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UNIT 6: STAGES OF VENTURE DEVELOPMENT AND FINANCING

6.0 Learning Objectives


6.1 Introduction
6.2 Stages of venture development
6.2.1 Stage 1: Seed financing
6.2.2 Stage 2: Start- up
6.2.3 Stage 3: Early development
6.2.4 Stage 4: Expansion
6.2.5 Stage 5: Profitable but cash poor
6.2.6 Stage 6: Rapid growth toward liquidity point
6.2.7 Stage 7: Bridge stage
6.2.8 Stage 8 : Harvest
6.3 The summary of various stages of venture development, its activities, risk perception,
alternative finances and type of securities at each stage
6.4 The rationale for staging of ventures
6.5 List of Few Venture capital funds in India divided by stage of Venture capital funding
profile
6.6 Case study
6.7 Notes
6.8 Summary
6.9 Key words
6.10 Self assessment questions
6.11 References
6.0 Learning Objectives:
1. To describe the stages of venture development

2. To discuss the various financing alternatives available to the firm at various stages of
venture development
3. To rationale for staging in ventures
6.1 Introduction:
Venture development involves various aspects from concept development to product
commercialization, expansion till fully developed. The venture development is divided into
eight stages in terms of development activities and financing alternatives available the firms
at every stage. This is very important to understand the risks involved and distinct financing
alternatives available in the progress of venture development to obtain adequate external
finance for long term and continual basis as per need arising thereof.
6.2 Stages of venture development
The venture development can be broadly classified into eight stages. The eight stages of
venture development and financing alternatives are discussed below:
6.2.1 Stage 1: Seed financing
This is the first stage of venture development wherein entrepreneurs develop the concept of
new business, formulating the vision for the new firm. The initial ground work has to be
done which may involve building small prototype of the product, detailed descriptions of the
service/product, preparation of business of plan and explore the actual market potential for
the product/service. In this seed stage Entrepreneurs expend a great deal of time but a
relatively lesser amount of money to explore the prospects of commercialization and
development of the concept. It usually involves 6 months to 1year of typical time duration in
this stage.
Finance is essential to pay the entrepreneurs at least the modest living wage, to provide office
space, equipment, assistants and so on. The two most common sources of seed stage
financing are bootstrapping and angel financiers.
6.2.1.1 Bootstrapping

In bootstrapping, Entrepreneurs tap their available personal savings and personal borrowings,
from friends, relatives or business associates, may also include customer advances or
extended payment lending from vendors. Bootstrapping is a broadly used and effective
means of financing a venture.
6.2.1.2 Angel Financing
A risk averse wealthy individual, who often possess some entrepreneurial experience
interested to invest in small companies which have high growth potential are the angel
investors. They are often interested in financing these firms in the early stages of
development. Angel network is informal.
6.2.2 Stage 2: Start- up
The results of development of the concept, explore its potential ability of the business plan
and its prospects, ensues the start-up stage.
In this stage, the management team is assembled to develop a more detailed plan, prototype
is tested and Product or service development takes place, and also marketing is done to test
the market potential. The typical time duration of this stage is one to two years
Development of this stage essentially requires an additional committed capital for actual
testing of the concept developed.
Finance at this stage is extended by angel investors, venture capitalists. Venture incubators of
corporation or universities are also extending support for the firms development at this
stage.

6.2.3 Stage 3: Early development


Firm reaches the early development stage after the testing of prototypes and test marketing
indicates the substantial potential ability of commercialization and the results being positive,
the firm moves ahead. In this stage the firm secures its initial property, plant and equipment

and products/ services are actually manufactured/ rendered and shipped in commercial
quantities. However the firm remains in the non profitable at the end of this stage.
Angel investors usually wishes to cash out at this end or may be interested in contributing
additional finance. Venture capitalists may also interested in investing at this stage. The
initial properties purchased may be able to secure bank financing.

6.2.4 Stage 4: Expansion


The company would have accumulated considerable experience in the market place, they
would have identified the major success factors even though the ultimate success is at
question. The firm is still not in the position to gain more profit or cash inflows. For the
expansion of its operations the firm requires additional finance to purchase equipments and
inventory and for increased working capital as well. This stage spans about two years.
Alternative financing sources include venture capital and banks for this stage of
development.

