Lesson 2 of 7
Venture Capital Funding is a form of private equity wherein the investor has a minority interest in the business. Typically it extends over a few years from ideation to exit.
Let us take a case study of Simply Switch, an online price comparison tool, where a user can switch to the best bargain for electricity, gas, credit card, broadband, etc. In 2002, after assessing Simply Switch’s growth potential, a venture capital firm called Bridges Ventures injected £125,000 pounds at the time when the company had just started. Over a period of three and a half years it totally spent 345,000 pounds. It sold its stake in 2006 for 22 million pounds returning £7.5 million pounds, resulting in an IRR of 165%. Bridges Venture chaired the company initially before placing an industry expert as chair. It undertook new market entry and growth strategies. The venture capitalist provided strategic and financial advice and ascertained the optimum time for exit. (Source: bvca.co.uk).
Clearly there are different stages to venture capital funding of a business. Schilit review offers an understanding into the various stages of venture capital investing. Funding varies from stage to stage. Given below is a table of the stages.
| Stage | Details |
|---|---|
| Stage 1: Seed stage | A business idea is funded. This initial funding is used for product development and market research. |
| Stage 2: Early stage financing | Funding is provided for initial operation before commercial production ensues and sales begin. |
| Stage 3: Formative funding | This includes seed stage and early stage funding. |
| Stage 4: Later stage funding | Funding provided for commercial operation and sales, but before an initial public offering (IPO). |
Early stage funding can be either start-up or first stage funding. In start-up financing capital is provided for initial operations and testing. This would include product development and initial marketing. First stage funding is provided for initial commercial production and sales.
Under the later stage funding there can be second stage, third stage and mezzanine funding.
The second stage funding is provided to the company for expansion even though it is not profitable despite commercial production and sales.
In third stage funding, capital is provided for major expansion, for example, in Simply Switch’s case for aggressive marketing of its service for awareness and adoption.
Mezzanine as the name suggests is a kind of bridge funding that will help the company prepare for its journey between its expansion of capacity and the IPO. Simply switch might have availed this between gathering more adopters and having its stake acquired by Daily Mail and General Trust.
Financing through all stages, seed funding to mezzanine, is referred to as balanced stage financing.