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What Entrepreneurs Need to Know About Late-Stage Venture-Capital Investors

If you're looking to scale up one day, it will pay to know now about how late-stage investing works.
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Venture funding of early-stage companies struggled significantly in the first half of 2011, falling 48 percent in terms of number of closings and capital committed. But late-stage funds had their strongest first half since 2007, according to Dow Jones LP Source.

Investors like Todd C. Chaffee, general partner at Institutional Investment Partners, a Menlo Park, Calif., venture firm, are bypassing hot, young startups for more mature companies. With investments that include Twitter, Zynga and LivingSocial, his firm has an eye for successful digital brands. Here, Chaffee weighs in on what businesses need to know about working with late-stage investors.

Why the strength in late-stage investing now?
In a word, it's probably returns. We've been seeing some high-profile IPOs and late-stage firms with favorable returns, so people are chasing the market. It's easier to spot the later-stage companies that are growing well, so they tend to attract more capital. It's low-risk capital, and you get a faster return. We look for a minimum of three to five times return on investment in three to five years.

What is the difference in an entrepreneur's relationship with a late-stage vs. an early-stage investor?
The early stage is much more driven by the entrepreneur, where you're taking an idea or a nascent technology and developing it into something that's going to have high impact in the marketplace. Late-stage and growth-stage are really about scaling, so the issues are different. Running out of space is something we deal with a lot, or helping a company go international. At this stage, the competitive landscape gets much more complex, because now you're on the radar of the big players, so you end up having a lot of discussion of partnerships vs. alliances, deciding when to fight fire with fire against this big incumbent.

What does it take for a company to attract a late-stage investor?
First, they need to have an excellent grasp of the market, and the team should know how it plans to win against both small players and large incumbents. They should have a clear description of the products and how defensible they are against competition. We want to know about the state of their technology and whether they need to bolster that infrastructure. Generally when companies come to see us, they've got most of the management team in place but still need a few key hires, which we can help them make.

How big does a company need to be for a late-stage investor to take it seriously?
We only look at companies that have at least $10 million in revenue, because ideally we like to be putting $50 million into a company, and you have to be a certain scale to take that much capital. There are two phases of our business: taking you from $10 million to $100 million, which is generally when you'll go public; then taking you from $100 million to $1 billion.

What should an entrepreneur look for when choosing a venture partner?
Does the firm have a culture of integrity and support? What's their reputation with the street, and do they have experience in your sector? How deep are their pockets? If they're making a $20 million investment, can they reserve $50 million against that? Having a war chest is important, because it indicates the firm is stable and has assets to help you grow. Finally, will the firm invest in the public market? We actually follow our companies into the public markets, and we'll buy on the initial public offering. You want a firm that will support you all the way up the growth ramp.

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