Deciphering the Five Stages of Venture Capital Investing
Published: March 24, 2018
Venture Capital or VC investing is an area of private investing that has received an increasing amount of attention as investors look for nontraditional sources of returns. Investors find VC investing attractive for a number of reasons:
- Potential strong returns
- Portfolio diversifier with lower and lagging correlation with the public markets
- Large, visible opportunity set
- Possible early identification of future market leaders
- Potential for participation in emerging high growth areas
But the world of VC investing can be daunting and confusing, with different stages of investing and various names sometimes applied to the same stage. There are five main stages in VC investing that are important for market participants to understand. What are they and what do they mean?
Seed Stage
In the seed stage, little exists but the idea or concept for a new product or service. Seed capital is typically solicited to fund initial research and development, creation of a business plan and start-up staffing. Investment amounts are generally modest and may come from professional VC firms, financial institutions or even friends and relatives. These latter are often referred to as angel investors, as they provide capital at favorable terms or even consider it an outright gift. The seed stage may sometimes be divided into early and late seed, depending on how developed a concept is or if the venture is operational, but hasn’t yet received additional funding.
Start-up Stage
In the start-up stage, companies have begun operations, but do not yet have a “real” commercially produced product. Rather, they have built a prototype to demonstrate to potential investors. Their goal is to obtain sufficient funding to refine their offering and ramp up operations. At this point, they may also seek to expand their team to include additional production staffing, business functions and more formal management.
First Stage
In the first stage, the company is ready to, or has already begun, ongoing operations and is expecting substantial market growth and profitability. At this stage, the company solicits additional funding to accelerate and scale production and sales supported by increased marketing and promotion. The amounts sought at this stage are significantly larger than the first two stages.
Second or Expansion Stage
Once the company has achieved a period of significant growth, possibly reaching the point where demand outstrips current capacity, another infusion of capital is necessary to facilitate expansion and grow profits. This may involve an enhancement or versioning of the initial product or service, or, the introduction of new products or services.
Mezzanine or Bridge Stage
For a start-up company (or a VC investor), reaching this stage and the next is the primary goal. The company has reached the point where it is “mature” and ready to engage in a transformational transaction. This could be an initial public offering (IPO) or a merger with, or acquisition by, a complementary business. Rather than focusing on building and expanding the business, as the previous stages did, mezzanine or bridge funding finances these endeavors.