Entrepreneurs always want to know what it will take to get a fair hearing from investors. It’s a tough challenge too because angel investment clubs, venture capital funds and private equity “buyout” funds can receive hundreds of executive summaries, business plans and investment proposals on a monthly basis.
One of the easiest ways investors sort through executive summaries in seconds is by eliminating investment opportunities that don’t match their preferred stage of business development. Investors like to specialize. It helps them understand how to value business opportunities in highly competitive market sectors.
The Start on Purpose Funding Directory organizes United States equity funding sources according to four stages of business development: startup or seed-stage businesses; early-stage businesses; expansion-stage or “later” stage businesses; and “recapitalization” or buyout-stage businesses.
“Stage-agnostic” investors will invest across the board—in seed, early or expansion-stage businesses. These opportunistic investors can often be found in large venture capital funds that have more than $200 million to invest.
Fortunately, the lines between the different stages are not absolute. The widest range of variance in “investment criteria” is at the expansion and buyout stages of business development. Some expansion stage funds work with companies with revenues of $10 million to $20 million; others target companies with revenues over $50 million.
Start on Purpose encourages its members to learn more about each stage of business development.
Seed-stage investors can include high net worth “angel” investors and a small number of venture capital funds. These investors are not scared off by investing in companies that are at the raw concept stage and don’t have any products, customers, revenues or assets to reduce investment risks. As such, seed-stage investors ask for large percentage equity stakes in companies with exceptional prospects for fast revenue growth or technology breakthroughs that can “disrupt” major markets.
Seed-stage businesses are usually run by the founders and a few first employees or independent contractors. Entrepreneurs at this stage are actively involved in incubating the company's business plan, evaluating opportunities for corporate partnerships to accelerate “progress,” and identifying new members of the company’s senior management team.
Validating the investment value of an idea through highly focused research activities, often called “proof of concept,” is an important priority to seed-stage investors. They will consider whether or not the founders can complete product/service development on time and within budget so the company does not face an unexpected cash crisis. Also, developing intellectual property is another investment priority at this stage of funding activity.
Seed-stage investors prefer to invest in companies that are located within the same metropolitan area or region to allow for frequent, convenient, in-person collaboration.
Early-stage investors include venture capital funds, angel investors and occasionally corporations. Early-stage venture funds typically provide the first round of “institutional” or “Series A” investment funds following investments by the company's founders, friends and family members and local angel investors.
Deal sizes for early-stage companies range broadly between $500,000 and $10 million. Early-stage venture funds can invest in promising companies on a regional, national or international basis, rather than strictly local basis.
The most desirable early-stage companies to venture funds have a disruptive technology or service, that is or will soon be, released to commercial markets. Investors look closely at a company’s potential to become the dominant product or service provider in a large, growing market as well as the potential to be acquired at a lucrative valuation or go public within five to seven years.
Companies should have a clear understanding of the funding requirements needed to achieve cash flow breakeven, business profitability or other points of “value creation” that will ultimately reward investors before approaching early-stage venture capital funds.
Expansion-stage companies, sometimes referred to as “later-stage” companies, have a capable management team in place and are seeking equity funds to once again accelerate revenue growth. However, essentially all the technical risk associated with a company’s products or services is behind expansion-stage companies.
Expansion-stage companies have a strong base of predictable revenue, cash flow and profits. They may have received prior rounds of venture capital or have achieved operational maturity without venture funding. In addition, expansion-stage companies may also be classified by their total enterprise value, which can range widely between $10 million to $100 million. Frequently, expansion stage investors provide the last round of capital before a company “goes public” on a leading securities exchange.
Funding proceeds are often applied to service expansion, planned acquisitions or to cash out a founder in part or in full.
Expansion-stage investors are more likely to invest in low-tech consumer-oriented businesses, retail chains and manufacturing businesses than high-tech seed-stage and early-stage investors.
Within the Start on Purpose Funding Directory, the Recap/Buyout stage applies to well-established privately-held or publicly-held “micro-cap” or “small-cap” businesses that may be undergoing considerable strategic change due to fast growth, acquisition activity or financial distress.
The most frequent areas of private equity investment activity involve providing funds to cash out company founders; spin-off or sell certain operating divisions of a company; acquire complementary companies possibly through leveraged transactions; turnaround financially-distressed revenue-generating operations; recapitalize companies or their subsidiaries; recapitalize bankrupt companies, take public companies private; provide “bridge” or mezzanine capital; or help employees buyout a business from a larger corporate entity. Transactions may involve debt and equity and can be provided by companies on a regional, national or international basis.