4 Main Stages of VC Funding: What They Are and How To Prepare For Them?

Venture capital financing is one of the most popular and dynamic sources of investment for startups. In fact, venture capital (VC) funding has been growing at a rapid rate over the past few years as more and more entrepreneurs seek to secure funding from investors, who provide loans and other forms of initial capital in return for equity in the business.

It seems like every week there is a new funding round announced by one of the top VC firms. If you’re an entrepreneur, then it can be hard to keep track of all the new developments across the capital markets.

Different (including) new types of VCs can be understood much better in terms of stages of VC funding (seed stage, startup stage, early stage and expansion stage). The primary goal of any venture capitalist is to invest their money in businesses that are likely to grow at a high rate of returns over the course of several years.

This article examines the different stages of VC funding and how VCs finance their portfolio companies, and how this might affect you if your startup is seeking funding.

What is Venture Capital Funding?

Venture capital is capital invested in high-risk, high-potential startups in exchange for equity or other financial returns. It might also be used as a precursor to an acquisition of another company, or as a way to help fund expansion of the business.

A return on investment is anticipated when the startup invested by the VC gets large and materialize the investment, usually through an exit strategy like an initial public offering (IPO) or corporate acquisition.

VC funding is different from traditional bank loans or other forms of financing, as there are no guarantees that the investment will yield a return. In fact, VC funding is extremely speculative, with a significant chance of losing money for the investor.

While traditional financing is rarely risk-free, VC funding is a high-risk endeavor with a significant chance of not being profitable at all. Distinguishing VC funding based on various stages of VC funding will help to better understand how VCs invest in startups.

Stages of VC Funding

Stages of VC funding help to understand different types of investors. These stages depend on the stages of startup development. There are four primary stages of startups:

1. Seed stage: Validating the business model is the main goal of the seed phase. There will be important decisions made, such as choosing the technique a startup will use. This stage looks for a startup’s initial manifestations. More explanations of the seed stage can be found in this blog post.
2. Startup stage: The goal of this stage is to prove the beginning value hypothesis correct. Early development prototypes are not required to be working models or marketable goods. It should not be mistaken with an MVP, which needs to be both feasible and functioning. It’s time to go through several iterations until you find the best answer.
3. Early stage: The early stage denotes the start of the period during which the concept is allowed to develop until it is commercialized as a good or service. The time has come to start a test. It will now be evaluated to determine whether it is a Minimum Viable Product; it will not be the final version (MVP). The test is simpler because the minimum viable product is a model without all of its features.
4. Expansion stage: When a startup’s product or service reaches this point, there is a significant market need. This implies that new customer, recurring customer, and billing numbers will all increase. Profitability is key in this situation. At this point, recruitment commences and the team starts to expand. More explanations of the expansion stage can be found in this blog post.

You can read more about startup stages here.

Some investors will only invest in one of these stages in order to acquire a stake in the company’s ownership, while others might try to help the startup in various stages of VC funding to grow by providing advice, financial support, and access to potential buyers or strategic partners.

As such, most VC firms only invest in a handful of companies each year, and don’t pursue additional rounds of funding until a few years after the initial investment.

1. Seed Stage

One of the initial stages of VC funding is called the seed stage. The business owner must persuade the investors that the final product or service will be profitable and successful. The potential investor will subsequently look at the technical details of the good or service and the viability of the concept from an economic standpoint.

Compared to later stage investment, seed stage funding is typically minimal. A venture capital firm’s initial seed investment round typically includes between $250,000 and $1 million.

The funding might be used for management team development, market research, or product development. This is the earliest stage and typically the main goal is to prepare startup through validation of the idea and customer or some other stakeholders’ interviews to make sure the idea is worth-investing further.

The seed stage of funding generally lasts from 6 to 18 months. During this time, the venture capitalist provides funding in exchange for a small portion of the company’s ownership.

2. Startup Stage

In the startup stage, which is one of the stages of VC funding, the venture capitalist provides funding in exchange for a larger ownership stake in the company.

At this point, startups often have a sample product accessible, but future product development requires finance. A management team will also be assembled, and a business plan will be created.

Funding will also be used by the startup to carry out preliminary product market research. In order to assess whether the market is large enough and whether there are enough customers to purchase the product, the venture capital firm wants to see the findings of market research.

In order to advance the business into the next phase, investors also want to develop a reasonable projection of the investment required. At this point, given there is more clarity into the financial projection than previous stages of VC funding, VCs may also cover costs associated with hiring more management staff, improving the product, or funding new research.

3. Early Stage

Like the seed and startup stages, the early stage of VC funding is generally followed by an expansion stage of funding. In the early stage of funding, the good or service has been created and is currently available for purchase.

Investors now get their first chance to assess how the product compares to its rivals in the market. At this point, funding is frequently used for manufacture, sales, and extra marketing.

Here, investment levels may be much higher than in earlier phases. Depending on its share of the market, the corporation can also be approaching profitability at this point.

The venture capital firm will presumably give the startup the go-ahead for the next phase if it and its product can compete successfully.

4. Expansion Stage of VC Funding

The expansion stage, as the last among stages of VC funding, is similar to the early-stage of funding, but the venture capitalist provides a larger portion of the investment. The expansion stage of funding is generally followed by an IPO, in which the company will go public and sell shares on the stock exchange.

At this point, money is intended to scale the business and increase market share. A company might launch a new marketing initiative, invest in manufacturing facilities abroad, or take steps to cut production and other costs with the venture capital money.

Increased diversification and differentiation of product lines as well as development into other markets, such as those in other regions, cities, or nations, should be made possible by the investment.

The venture capital firm will then assess whether the management team has achieved the anticipated cost savings and how the startup performs in comparison to its rivals.

Conclusion: Toward an IPO

Venture capitalists are funding companies for the long term in exchange for ownership stakes. While this might sound risky, it’s important to note that VC funding is extremely speculative, with a significant chance of not being profitable at all.

This is why it’s important to plan for and prepare for funding scenarios, such as becoming a venture capitalist yourself.

Once the company has proven its revenues and profits, the next step for the venture capitalist is to seek an IPO. At this point, the venture capitalist will seek to sell shares to the public and generate a return on their investment.