Startups face numerous challenges when it comes to getting financing.
Firstly, many banks lend money on the basis of the 4C’s of Credit. These are Capital (assets linked to your business), Collateral, Capacity (a track record showing the business earned sufficient income to cover its loan repayments) and Character (usually a good credit rating). Since it is difficult for startups to have all of these C’s, it is, therefore, difficult for startups to get loans from banks.
Secondly there many non-bank financing sources for startups, such as the 3F’s, angel investors, venture capital firms, government institutions or even Development Finance Institutions (DFI’s). All of these have their own specific requirements.
Whichever non-bank institution you seek finance from, here are four main reasons why your application may be rejected.
Very few institutions provide funding for just an idea, as can be seen by research from the Aspen Network of Development Entrepreneurs (ANDE). It found that, out of 214 support organisations in the South African entrepreneurial ecosystem, none provided financing at the ideas stage.
Darlene Menzies, the CEO of SMEasy, an innovative South African online accounting and business management platform, stated that the 2 top things her investors wanted to see were proof that SMEasy had been able to get paying customers (product validation) and had been able to grow and keep its clientele on its platform (traction).
Moushmi Patel, Principal at Sanari Capital, a South African private equity investment company, that specialises in founder-run, owner-managed, and family-owned companies, agrees. She stated that in the rare event Sanari invests in early stage companies, they invest in companies that have earned revenue and are on track to soon make a profit.
Potential investors want to see that you understand risks in your industry and will take steps to mitigate them.
There are many risks, for instance, it is important to show you know your competitors and understand their strengths and weaknesses. It is also important to show you planned how your company will defend itself against its competitors while exploiting their weaknesses.
If you feel confident your business does not have any competition then, according to Tim Berry, Chairman of US business planning software Palo Alto Software: “That normally means you either don’t understand your business or have a business nobody else wants. Neither option is good.“
Most investors are risk averse and want to invest in opportunities where the entrepreneur will not represent a risk.
Shawn Charlie, Area Manager for Business Partners, a South African specialist risk finance company for formal small and medium enterprises, refers to it as “Entrepreneur Risk”. During an in-person interview, Shawn mentioned two examples of “Entrepreneur Risk” being when the entrepreneur is not coachable or lacks integrity. These are red flags that will lead to Business Partners rejecting your application for funding.
If you’re a business owner who isn’t coachable, who can’t accept the idea that someone else might be better at executing your company’s growth strategy than you, or who doesn’t want to be held accountable to anyone, then strategic capital is not a good avenue for you.
Although most funders make it quite clear what types of companies they invest in, many still receive applications from entrepreneurs that have adopted the shotgun approach.
This is the approach where, much like someone firing a shotgun, the entrepreneur sends out applications to every funding institution they can think off, hoping one will hit the bullseye.
Examples of getting it wrong are applying for to a venture capital fund that focuses only on technology, when your startup makes leather products; or applying to a fund whose minimum deal size is US$1-million, and your company only really needs US$500 000.
Often entrepreneurs approach potential investors at the last minute, when neither they, nor the investor, have had a chance to get to know, like or trust one another, with predictable results:
Ideally, an entrepreneur should try and build a relationship with investors, long before they need funding, to allow for mutual trust and liking to develop. After all, asking for funding from an investor who does not know you, is like asking to marry a stranger.
Would you say yes if a stranger asked you to marry them?
That is why, ideally, entrepreneurs should seek to establish relationships with potential funders as early as possible. Moushmi Patel, Principal at Sanari Capital, recommends inviting them to be informal advisers. This will allow you to get to know each other, trust each other and see if you are a good match.
If this is not possible, for instance, if you need funding now and have not built trusting relationship with potential investors, it pays to be introduced to them by people they trust. As an example in 2014, out of the over 960 applications received, AngelHub Ventures, a (South) African venture capital firm, only invested in 5 ventures, 4 out of these 5 were referred to AngelHub Ventures by trusted sources.
What other reasons, in your experience, can result in your funding application being rejected by potential investors? Please share in the comments below.
Feature image: Dmitry Tsiryulnik via Flickr.