will likely begin to reverse the flow of startup funding.
  8. Entrepreneurship

    Is Equity Financing the Right Choice for Your Business?

    Discover the benefits and drawbacks of equity financing for a small business, and learn when equity financing should be used instead of debt financing.
  9. Investing

    How Venture Capital Will Change in 2016

    Venture capitalists face a tech bubble on the horizon, along with an influx of new non-traditional investors via Wall Street and crowdfunding platforms.
  10. Personal Finance

    Seek An Adventure In Venture Capital

    Make a career out of chasing down the "next big thing".
RELATED TERMS
  1. Seed Capital

    The initial capital used to start a business. Seed capital often ...
  2. Venture Capital

    Money provided by investors to startup firms and small businesses ...
  3. Alphabet Rounds

    The early rounds of funding for a startup company, which get ...
  4. Venture Capitalist

    An investor who either provides capital to startup ventures or ...
  5. Funding Gap

    The amount of money needed to fund the ongoing operations or ...
  6. Startup Capital

    Startup capital refers to the money that is required to start ...
RELATED FAQS
  1. How is venture capital different from other kinds of equity financing?

    Learn how venture capital equity financing differs from other funding options and what companies need to be aware of prior ... Read Answer >>
  2. What is the best form of equity financing for a start-up company?

    Learn the equity financing options available to small business, and understand the best equity options for companies during ... Read Answer >>
  3. What are the different equity financing options available to companies in the United ...

    Learn what equity financing options are available to small, mid-sized and large companies within the United States and understand ... Read Answer >>
  4. What are some of the disadvantages to taking venture capital?

    Learn how financing a business through venture capital can be a viable source of funding for small businesses but know caveats ... Read Answer >>
  5. Where does venture capital come from?

    Obtaining funding from venture capitalists is the way to go for those who have great ideas with potential for becoming lucrative ... Read Answer >>
  6. What resources are available to an entrepreneur to raise capital?

    Learn how entrepreneurs can use various resources to raise capital and how each is beneficial throughout the different phases ... Read Answer >>
Hot Definitions
  1. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  2. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  3. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
  4. Generally Accepted Accounting Principles - GAAP

    The common set of accounting principles, standards and procedures that companies use to compile their financial statements. ...
  5. DuPont Analysis

    A method of performance measurement that was started by the DuPont Corporation in the 1920s. With this method, assets are ...
  6. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
Trading Center