ACARREOS

Although there is partially no consistent classification of the investment stages a VC can invest in, German literature basically has adopted a differentiation into eight stages:82

Seed: This first stage is characterized by the promotion of the original product idea or

proposal of the potential founders of the venture business to-be. Main focus is put on the development of the business model and a first prototype. By primarily investing in research and development activities, utilizable results are to be achieved.83 Major challenges during this phase are the balanced and sustainable evaluation of the product idea and of the market environment as well as the extent of the management support needed.84 All activities during this stage aim at preparing the venture for its official foundation.

Start-up: This stage refers to financing of venture business' foundation. The required

capital is employed for initial marketing efforts as well as the preparation of production.85 At this point in time, the newly-founded firm has not yet started or recently begun to sell its products or services on the market. Establishing trust to the involved venture capital

80 _{See Arnold (1989), pp. 211 ff. An early buy back of the shares is often restricted to the existence of} specific reasons, which have been defined beforehand, or to potentially long cancellation periods. See Schefczyk (2004), p. 37.

81 _{Which of the investment stages are focused on will be explained in detail in section 5.1.1.2.} 82 _{This categorization is also used by the BVK. See BVK (2005c), pp. 35-36.}

83 _{See Rams/Remmen (1999), pp. 687 ff. Also see Wupperfeld (1994).} 84 _{See Schefczyk (2004), pp. 41-42; Frommann (1991), p. 733.} 85 _{See Beyel (1987), p. 658.}

Venture Capital 26

providers and the recruiting of qualified personnel represent major challenges during this stage.86 By taking up personal loans, receiving financial support from governmentally- funded loan programs, or by establishing cooperations to other businesses in related industries, entrepreneurs may significantly incite VCs and thereby compensate for potential deficiencies, for example regarding the business plan.87

Expansion: Some authors, for example Rams and Remmen (1999), Leopold (1993), or

Weitnauer (2001)88 refer to the terms 'first stage', 'second stage', and so on. Due to this inconsistency with respect to other literature, the more concrete terminology as given, for example, in Schefczyk (2004), Frommann (1991), or the BVK is adopted. During this stage, investments are directed to expand the production of the business, which finds itself approximately at the break-even-point. Emphasis is put on product modifications and product differentiation as well as on the increase of the company's market share. Major challenges are the establishment of an image and positioning in the market as well as the raising of debt capital. Despite a strong interest of VCs in seed-, start-up-, and expansion-financings during the period from 1997 until 2000, the investment focus has shifted to later stages in recent years.89

Bridge: In bridge financings, funds invested are employed to prepare or 'bridge' the time

period until the disinvestment of the VC. Above all, these financings help to set up the venture business to be taken public in an IPO or to promote the growth of the company, resulting in an improved positioning vis-à-vis an industrial investor in a trade sale.90 Challenges regarding the organizational structure and processes as well as a strengthened competition on product markets are critical factors during this phase. Often, bridge financings are provided by the banks accompanying the IPO in the form of the so-called

86 _{See Schefczyk (2004), pp. 41-42; Frommann (1991), p. 733.}

87 _{See Nevermann/Falk (1986), p. 74. Sometimes, the terms 'first stage', 'second stage', and so on, are used} in literature as well. See Leopold (1993), p. 356. However, since these expressions are partially also used for the expansion stage (see Weitnauer (2001), pp. 10-11.), they are not applied here.

88 _{See Rams/Remmen (1999), pp. 687-691; Leopold (1993), pp. 345 ff.; Weitnauer (2001), pp. 10-11.} 89 _{Also see the development of the (German) venture capital market in chapter 2.1.2. See also}

Nevermann/Falk (1986), pp. 75-76.

mezzanine capital, being an intermediate form of capital in-between equity and debt capital.91

MBO/MBI: The MBO or MBI refer to the takeover of a company by the internal (MBO)

or external (MBI) management.92 In MBO/MBI transactions, often the lack of financial resources and cohesion of the management team represent particular challenges.93 In an MBO/MBI the management holds at least 10% of the company's shares.94

LBO: In an LBO, investors take over the company while the management does not hold

more than 10% of the company's shares.95 In an LBO, the company takes on a significant amount of debt, which should be paid back over a comparably short period of time.

Replacement Capital: This form of financing refers to the acquisition of company shares

from an existing shareholder, i.e., from an existing equity capital investor.

Turnaround: In a turnaround financing, a company receives funds after having overcome

significant economic difficulties, for example a downturn in sales. At this point in time, the investment aims at promoting the economic constitution of the company.96

A condensed illustration of these investment stages is given in table 2.1.

91 _{For a discussion of financing with mezzanine capital, see, for example, Gereth/Schulte (1992); Golland} (1999). 92 _{See Frommann (1991), p. 734.} 93 _{See Frommann (1993), pp. 444-446.} 94 _{See BVK (2005c), p. 36.} 95 _{See Schefczyk (2004), p. 41; BVK (2005c), p. 36.} 96 _{See Schefczyk (2004), p. 41.}

Venture Capital 28 Early Stage •Original product idea •Market analysis •Prototype •Concept development Seed Start-up Investment Stages Stage of company Expansion

Stage Late Stage

Expansion Bridge MBO/MBI

•Foundation of the firm •Initial marketing efforts •Readiness for production •Expansion of production •Differentiation of product(s) •Image/market positioning •Preparation of - an IPO - a sale to an industrial investor (trade sale) •Takeover by internal management (MBO) or external management (MBI) Profit/loss expectations of portfolio company t Sources of funds Own capital Governmentally-funded support program Debt capital Stock exchange Typical challenges for management •Evaluation of

product idea and market environment •Extent of management support needed •Establishment of trust to Venture Capital providers •Recruiting of qualified personnel •Creation of image and market positioning •Raising of debt

capital for further growth •Challenges regarding organizational structure and processes •Strengthened competition •Potential lack of financial resources of management •Potential lack of cohesion in management

Venture Capital Privat Equity

Table 2.1: Overview of investment stages97

While the so-called 'early stage' comprises the seed- and start-up stages, bridge financings as well as MBO/MBI transactions are considered to be 'late stage' financings. Expansion stage financings are classified to be in-between early stage and late stage investments. Although increasingly being offered by VCs, LBOs and replacement capital are, by its definition, not strictly allocated to venture capital financings. The comparably large late stage financings are also referred to as private equity.98 Turnaround financings represent a special case of financings by VCs. However, they cannot be integrated into this chronological development of investment stages.99

So far, a common understanding has been established as to the types of firms being active in the venture capital market, the characteristics of the portfolio companies, and the

97 _{According to Schefczyk (2004), p. 42; Schmidtke (1985), p. 50; Klemm (1988), p. 41.; own illustration.} 98 _{For an explanation of the different uses of the terms 'venture capital' and 'private equity', also see}

chapter 2.1.1.

various investment stages a VC can invest in. In addition, what is important to understand, is the value-generating process of a VC. Since this study will analyze the deal flow of VCs, and since deal flow is one part of that value-generating process, it is helpful to put that part into the bigger picture of the entire value chain.