6.2.5 Stage 5: Profitable but cash poor


Expansion stage being successful, the firm adheres substantial growth. in this stage the firm
is generating profit margin, being positive thereby reducing the downside risks. Retained
earnings can become a internal source of finance available to them. However, cash generated
is not sufficient to meet the requirements of expansions and working capital needs.
Venture capital firm would continue to be major financing source, banks would also lend if
there are enough collaterals.

6.2.6 Stage 6: Rapid growth toward liquidity point

Ventures which reach this stage would have reduced the risk significantly and have become
fairly stable. However, capital infusion might be necessary to finance continuing expansion.
The firms would prefer debt financing as the entrepreneurs and all other equity investors
prefer to limit dilution.

6.2.7 Stage 7: Bridge stage


This stage is also called as Mezzanine Financing. It is the final growth and preparation stage
required before the harvest. At this stage the form of harvesting alternative will be
determined, so that the growth strategy and preparation is coined along the alternative
chosen.
The firm may need additional finance for further growth, financial restricting or for a limited
cashing out of the early investors.
The firm may issue subordinate debt, convertible bonds, or convertible preferred stock, as
the entrepreneurs generally sensitive towards the dilution issue.

6.2.8 Stage 8 : Harvest


Harvest is the last of venture development. It involves the exit and cashing out of
investments and all short term investors. The three main Harvesting options are
i.
ii.
iii.

Remaining private and replacing short term investors with long term investors
Being acquired or
Going public

6.2.8.1 Remaining private and replacing short term investors with long term investors:
A developed firm chooses to remain private however the short term investors are cashed out
and replaced by long term investors by issuing long term additional securities to long term
investors.

An alternative is a management buy out(MBO), in the firms management raises capital


( usually the debt capital) to buy out the interests of most or all of the shareholders.
6.2.8.2 Being acquired
The larger established firm wishes to acquire the developed firm and offers the acquisition
bid. If the developed firm accepts the offer of being acquired, all the investors would either
receive cash for their held securities or shares of stock the acquiring firm.
6.2.8.3 Going public
To liquidate the investments made by the private investors, a part of or in full their equity
positions in the firm, they may choose the firm to go for IPO. The firm issues new common
shares to raise capital for the firm from public. This new cash may be used for many
purposes like paying off debt, constituting the primary portion of the firm. However the
secondary portion of IPO could be used for liquidating the at least part of their equity.

6.3 The summary of various stages of venture development, its activities, risk
perception, alternative finances and type of securities at each stage
Stage
development
1.Seed

of Development
of venture

Perception of Sources
risk

Concept

Extreme

development;
basic

of Securities

financing

typically

Bootstrap;

issued
Personal loans;

angels

common stock

Angels,

Notes

business

plan;
prototypes;
explore market
2.Start up

potential
Detailed
business

Very high
plan;

Venture capital, warrants;

with

Initializing
operations

or

corporation,

convertible

university,

preferred

developing test

stock;

prototypes;

partnership

finalize

interest;

product/service

common stock

3.Early

lines
Start

Development

commercial

Venture capital, bonds;

production and

Government

High

Angels,

marketing

Guaranteed
Notes

with warrants;
convertible
preferred
stock;
partnership
interest;

4.Expansion

Develop

Sufficiently

common stock
Venture capital, Guaranteed

marketing

high

Government,

bonds, secured

bank

debt,

strategy

&

expand

convertible

production

bonds,

capital; working

convertible

capital

preferred

needs

emerge

stock, common
Medium

stock
Venture capital, secured

5.Profitable/Cash

Expand

debt,

poor

production

bank, retained convertible

capacity;

earnings

bonds,

working capital

convertible

needs grow

preferred
stock, common

6.Rapid growth

Market strategy Medium

stock
Venture capital, Subordinate

refined

bank, retained debt;


earnings

convertible
bonds;
convertible
preferred
stock; common

7.Bridge/Mezzanin

Marketing

R&D

& Medium

stock
to Venture capital, Subordinate

high

bank, retained debt;


earnings

convertible
bonds;
convertible
preferred
stock; common
stock

8.Harvest

Recap; buyout; Low


sell to acquirer;
go public

6.4 THE RATIONALE FOR STAGING OF VENTURES


Staging of ventures gives clear picture to the sources of finance about
1. The state of development of the business: staging of ventures provide a clear
picture about the state of development of the business, many financial sources have
preference depending on the stage of development to provide finance.
2. Activities engaged at the specific stage: staging of ventures portrays the major
business activities which have to be in place, this is important concern in case of
private equity and venture capital form of business.

