Understanding the Development Stage in a Business Life Cycle

What Is the Development Stage?

The development stage is the first phase of a business life cycle, when a new company focuses on market research, product development, and building a workable business model. It's high-risk and often cash-flow-strained, but it can offer higher returns for investors if the company succeeds. Pebble Technology is a common example of how this stage can swing from promise to failure.

Understanding the Challenges and Opportunities in the Development Stage

Development-stage companies have often not generated any revenues. At the same time, they may be incurring mounting expenses as they seek to ramp up operations. Development-stage companies are prone to chronic cashflow shortages and have a high rate of failure. Investors in development-stage companies must therefore have a high risk tolerance, and often seek to reduce their risk through diversification.

For investors who have the financial resources and temperament necessary to bear the associated risks, investing in development-stage companies can occasionally produce fantastic returns. Whereas most development-stage companies are unlikely to reach success, the few that do become successful can attain valuations that are tens or even hundreds of times that paid by their earliest investors. For this reason, venture capitalists (VCs) and other early-stage investors often find that a very small percentage of their portfolios are responsible for a large percentage of their overall return on investment (ROI).

The development stage is a famously difficult period in the life of any business, as the company’s founders must attempt to develop their business model despite while also relying on relatively meager and uncertain financial resources. Oftentimes, early-stage investors will only provide funds in stages; the next installment of their funding is conditional on the achievement of specific performance objectives.

For developing companies, this uncertain funding outlook can make it challenging to attract and retain new customers and employees who may be reluctant to sign contracts with a company that might prove unable to deliver on its promises. Similarly, investors face a very high risk of failure when backing development-stage companies because these companies’ business models are still relatively untested. When these investments fail, moreover, investors often lose all of their invested capital.

Real-World Example: Pebble Technology's Journey Through the Development Stage

An example of a development-stage company was Pebble Technology, an early product innovator in the market for wearable devices. Pebble Technology created one of the first commercially viable smartwatches, attracting widespread attention through its successful crowdfunding campaigns.

Through its flagship product, the Pebble Watch, the company attracted growing demand from consumers before encountering cashflow difficulties in its attempts to scale up production. Eventually, Pebble Technology became insolvent and sold off its assets to its competitor, Fitbit (FIT).

The Bottom Line

The development stage is the first and often toughest phase of a business's life cycle, when companies build a business model and develop products with limited resources and a high risk of failure.

Investors with high risk tolerance may see substantial returns if the company clears early milestones, but funding is often staged and tied to performance targets.