The Company Life Cycle and the 4 Stages of Venture Capital Fundraising
Last week I gave an ‘introduction to fundraising’ to the team of a startup where I am on the advisory board. I talked about the different stages of venture capital fundraising and decided to map them to the company life cycle. Doing so provides a framework for thinking about which investors to talk to at each phase of your company’s life.
The Company Life Cycle
The Company Life Cycle is an old concept but still helpful in thinking at a high level about the different phases of a company’s life. There are four:
- Startup
- Growth
- Maturity
- Decline
There is no strict definition but think of the Startup phase as the period where you go from an idea to product-market fit. Maybe this happens in the first 2–3 years.
Once you’ve found product-market fit, you go from a small number of customers to a large number of customers. For this, you need to scale the company. It is all about Growth. Growth in terms of your team, revenue, and quality of your product or service. Maybe this is the focus of years 3 to 10. The Growth period can be long and extended, especially if you are in a growing market as is the case for many technology startups.
At some point in time, your company is ‘established’. You have a solid customer base and your business operations are running smoothly. There is definitely still growth potential, but the days of hyper-growth are over. This is when you have reached Maturity. Your primary focus is no longer on growth, but on optimization.
Just as with most things in life, a period of Decline is inevitable. Your innovative edge is no longer defensible and new kids on the block are pushing new technologies and business models at an ever-increasing pace. The disruptor is being disrupted. Think about how Nokia got disrupted by Apple with the introduction of the iPhone. Think about how Walmart got disrupted by Amazon. Think about how Volkswagen and other carmakers are being disrupted by Tesla. Getting disrupted does not mean that life is over, but it does mean that you have to fundamentally change the way how you are doing business in order to survive.
Types of Investors
Each one of the life cycle phases is characterized by a different risk and return trade-off, and therefore attracts different types of investors. So before talking about how the different stages of fundraising map to the company life cycle, let’s look at the different investor species that are out there.
I am going to skip banks and providers of grants and focus on financiers who invest in the equity of a company. Banks provide funding through debt (loans) and are typically not interested in financing startups. Grants mostly come with little or no strings attached and you don’t have to issue equity or debt (which is why grants are great for you).
I want to talk about the following types of investors:
- Founders, family, and friends (FFF)
- Venture capital (VC) investors
- Private equity (PE) investors
- Strategic investors
- Public investors
Founders, Family, and Friends (FFF)
Although not your typical ‘investor’, this category is often your first source of fundraising. You have an idea for a new business. But who is going to put money into something that is just that, an idea? Exactly: your mom, dad, and wealthy uncle, who have known you all your life and know how talented and gritty you are. As the founder, you chip in your savings and max your credit card. Maybe your family provides the money as a gift, a loan, or they get common stock in your newly founded company. These funds get you started.
Venture Capital (VC) Investors
Venture capital investors are known as financial investors, meaning their main objective is financial return. (This is different from FFF discussed above, which you could argue, are love investors as they may largely invest out of love for you as a person.)
Venture capital can be broken down into sub-categories known as ‘stages’. These stages can be mapped to the company life cycle, which we’ll do in a minute. The four stages are:
- Pre-seed
- Seed
- Early & growth
- Late
Pre-seed investors provide capital in the earliest days of your company. The types of investors you’ll see in this phase are FFF and angel investors. Angel investors are private individuals who are wealthy enough to make risky investments in startups. What you’ll often see is that these angels are (former) entrepreneurs who have sold a company and got rich. The proceeds from a pre-seed funding round are used to build the first version of your product and test initial market demand.
Your goal with the pre-seed money is to find early adopters and get enough traction to convince Seed investors to give you money to build your minimum viable product (MVP). Seed investors include seed funds and angel syndicates. Seed funds are professional investors, whose day-job it is to make and manage investments in startups. Angel syndicates are groups of angel investors and can be more or less organized. The difference between the two is that Angel syndicates invest with their own money, and seed funds invest (largely) with someone else’s money.
