Venture Capitals Stages of Financing Buyouts Buy-ins

Early Stage Financing: The European Venture Capital Association defines early stage finance as finance provided to companies that have completed development stage and require further funds to initiate commercial manufacturing and sales. They will not yet be generating profit. This is the kind of financing required for completing the project. It is required immediately after the start up stage of a project. The enterprise may need further investment before completion of the project. The need for additional funds arises when the project encounters cost and time over runs or when the completed project starts making losses, thus necessitating the infusion of equity type funding. This type of funding may also be required when the start up has been successful and the business is growing.

Follow up on financing:

The European Venture Capital Association defines follow up financing or second round finance as “the provision of capital to a firm which has previously been in receipt of external capital but whose financial needs have subsequently expanded”. Later stage in a project is that the project has passed the best of acceptability and has proved to be successful. Since project at this stage promises to be attractive in terms of earning potential it is considered to be the most attractive stage for venture capital financing. Financing, at this point in the project, is preferred by ventures capitalists around the world particularly in the UK and USA.

Expansion Financing:

The European Venture Capital Association defines expansion capital or financing as “the finance provided to fund the expansion or growth of a company which is breaking even or trading at a small profit. Expansion or development capital will be used to finance increased production capacity, market or product development and/or to provide additional working capital. This is one of the later stage financing methods, whereby finance is provided by the venture capitalists for adding production capacity, once it has successfully gained a market share, and faces increased demand for the product. Financing is also made available for acquisition or takeover.

Replacement Financing:

A later stage financing method also known as ‘money-out deal’, whereby venture capitalists extend financing for the purchase of the existing shares from an entrepreneur or their associates in order to reduce their holdings in the unlisted company, is known as ‘replacement financing’. This sale of shares may be by persons other than entrepreneurs or their associates. The venture capitalist may buy ordinary shares from vendors and may convert them into preference shares bearing a fixed dividend coupon. Such shares may be converted back into ordinary shares if the company is listed and can thereafter be sold.

Turnaround Financing:

This is the type of financing provided by the venture capitalists in the event of an enterprise becoming unprofitable after the launch of commercial production. This is provided in the form of a relief package from the existing venture capital investors, and the enterprise is provided with specialists skills to recover. This form of financing is popular in the US. Finance is made available to a non-listed and non-profitable venture in need of equity funds to allow for a turn round. The finance may also be provided to sustain the current operations of the enterprise.

Mezzanine Finance:

The last stage of equity related funding is known as ‘mezzanine financing’. It is half way between equity and loan capital, in terms of risk and return. It is often the last type of financing supplied to a private company in the final run up to a trade sale, or a public floatation. Mezzanine financing is supplied as a layer, which ranks behind secured lending, but before ordinary share capital. Thus mezzanine funding may be supplied either as debt (high coupon bonds), or as high ranking equity (preferences shares)

Mezzanine finance is intended as bridge finance, and has a maturity period of less than 2 years. When structuring a MBO, the provision of mezzanine finance allows the management to retain a greater share of the business than could be afforded.