News about series funding or staged investments from venture capitalists

This is the third post in my series on How a Venture Capitalist Firm makes money. Part one, two, and four, are also available. I’m going to explain why venture capital firms invest in stages rather thanin a one-time largeinvestment. This will illustrate why Facebook receives rounds of investments.

Venture capitalists want to have some control in their investments. By staggering their investments in rounds, they can evaluate if the startup should receive more money or not. In this way, the VCs can monitor the entrepreneur’s progress and gather additional information to make a sound investment.

From the book “The Venture Capital Cycle - 2nd edition”, we have the Apple Computer’s story that illustrates this well:

“Apple Computer received three rounds of venture capital financing. In the first round, venture capitalists invested $518,000 in January 1978 at a price of $0.09 per share. The company was doing well by the second round of venture financing in September 1978. Venture investors committed an additional $704,000 at a price of %0.28 per share, reflecting the progress the firm had made. A final venture capital infusion of $2.331 million was made in December 1980 at $0.97 per share. At each stage the increasing price per share and the growing investment reflected resolution of uncertainty concerning Apple’s prospects.”

These rounds of investments may be called Series A,B, C, or even D.

From the entrepreneur’s side, these rounds of investments may mean that they achieved a milestone event such as breakeven, getting their 1,000,000th customer, having the patent granted, or having the drug trial phase IV passed.

In our Facebook and Accel example from my previous post in this series:

“Facebook received its first investment of US$500,000 in June 2004 from PayPal co-founder Peter Thiel.[25] This was followed a year later by $12.7 million in venture capital from Accel Partners, and then $27.5 million more from Greylock Partners.[25][26] A leaked cash flow statement showed that during the 2005 fiscal year, Facebook had a net loss of $3.63 million.”

So, Facebook had at least three rounds of investments by 2005.

- Peter Thiel: US$500,000

- Accel Partners: US$12.7 million (Accel invested probably because Facebook achieved some milestone)

- Greylock: $27.5 million (Greylock invested probably because Facebook achieved some milestone, but probably it had to pay more for less share)

- Microsoft’s: $240 millionAccel and Greylock likely invested because Facebook achieved a milestone event. Microsoft’s rather sizeable investment occurred much later than the others investments.

Let’s pick up Accel’s investment and see how it increased in value.

“Among venture capitalists it’s a poorly kept secret that Facebook’s valuation came in just shy of $100 million. Assuming that’s true (Mr. Breyer declined to say), Accel paid a little more than $12 million for roughly a 15 percent share.”

Usually, when a company receives a round of funding with increasing value (a higher price-per-share), no previous investors require more shares of the company. If the company has a “down-round” (the price-per-share of the latest round is lower than the previous one,) usually the VCs require more new shares to compensate for their loss in the valuation. I explain this here.

So, in later reports, Accel still has 11% of Facebook. This means at the time of Microsoft’s investment, Accel’s investment was valued from $12.7 million to $1.65 billion. That’s an increase of 130 times their initial investment!

Other VCs and investors invest in Facebook because they hope that their shares will similarly increase the value of their investments.

Is this the way VC makes money? Not quite This is simply the value of their investment. They still need to “transform” their shares of the company into money.

This transformation is what VCs call an “exiting event”.

The “exiting event” can be divided into four types:

- Staying private

- IPO

- Bankrupt

- Acquired / Merger

In the part 4 of this series, I will show what each of the exits would mean for Accel’s investment. Then, we’ll really see  how VC firms make money.

In this post, I’ve gathered info fromm these pages:

Twitter Raises $35 Million Series C From Benchmark and IVP

MARINUS PHARMACEUTICALS RAISES $20 MILLION IN SERIES B FINANCING

Wozniak’s storage startup Fusion-io raises $47.5M more

Irvine Chip Startup WiSpry Nabs $10M Funding