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VC funding is not a blank cheque with no strings attached

Receiving venture capital (VC) funding is a significant accomplishment for any entrepreneur as it takes months of hard work and negotiation. Some entrepreneurs believe that once they have secured a funding commitment from an investor, they will have carte blanche with the cash and can report back to their investors as and when it suits them.

Alexandra Fraser
Alexandra Fraser joined Invenfin, an early-stage venture capital firm wholly owned by Remgro in 2009, after completing her Masters in International Business and Emerging Markets (cum laude),... More

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Nothing could be further from reality. A VC will not write you a cheque for the full amount allowing you to spend it as you please.

An early-stage funder will typically fund your business in stages. This means is that you will get funding for a period of time e.g. six months, which you will need to use to achieve specific objectives for the business. VCs do this because they want to know whether you can actually execute on the plan. You’ve talked the talk, now can you walk the walk? This is why you should know what you want to achieve and how much money you need to do this, before you even talk to a potential funder. Your funder, once they have approved and agreed with the plan, will expect you to deliver on it.

Secondly, VCs fund businesses in stages to reduce their risk. Early-stage investments are high risk because many aspects, which possibly include the market, team, technology, and business model of the business are unknown. Milestones provide clear indications whether the business is on the right path or whether the company needs to adapt its strategy or technology to be successful in the market.

Providing funding in a staggered manner is a key control mechanism to allow the investor to limit risk.

For example, if a VC agrees that you need $5-million for the next 2 years and you can’t achieve the first milestone e.g. getting customers to buy your product after spending $1-million on development, sales and marketing, the VC will have saved $4-million. By not investing the full $5-million upfront, the VC has limited its exposure in the case of a burn-out.

The primary way that VCs seek to add value (and control risk) is to be actively involved with their investments. They are attracted to entrepreneurs with vision and drive, but this sometimes has to be tempered with a healthy dose of reality to keep the business in check and on track to achieving its goals. VCs tend to be hands-on investors and while they do not necessarily get involved in the day-to-day operations of the business (this is why they invest in great entrepreneurs or management teams), they are involved strategically through active board participation, leveraging their experience and networks for the benefit of the business, helping you to grow and exit your business providing all shareholders with significant financial return and in supporting the entrepreneurial team and executives were needed.

Image: Roger’s Wife

  • mark

    Alex, hi
    Good article. Although in some ares I disagree as at times I do feel that the strategy of a VC can sometimes hamper a startup. Eg. VC driven by short term growth to please its shareholders versus a startup which is looking to establish a reputable brand. That is a seperate debate.

    What I am most interested in is to find out from you if you actually know any VC’s in Africa that invest in startups that have not yet started executing their idea?

    All, and that is a significant number, that I have come into contact with will not even talk to you unless you have a product and some proven track record with it. This is regardless of your experience as an individual (i have approached VC’s with partners who are highly skiled with a track record in the corporate world).This leaves a startup at this stage to either self fund or put his own word out to any Angel investors he may know. And then, when he has something that is working to contact a VC. A risk model which in itself favours VC’s.

    Interested in your reply…

    • Alexandra Fraser

      Thank you for your comment. Each VC has it’s own strategy around exiting investments – all depending on the fund’s structure. Invenfin’s position is that we would rather remain invested in a company for a longer period if we feel that it will benefit the business and the shareholders as a whole. This is a complex debate as you allude to, and a simplistic answer is not sufficient to cover all the factors or motivations for an investor to behave in a specific manner.

      Almost all venture capital funds will require you to have some proof that your idea or concept is a reality. At Invenfin, we only consider post proof-of-concept business proposals i.e. a working prototype or beta-tested version of software before we will consider a business for funding. There are other funding avenues and support networks for an entrepreneur to explore if they are only at concept stage. Instruments like the Technology Innovation Agency’s Idea Development Fund, incubation and accelerator programs and Angel investors will often back an enthusiastic founder who only needs a small amount of money to start building a prototype or demo version of their product or service.

      Once there is a working prototype or version (sample) of a product, there is still significant risk in the business and it is by no means guaranteed to be accepted by the market and be a success. Often the product has to go through a number of iterations before it is even vaguely commercially or market ready, and at this point there is still significant work to be done to launch the business to start generating revenue. Entrepreneurs who believe enough in their concepts to commit their own time and resources also indicates to a potential funder that they are truly committed to the venture and that they have the drive to implement their thoughts into actions and tangible outcomes.