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The following was written by guest blogger Dave Stech.
Have you ever had a phone call, or an early-stage venture “deal” hit your inbox, and you didn’t know what to do or even where to start? Welcome to the club; we all start there.
Early-stage venture investing can be a rewarding endeavor, but it’s not nearly as straightforward to evaluate as real estate or private lending. If you don’t understand it, you are at material risk of getting it wrong, especially since early-stage deals are often pre-product, pre-revenue, and pre-results.
Our family office invests in only three things: real estate, private lending on real estate, and early-stage venture capital or private equity deals, mostly disruptive technology companies. Having done a lot of all three and realizing that private equity investing is the least understood, we put together a simple, yet powerful framework for assessing deals. We hope you become a better-informed investor and find the deals with the best likelihood of success and eventual return on investment, both money and time.
What is venture capital?
Let’s start with the basics. Venture capital (vc) is a type of private equity and is typically provided by outside investors to new businesses that show promise for rapid expansion and valuable enterprise. These investments are often high-risk, especially in their early stage, yet offer the potential of high reward.
It’s also important to note that venture capital is long-term investing, meaning it doesn’t produce regular cash flow. In the early stages, the opportunity for high net worth investors (often called accredited investors) is greatest. These high net worth investors are often referred to as “angel investors” in the earliest stage of investing.
Private equity, the root of venture capital, can be traced back to the 19th century. Venture capital itself became an industry after the Second World War when a Harvard Business School professor, Georges Doriot, began raising funds for the American Research and Development Corporation. He raised $3.5 million to find companies that were commercializing technology developed during the war.
Stages of a venture deal
Seed Stage: The first stage of a vc deal is the seed stage, and sometimes pre-seed. This is the stage of a company that is pre revenue and pre-product. You’re investing in an idea and a great founding team. This is the highest risk stage because it’s speculation, which is why the founding team is so important. This stage is all about developing a product and getting traction.
Series A: The next stage is Series A. This is the stage where, typically, the product is built and there is some traction in the form of revenue. There’s still a significant risk at this stage, though less than the seed stage. This stage is about scalability of the established product. Benchmarks such as how the unit of production looks and revenue will be key here.
Series B: This stage is often when a business has meaningful revenue and growth. This is the point at which the downside has been materially de-risked.
There will always be risk, however there is compelling evidence that the business model is viable. The risk at this stage is much smaller and capital will be used for further growth—either in the core business or product line expansion.
Series C and Beyond: And then there’s Series C and all the way to G. We treat C-G as one large category. Consider this the “add capital” phase. The business is working, the core product is working, and the unit economics look good (or there’s a clear path to it). The team is impressive, there’s tremendous opportunity in front of them. They simply require the capital to realize it. Series C and beyond is really about taking a viable, stable business model to the next level.