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A Venture Capital Cheat Sheet

Lately I’ve found myself in many conversations about startups and sources of funding. It’s a natural part of the work we do at Atomic; we build software products for other people’s businesses, and many of the new clients who reach out to us are part of startups. Locally, the Momentum program and 5×5 night have sparked conversation and excitement around the Grand Rapids entrepreneurial community. The Michigan chapter of the Lean Startup Circle is kicking off soon. Globally we’re in the wake of several new tech IPOs (Linked-In, Pandora, & Zynga).

In these conversations I’ve observed and experienced a little hesitancy in defining or making distinctions between different terms in the venture capital space. For instance, one common misconception is that different types of funding relate directly to specific dollar ranges, rather than company stage.

Here I’d like to lay out a basic outline of the terms of venture capital, keeping in mind the sometimes loose colloquial uses that make rigorous distinctions impossible.

Venture Capital Stages

Venture capital is not what “venture capitalists” or “VCs” — as in, professional venture capital firms, give you: it’s more broad. Venture capital is simply a form of private equity dedicated to new or relatively new firms (as apposed to money dedicated to acquiring established firms). This funding can occur in many different ways. What follows are approximate guidelines that attempt to make sense of the general delineations of venture capital financing. I’ve organized the stages into the broad categories of “formative,” “expansion” and “bridge/mezzanine” (I borrow these terms from the CFA institute’s description of VC stages.) I prefer these as organizing terms to first, second, third and fourth because there are no set hoops to jump through, no correct number of rounds of financing to get from startup to exit.

As stated above, stages of VC funding have everything to do with company stage. The actual dollar amounts that a company needs to get to the next stage varies widely by industry. A manufacturing plant needs much more money to bootstrap than a web startup.

FORMATIVE STAGE

Pre-Seed

  • This term, while not formally different from seed, is a practical distinction common in technology startups.
  • It’s often associated with minimal or lean financing options for early product or market validation (or customer development).
  • This sort of financing is typically small enough that it wouldn’t come from formal private equity sources.

Seed Stage

  • The seed stage happens when a company is still in the concepting phase.
  • The money may go to creating prototypes, conducing market research, creating a business plan, etc.

First Stage

  • Your company has a validated business plan/idea.
  • This round of financing typically helps companies move into operations.
  • Financing may go into product development or to initiate commercial manufacturing.
  • In some cases, the product may be commercially available (this is the case with many web startups).

EXPANSION STAGE

  • These later stages include various rounds of financing to help your company become profitable or scale.
  • Typically “second stage” financing occurs when your company is post-revenue, but maybe not profitable, whereas “third stage” financing contributes capital for major expansions to an already profitable business.

BRIDGE / MEZZANINE

  • This round helps companies position themselves for exit, e.g. IPO or strategic acquisition by a larger firm.

Venture Capital Investor Types

1. Friends and Family
2. Angel Investors
3. Venture Capital Firms

Venture capital can come in many different forms, but the two that are most commonly distinguished are angel investors and venture capital firms. What distinguishes angel investors from VCs is that VCs typically have some combination of increased 1.) amount of capital, 2.) investor sophistication, and 3.) influence over business decisions. Angel investors are wealthy individuals or groups of indivudals (e.g. Grand Angels) who help young companies get off the ground. While in theory you could have angel or venture financing as your first source of capital, angel investing typically occurs at the seed or early stages and forms a bridge to later rounds of venture capital financing. The difference between friends and family and angels is that you know your friends and family, and they typically don’t have as much money and aren’t as willing to part with it.

This delineation inevitably lacks the level of nuance appreciated by most connoisseurs of finance. But I hope that what it lacks in nuance it adds in clarity. If you’d like to dig deeper, I’ve listed a few resources I used while writing this post.

Resources
1. CFA Level One Curriculum on Stages in Venture Capital Funding, available online at Investopedia.com.
2. Macabacus.com, Venture Capital: Rounds of Financing.
3. Wikipedia on Venture Capital.