Step 1: Formation
In the first stage an entrepreneur will have an idea–some market need or want is not being met, and the entrepreneur has a unique solution to fulfill that need or want. At this stage there are few people involved, maybe a team of one to two people inside the company. In most cases, those two will work to build up the company, but increasingly financiers have gotten involved through startup incubator programs. To identify potentially successful companies, incubators rely on a lot of qualitative factors: who the founders are, how popular they think the company’s product will be, and how likely it will be that the company can produce that product and bring it to market.
Step 2: Pre-Revenue
The second stage is the pre-revenue stage–this is where the entrepreneurs have begun building up the company and, ideally, have established some standard operating protocols and a strategy to go to market, get a customer base, and grow. This stage usually involves a lot of marketing and promotion; you need to get ahead of your potential audience and wow them with your company’s new product. At this stage, seed investors might get involved if they see your product before the general public has found value in it. Obviously, the best seed investors are those who have a good sense of the market the startup is working in, and who are willing to put their money where their mouths are.
Step 3: Hyper Growth
Once a company has released its product, next is (ideally) hyper growth. One customer becomes two that becomes four and so on and so forth. It is at this stage that many companies fail–they may have a good product or a good idea, but the market is not willing to pay the economic value of the product or, at least, not pay the price that the company wants to charge. In hyper growth, the ability to market and to compromise with the market’s desires are key. It is at this stage where conventional financial analysis comes into play; at this stage, usually referred to as the Series A, B, C, and D rounds of funding, a mixture of the qualitative analysis of the market and the quantitative tools of financial analysis are used to determine the company’s future revenue and, thus theoretically, its future value.
Step 4: Growth
You can think of the growth curve of a company as kind of the curve of Mount Fiji–it should shoot up sharply from 0, rise higher at a less severe slope, until it finally levels off. When the slope starts to get less severe, it’s gone from hypergrowth to growth. Historically, this was the moment at which companies would IPO, but increasingly growth companies are staying private. Either way, funding rounds depend more on quantitative financial analysis than qualitative, but the latter still plays a part.
Step 5: Maturation
Typically many years after a company’s IPO, it will mature into a slow, steady, and somewhat predictable rate of growth. The difference between a growing and mature company is somewhat arbitrary and subjective, but revenue growth less than 10% per year, and a growth rate that is relatively stable, are typical signs of a mature company. These companies will typically be valued in pretty predictable and narrow ranges, dictated by the company’s sector and its peers. A mature company appeals to value investors, and it is here where dividends and buybacks become an important part of the company’s value to shareholders.
Step 6: Consolidation
Following a company’s maturation, it can last in the market for many, many decades–but eventually it will end. This can happen in a few ways, but the most common will be it will be acquired by another, newer company that sees value in its history, marketplace, or products. Another possibility is that the company will simply go bankrupt or cease operations; this is pretty rare, as mature companies that have stagnated have a lot of assets of value that they can sell off to other companies. Even firms that do go bankrupt, most notably Bear Stearns, do not entirely disappear, but their parts are bought by other firms (JPMorgan (JPM) bought Bear Stearns, where much of the company still survives). In the consolidation process, financial analysis becomes entirely quantitative, and companies are retired one way or another based entirely by how the numbers work.