We have briefly tackled what venture capitalism is and who a venture capitalist (VC) is in part 1. Last week we looked at early stage financing and the purpose of the 2 legs of financing at this stage in preparation for growth stage financing.

This stage comes right after the early stage where the entrepreneur has sourced funding from personal savings and family. By this time, the establishment has already taken off and ample research has been conducted by the entrepreneur regarding demand and supply of the product or service being offered in the market. The most immediate need at this point is the stable generation of cash flow to support operation of the venture. Funding sources associated with this stage include:

Series A

This refers to preferred stock that is offered to the VCs in exchange for funding the business. The objective of this round is to finance the company’s product development and inventory. Preferred stocks assure the investor of dividends payable at the end of every period and comes after stock options are given to the founders and fund contributors in the early stage. These stocks also have the effect of giving part ownership of the company to the VC and may range from 15% to 30% (or higher depending on negotiation). As such, the entrepreneur has to reshuffle his/her capital structure and decide whether they want a larger portion of their capital to come from equity or from debt. The former usually applies to companies that offer services since cash flow is dependent on consumer traffic while debt is preferred when dealing with the manufacture of products. Conversion of the preferred stock by the VC to common stock can be done at their and is usually the case when the company is later sold.

Series B

This series comes right after round-A if the product or service in mention have penetrated the market and whose sales are growing. The customer base is being established and the company at this point may seek to increase the range of products or services offered. Focus is now shifted to customer deployment and market share growth as the company looks to rival its competitors. Marketing plays as important a role as it did in the seeding stage since their cash flow will depend on customer reach and competition from rivals in the same industry. Resource allocation is occurs in this stage as a more focus is given to the sales and marketing functions. Cost cutting is also exhibited by many a venture in this stage since the companies are looking to get returns well over their break-even point.

The risks associated with this growth stage are mostly cash flow oriented since it is mainly characterized by capital structure changes and resource allocation. The company is also exposed to a bad debt risk as assumptions made are that the customers will all pay for the product when required to.

This is the third instalment of a 4-part series covering financing for business start-ups. Next week shall be the last of these and shall cover financing at the late stage of a business. By which time your startup should, in theory, be running itself.