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Venture Capital in Stages

Ken Freeman, September 27, 2021

Investors should keep in mind that not all venture capital investment is alike. There are big differences between early and late stages.

Venture capital invesment is booming. It reached a global record six-month total of $288 billion during the first half of 2021. That’s a gain of 61% versus the previous six-month record in second half 2020, and almost triple the level just four years ago in first half 2017. This growth reflects heightened appreciation for venture capital returns potential. Investors recognize the opportunities for innovation to address increasingly visible problems, needs, and opportunities. 

However, Investors should keep in mind the differences within venture capital investment and strategically manage how they allocate their investment dollars across this asset class. 

The Friends and Family Stage

Start-up funding begins informally, outside of the formal venture capital industry infrastructure. This is often called the friends-and-family stage, as start-up funding often begins with loans and equity investments from friends and family. It also often entails the entrepreneur’s personal investment if he or she is fortunate enough to have amassed substantial personal capital. Those less affluent may rely substantially on credit cards and even second mortgages. 

Seed Stage

This is the first step in the formal venture capital funding process. In this stage, a relatively small amount of capital is provided. Until less than ten years ago, it was typically only about $0.5 million. This often had been sourced from individual angels and angel groups. In more recent years, as seed stage funding has grown (more on that later), this funding is increasingly sourced from professional venture capital firms.   

Seed stage funding typically is used to validate market need and product concept. This usually involves market research, product development, and then, assuming going-in hypotheses are borne out, beginning to build a management team and business plan and sometimes pursuing a small number of test customers. Given the considerable risk of failure at this stage, the share price is generally very low. This is the ultimate high risk/high potential reward stage.

Early Stage (Series A)

The process of venture maturation is like a funnel. Lots of start-ups enter the wide top end of the funnel at the seed stage, but the funnel narrows rapidly even by the A round, as a large portion of start-up ventures fall off the rails over time. The majority of seed stage ventures won’t even reach this post-seed early stage. Perhaps the hypotheses that motivated the venture will be invalidated, or it will appear likely to prospective investors (and maybe even to the founding entrepreneur) that success odds and return potential just aren’t great enough to risk further investment.  

For those ventures that pass this screening stage, their A round share prices will be higher than at the seed stage. Risks and uncertainties, while still great, will have diminished some. The probability of a positive return, while still pretty low, will be greater than before.

Financing needs at this stage are usually greater than at the seed stage, until the last five years typically in the $3 - $5 million range.  This is where venture capital firms take over from the angels if they hadn’t at the seed stage. 

At this stage, the venture generally is approaching product development completion and is focused on market testing and/or pilot production, with product refinement often still ongoing. While possibly still fleshing out its organizational structure, the company is often already selling in the marketplace on a limited scale, though almost always too small to be profitable. 

Expansion Stage (Series B)

Winnowing down continues. While ultimate marketplace success may still be uncertain, the odds are getting better, and the share price is increasing as well.

The dollar magnitude of financing rounds continues to increase at this stage, until just the past few years to the $5 to 10 million range. At this stage, the venture usually is being actively sold in the marketplace. The greater funding typically is needed for growing working capital and perhaps increased production capacity. The venture likely is still operating at a loss while investing aggressively in envisioned substantial long-term growth. Risks are likely still great enough that a conventional lender like a bank is generally not viable.  

Some venture capital firms focus most of their dollars on this and later financing stages. The larger the financing round, the more likely the money will come primarily from institutional investors and the less access individuals will have. Firms still working primarily with individual investors may, however, participate as well at this stage in support of ventures they funded earlier and which still hold attractive promise. If the potential of a venture they funded earlier no longer seems as attractive, though, the firm’s focus will instead be on recouping as much cash as they can, if any, limiting losses and moving on to greener pastures.

Late Stage (Series C and beyond)

At this point, the likelihood of marketplace viability and even sustainability is greater, even if ultimate growth potential may still be uncertain. This is where the dollars sought for investment get really large, often in the tens of millions of dollars and sometimes $100 million or even more, as the business may need substantial investment capital for rapid growth and timely market leadership.  

While the venture may already be large and sometimes even well known, its owners may believe its value will be still greater as it more closely approaches longer term potential. Share price is usually considerably higher at this point, as the risk of total failure and total loss is considerably less. Participation at this stage is generally limited to the major institutional venture capital firms catering primarily to institutional investors with the capacity to meet the much greater investment need.

Risk/Reward Tradeoff by Funding Stage

Investment at different stages carries different degrees of risk and associated potential gain. Generally, the earlier the financing stage, the lower the share price, the greater the return potential, and the greater the risk of total loss.

Here are some typical metrics by investment stage, compliments of Industry Ventures, LLC.

InvestmentRisk of LossTypical Hold PeriodTarget
Net Multiple
Net IRR%
Early Stage CompanyHigh >65%8+ years10x+30%
Late Stage CompanyMedium ~30%6 years or less3x20%
Early Stage Venture FundMedium ~30%10-12+ years3x20%
Late Stage Venture FundLow <30%10-12+ years1.5-2x12-18%

Four reasons why venture capital investing is booming

  1. Numerous visible start-up successes, especially in IT and biotech, have boosted venture capital credibility and investor appetite.
  2. “Back in the day,” entrepreneurs were often viewed as rebellious and idiosyncratic, giving investors more pause. Today the start-up world is attracting the best and brightest, including from top business schools. Entrepreneurship is prestigious and more attractive to investors.
  3. Successful serial entrepreneurs, as well as seasoned executives, are choosing to follow their entrepreneurial ambitions. They come to the party with greater personal capital as well as access to greater friends-and-family funding. They are therefore able to pursue further development before seeking formal venture capital funding. 
  4. Industry consolidation and globalization have heightened the awareness of the greater rewards possible through category domination. This has encouraged greater funding rounds in pursuit of greater scale and timely category domination.

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