With the seed funding, your goal is to find product-market fit and build your customer base. With enough traction and growth potential, you spark interest from Early & Growth-stage investors. These include your typical venture capital funds, such as Andreessen Horowitz, Union Square Ventures, and Sequoia Capital. You may also see strategic investors, including corporate VC arms. Corporate VC’s are the investment entities of large companies that invest in startups. Examples include Samsung Ventures, Google Ventures, Intel Capital, and Novartis Venture Fund. VC investors often invest over multiple rounds of financing, structured as Series A, Series B, Series C, and so on.
The lines between Early & Growth and Late-stage can be fuzzy, but generally, Early & Growth-stage investors participate in Series A and B rounds, and Late-stage investors in Series C and up. Some VC funds are structured in such a way that they can do follow-on investments in late rounds to roughly maintain their ownership. An early-stage investor leading your Series A round may also participate in the Series B and C rounds, led by a different investor. What this indicates is that relationships with your investors can span many years, so you better choose your financial partners wisely.
Strategic Investors
Strategic investors are investors whose main reason for investing is not financial but strategic. An example here is Walmart acquiring Jet.com, an e-commerce platform that competes with Amazon. Amazon is increasingly taking away market share from Walmart, as shoppers increasingly buy online. In order for Walmart to protect its market share and compete with Amazon, it needs digital capabilities. By acquiring Jet.com Walmart gets these capabilities in-house, and the acquisition can thus be seen as a strategic investment.
Private Equity (PE) Investors
Private equity investors, just like VC investors, are financial investors and their main objective is financial return. Private equity invests in private companies (i.e. not publicly listed and part of an index like the S&P 500) that are in the maturity or decline phase. PE investors are looking to invest in companies where there is an opportunity to maximize cash flow. For mature companies, free cash flow is a key driver of a company’s value and hence the price the PE can sell the company for in the future. PE investors are looking at companies where they can cut costs, that can be broken up and sold in parts, or that can be combined with other companies to achieve economies of scale. Examples of private equity investors are KKR, CVC Capital Partners, and The Carlyle Group. PE investors occasionally invest in late-stage rounds that normally are the playing the field of VCs. One reason for this is the emergence of mega-rounds that require deep pockets, and PE funds tend to be larger than VC funds. Another obvious reason is the attractive returns that can be made in these large tech deals.
Public Investors
Public (equity) investors, like you and me, pension funds, and asset management funds, invest in companies whose shares are publicly listed and typically are in the late-growth or maturity phase. This is because in order to go public you have to be of a certain size to handle all that comes with a listing (financial reporting, corporate governance, and so on). A company can go public through an Initial Public Offering (IPO), which is the process of listing the shares of a private company on a stock exchange and offering these shares to the public.
Mapping VC Fundraising Stages to the Company Life Cycle
Now that we have an idea of the types of investors and VC stages, let’s look at how this maps to the company life cycle.
As you now already know, venture capital fundraisings occur in the startup and growth phase of the company. More specifically, pre-seed and seed rounds happen in the Startup phase to get things off the ground. Early & Growth and Late-stage rounds take place in the Growth phase and are used to accelerate the growth of the business.
To complete the picture, the maturity stage is where you no longer see VC investors. Instead, this is the phase in a company’s life cycle where PE and public investors play an active role. The role of PE investors may extend into the decline phase, where they seek to create value through optimization, turn-arounds, or restructuring.
The different phases of the company life cycle are characterized by different risk and return trade-offs. Startups are perceived as riskier than growth or mature companies, but investing in them is associated with higher expected returns. Mature companies have lower growth rates, but there may be an opportunity to cut costs and squeeze profit margins, resulting in attractive pay-offs.
Understanding which life cycle phase your company is in will guide you in deciding which investors to talk to. Fundraising is a time-consuming process that will distract you from your day-to-day responsibilities. You want to make your effort as efficient and effective as possible. Do your homework, get yourself familiar with the different concepts, and increase your probability of success.
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