Friday, February 6, 2009

Smart Money for 2009 -- Growth Stage Venture Capital

Rather than investing in new concepts and start-ups, growth stage venture capitalists focus on companies that are already profitable and relatively mature. These companies may be looking to enter a new market, to finance a bolt on acquisition, or to expand operations.

A recent Forbes article noted that in the current economic environment, venture money is gravitating away from the high risk/high return early stage investments to the more moderate risk/moderate return growth stage investments. This move towards growth stage investing may also be a result of the relatively large venture funds that have been raised in recent years. Growth stage investing requires larger investments (from $5 million to $100 million or more) and is more suited to the multi-billion dollar funds found in recent vintages. In an early blog post, I noted that these larger funds would also gravitate towards the capital intensive VC sectors that are popular now -- such as cleantech and biotech.

You may wonder why these companies that are generating revenue and have operating profits would turn to an equity investor rather than simply borrow the money they need, since debt is usually cheaper than equity. Typically, it is because debt is unavailable for one reason or another. Perhaps the company already has too much (or just enough) debt on its balance sheet or it has unstable or lumpy earnings that are difficult to borrow against. Or perhaps the new opportunity that the company sees is just too expensive for the company to finance entirely with debt.

Growth capital really exists at a cross-roads in the private equity world. On the one hand, it is frequently financed by venture capital funds that will approach it as a minority investment and will negotiate accordingly. On the other hand, larger private equity and buy-out funds will consider taking majority stakes or even minority stakes that have contingencies that can lead to buying the company as a whole -- e.g. buy/sell arrangements, put rights, drag along agreements and rights of first offer/first refusal.

For a broader treatment of the various financing stages a start-up company may pass through, check out my Flora and Fauna of Venture Capital blog post.

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Dividends and Preferences by Hank Heyming is licensed under a Creative Commons Attribution 3.0 United States License.