3. The level of risk involved: each stage has its own level of risk involved, however
when the company moves up in chain of stages the level of risk involved will also be
reduced substantially.
4. The quantum of capital required : the development stage can predict the quantum
of capital required, and also the purpose of capital requirement.
5. Time frame for exit: the development stage also portrays the length of investment to
made, time frame for exit. The later stages has lesser time frame for exit however the
early stages will have lengthy investment lock in period.
6.5 List of Few Venture capital funds in India divided by stage of Venture capital
funding profile
STAGE OF INVESTMENT
Seed stage

VENTURE CAPITAL FIRMS


Blume ventures
India Innovation funds
Venture east

Early stage

Seed fund
Ratan Tata ventures
Accel India
Sequoia capital
Tiger global

Growth / expansion stage

IDG ventures
Canaan Partners
Helion Ventures
Kalaari Capital
Nexus Ventures
SAIF
Sequoia Capital India
Ventureast

PE Investors

Aquarius

Abraaj Group
Avigo Capital
Bessemer
Gaja Capital
Headland Capital
IFC
IFCI Ventures
Lighthouse Funds
Mayfield

6.6 CASE STUDY


Kalaari is a leading India focused venture capital fund, with a strong advisory team in
Bangalore investing in early-stage, technology-oriented companies in India. They are
passionate about investing in entrepreneurs who are poised to be tomorrow's global leaders.
They seek companies that are capturing new markets, providing innovative, solutions, and
creating new wealth for India and beyond. Preferred Sectors of investment: Internet
products and services Mobile and mobile enabled technologies Enterprise software (IP led
products, SaaS/Cloud), Education. Investment Range: $2M - $5M. Select Investments:
HandsFreeNetworks, Magzter, Myntra, Ovenfresh, Power2SME, Robosoft, Simplilearn,
Snapdeal, Urban Ladder, Vyome. Looks for: early stage companies that are technologyenabled,and have high potential to emerge as market leaders. Companies that have strong

management teams, targeting large,and growing markets through innovative and disruptive
business models, are ideal partners for Kalaari.
Question:
1. What is the strategy of Kalaari capital in venture capital investments ?
2. What do you think are the strenghs of Kalaari capital?
3. What do you think as rationale for their choice of funding early stage? Does the
expertise help the development of business at this stage?

6.7 NOTES

6.8 SUMMARY

Venture development involves various aspects from concept development to product


commercialization, expansion till fully developed. This is very important to understand the
risks involved and distinct financing alternatives available in the progress of venture
development to obtain adequate external finance for long term and continual basis as per
need arising thereof. The eight stages of venture development are seed stage, startup, Early

development, Expansion, Profitable but cash poor, Rapid growth toward liquidity point,
Bridge stage, Harvest.The various financing alternatives are bootstrapping, angel investors,
venture capital, cooperation, university, bank, retaining earnings, private equity.

The

rationale of staging of ventures helps the firm to recognize the state of development of the
business, activities engaged at the specific stage, the level of risk involved, the quantum of
capital required, time frame for exit.
6.9 KEY WORDS
Venture development
Staging
Seed stage
Mezzanine
Angels
Bootstrapping
Liquidity
Cash poor
Risk

6.10

SELF ASSESSMENT QUESTIONS


1. Explain the different stages in the venture development
2. Discuss the two forms of early stage financing
3. Describe the rationale for staging in the development of a venture
4. What are the reasons for the stage preference in financing?
5. Enlist and describe the various sources of financing alternatives available at
different stages of venture development specifying the respective stage.

6.11

REFERENCES

Joseph P. Ogden, Frank C. Jen, Philip F. OConnor, Advance Corporate Finance, Policies and
Strategies, 2003 edition, published by Pearson Education Pte Ltd, Indian branch.
Handbook on venture capital, published by Venture Intelligence, retrieved from google.