A Guide to the Venture World: Stages of a Venture Deal

Venture capital investment is a high-risk, but potentially high-return process of investing capital in startups and companies with significant growth potential. Venture deals have a clear structure and go through several stages, each requiring careful preparation and analysis.

1. Sourcing and selection of startups

The first stage of a venture deal is sourcing promising projects. Venture investors, whether funds or business angels, actively study the market to find companies with high growth potential. This can happen through:

— direct applications from startups: Founders send pitch decks describing their idea, business model, and potential
— networking and events: Venture investors attend startup events, accelerators, and demo days to find interesting projects
— data analytics: Modern funds, such as SignalFire, use artificial intelligence and big data analysis to identify promising startups. For example, they analyze 10 million sources, including patents, publications, and sales data, to find companies with high potential.

For example, the venture fund Sequoia Capital discovered Google in 1999 through personal contacts with the founders. An investment of $12.5 million brought in billions after the IPO in 2004.

2. Initial assessment and due diligence

Once a startup attracts the investor's attention, the initial assessment and due diligence stage begins. At this stage, the investor examines:

— the team: experience and competencies of the founders
— the product: presence of a minimum viable product and its uniqueness
— the market: growth potential and competitive landscape
— financial metrics: revenue, business model, and forecasts
— legal aspects: company structure, presence of patents, contracts.

Due diligence can take from several weeks to months. Investors often request access to financial documents, customer reviews, and technical documentation. At this stage, a non-disclosure agreement is also signed if the project requires confidentiality.

3. Negotiations and term sheet

If the startup successfully passes due diligence, the parties move on to negotiations and drafting a term sheet — a preliminary document that fixes the main terms of the deal. The term sheet includes:

— investment amount
— equity stake: typically, venture investors receive 15–25% at early stages and 12–15% at later stages
— company valuation: pre-money and post-money valuation
— investor rights: for example, the right to participate in an IPO or protection against dilution
— exit conditions: provisions regarding the sale of the company or IPO.

A term sheet is not considered a legally binding document, but serves as the basis for further agreements.

4. Legal documentation of the deal

After agreeing on the Term Sheet, the parties proceed to the legal documentation of the deal. Legal documentation includes a shareholders' agreement, a share purchase agreement, or option agreements. At this stage, a cap table is also formed, reflecting the distribution of shares.

5. Investment and tranches

After signing the documents, the investor transfers the funds. Often, investments are provided in tranches, which reduces risks: each tranche is tied to the startup achieving certain milestones. For example, launching a product or reaching a certain revenue level.

6. Support and scaling

Venture investors not only provide capital but also help the startup grow. This may include: 

— expertise: consultations on strategy and management
— network: access to partners, clients, and new investors
— resources: assistance in hiring key employees or developing the product.

At this stage, the startup works on scaling the business, increasing revenue, and preparing for the next rounds of funding.

7. Exit from investment

The final stage of a venture deal is the investor's exit from the project with a profit or loss. The main ways to exit are:

— IPO, Initial Public Offering: the company goes public, and the investor sells its shares. For example, Google's IPO in 2004 brought huge profits to early investors
— M&A, Mergers and Acquisitions: selling the company to a strategic buyer. For example, Facebook's acquisition of WhatsApp in 2014 for $19 billion brought Sequoia Capital investors multiple returns.

— secondary sale: the investor sells their stake to another investor or fund.

The average duration of a venture investment is 5–10 years, and only 10% of projects bring significant profits, compensating for losses from failed investments.

For example, Facebook investors, including Peter Thiel, exited with a profit after the company's IPO in 2012, earning billions on an investment of $500,000.

Main stages of venture funding

Venture deals go through several stages that correspond to the stages of startup development:

1. Pre-seed: investment in an idea or prototype. Main investors are founders, FFF — friends, family, fools, or business angels.
2. Seed: funding for creating an MVP and studying the market.
3. Series A: investment for scaling the product and entering the market.
4. Series B: funding for expanding the business and increasing market share.
5. Series C and beyond: preparation for an IPO or major M&A.

Each stage increases the company's valuation but reduces the stake received by the investor due to lower risks.