Venture Capital Investment Stages

Venture capital is one source of financing for startups and is an important source of funding for startups that do not have access to other capital or the ability to generate sufficient operating cashflows through revenue from launch.  Venture capital is offered with the expectation of generating a return on investment, typically through an exit event such as an initial public offering (IPO) or acquisition of the company. Smaller ventures sometimes will first rely on family funding, loans from friends, personal bank loans, or crowd funding. Larger projects or more experienced entrepreneurs may turn to “angel” investors or venture capital companies that specialize in financing new ventures.

There are five common stages of venture capital financing:

  1. Seed stage
  2. Start-up stage
  3. Early stage (also called first stage or second stage capital)
  4. Expansion stage (also called second stage or third stage capital)
  5. Bridge stage (also called mezzanine or pre-IPO stage)

Stage 1: Seed Stage

The seed stage is when a startup approaches an angel investor or a venture capital firm to seek funding for their idea or prototype.  At this stage, the startup may not have a commercially available product yet and is instead focused on convincing the potential investors why their ideas are worthy of venture capital support.  The entrepreneur must convince the investors why the ultimate product or service will be viable and successful in the market.  The potential investor will then investigate the technical aspects of the product or service, and the economic feasibility of the idea.  Seed-stage financing is usually modest in comparison to later stage financing.   An initial seed investment round made by a venture capital firm typically ranges from $250,000 to $1 million.  The financing may go towards product development, market research, and/or building a management team.

Stage 2: Startup Stage

If the idea or product appears to warrant further investigation or investment, the new company will advance to the startup stage.  Startups typically have a sample product available at this stage but will need funding for further product development.  Additionally, a management team will be formed, and a business plan prepared.  The startup will also use funding to conduct initial market research on the product. The venture capital firm wants to see results of market research in order to determine whether the market size is big enough and if there are enough consumers to buy the product. Investors also want to create a realistic forecast of the investment needed to push the venture into the next stage. Venture capital funding at this stage might also include spending money on acquiring additional management personnel, fine-tuning the product, or conducting additional research.

Stage 3: Early Stage (also called first stage or second stage capital)

Though also called “first stage,” this stage usually only comes after the seed and startup stages.  At this stage, the product or service has been developed and is being sold in the market.  This is the first opportunity the investors have to see how the product fairs with its competitors in the market.  Funding received at this stage will often go towards manufacturing, sales and additional marketing. The amount invested here can be significantly higher than prior stages. At this stage, the company could also be moving toward profitability, depending on its share of the marketplace.  If the startup and its product can hold their own against the competition, the venture capital firm will probably give a green light for the next stage.

Stage 4: Expansion Stage (also called second stage or third stage capital)

At this stage, the startup should be growing, the product selling, and the company taking in significant revenue.  The goal of funding at this stage is to scale the business and expand market share.  The venture capital funding could be used to invest in overseas manufacturing facilities, start a new marketing campaign, or take steps to reduce production and other costs.  The funding should help enable expansion into additional markets, such as other cities or countries, and also increase diversification and differentiation of product lines. The venture capital firm will then evaluate if the management team has made the expected cost reductions and how the startup fares against the competitors.

Stage 5: Mezzanine Stage (also called bridge or pre-IPO stage)

This is commonly the last stage of the venture capital financing process. The primary goal of this stage is for the startup to go public so that investors can exit the venture and make a profit. Funds received at this stage are generally used for activities such as merging with or acquiring other companies, taking measures to eliminate competitors or keep new competitors from the market, or financing the steps involved with an IPO.