Although most of the venture capitalists in the United States invest in technology companies—and the industry gets a lot of attention for these investments—they also invest in business services, construction, industrial products, restaurants, retailing, and socially responsible companies. The following are different stages of a company development that VCs will invest in and why:

Early-Stage, Expansion, and Mezzanine Financing

Venture capitalists can be general investors or they can concentrate in a particular industry, sector, or development stage of a company. Not all venture capitalists invest in start-ups; some of them invest in different stages of a company’s life cycle, such as early-stage financing or expansion financing.

Early-Stage Financing

Seed Financing: Here, venture capitalists fund entrepreneurs in the idea stage, when a company has not yet produced a product or service and is building its management team. You should expect to receive capital under $50,000. In this stage, businesses should look for private investors. Outside investors may look to negotiate for a larger share of the company or require other people to join your management team. You will be sharing confidential information about your company with prospective investors, so research those people thoroughly before entering into negotiations.

Start-Up Financing: This capital is reserved for companies that are in the product-development stage. This funding includes the initial marketing for the product.

First-Stage Financing: This capital is earmarked for commercial development, production, and sales. It is for companies that have already developed a sellable product, proven their business concept, and have assembled a credible management team. At this point, your business is ready for the market and investors will take a passive role in comparison to either seed or start-up financiers. Investors will look to your business plan for:

  • An explanation on how you and your team will implement your company’s mission statement.
  • Financial analysis identifying business costs, sources of revenue, and financial projections.
  • Market research establishing the market size, growth potential, and any potential factors that may affect your estimates.
  • Competitive analysis assessing the strengths and weaknesses of your competitors.

Expansion Financing

Second-Stage Financing: Venture capitalists provide funding for companies that produce and sell products. At this stage, companies establish strategic alliances and hire more management and staff. These companies are generating more sales, growing their accounts receivable, and need working capital for expansion. When seeking funding, expand on your marketing plan, set achievable revenue and profit benchmarks, and correctly value your company—this will help you show how much your company is worth to initial and subsequent investors.

Third-Stage Financing: This is capital allocated to companies that are going through major growth such as marketing and sales, a major plant expansion or purchase, or product development.

Mezzanine (Bridge Financing): In this stage, venture capitalists fund companies that will go public in a year or more. Companies in this stage are already selling a product or service, are experiencing increase in sales, and plan to finance a major expansion. This financing can facilitate investment in an emerging growth opportunity, debt refinancing, corporate restructuring, mergers and acquisitions, or re-capitalization. This financing uses debt or equity. This is late-stage financing, and the risk and expected returns for an investor are less than in the earlier stages.

Special Case Financing

Turnaround: Funding provided to a company that is experiencing problems in order to re-structure or help solve their problems and gain momentum. Investors evaluate a company’s cost structure, management, and position in the market.

When evaluating the cost structure, an investor’s focus is on a proposed cost-cutting and savings strategy rather than on new management or a shift in the business plan. The new management team is evaluated in its previous experience with turnarounds of similar companies, its investment into the business, and its proposed strategy. Investors also weigh in the company’s position in its market. These are outside factors that affect a company’s performance.

Leveraged Buyouts (LBO): These are funds provided to buy a company or a subsidiary from a major corporation. The assets of the company are used as collateral for the funds. Proceeds are used for acquisitions, divestitures, valuations, refinancing, and management acquisitions.

Leverage-buyout financing is based on a company’s cash-flows strength and likelihood to continue. This type of company has cash-flow predictability; operating performance; and enterprise-value based on technology, customer base, franchise value, or brand.

Expected Returns

Venture capitalists consider it a success if they get a 40 to 60% return on their investment, which is not out of line considering the amount of risk they are taking. However, on average, they get returns ranging from 10 to 20%. They expect to net these returns after they “cash-out” of the company, if possible within a three- to five-year period. However, the cash-out period can be as long as ten years or more. Consider this when assessing your business potential return on an investment.

On another note, it is normal for venture capitalists in the earlier stages of financing to expect a tenfold return on their investment while a mezzanine investor will be happy with two to four times their investment. Early-stage investors expect to wait four to seven years for a return, while a late-stage investor expects to exit in less than two years.

You will need to write a business plan and make sure that your financial statements and revenue projections are in order before you approach a venture capitalist.

Direct Investing

Established corporations also invest in small companies, this is known as direct investment. Non-financial corporations try to improve their competitive position by investing in companies that match the parent company’s technology strategy, usually by providing cost savings or other type of synergy. Corporate venture capitalists invest their own company’s money, while mainstream venture capitalists invest outside investors’ funds.

Exit Strategy

Venture capitalists want to cash out of an investment and receive a profit. Although an Initial Public Offering (IPO) is the most popular form of receiving capital, most venture capitalists exit the investment when they sell their partnership through successful mergers or acquisitions with larger corporations.