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Getting access to the right seed and growth finance is critical to the success of most emerging technology companies. But finding the right investor can be a daunting task for any founding team.
You have to deal with different mandates, big egos, various terms and long lock-in periods just to start discussions and there are many boxes to tick. In working on over R300-million worth of seed and growth finance deals for our clients (see the infographic below), our team has seen it all.
Without significant direction, founders can spend months worth of crucial time and energy in pursuit of an investor instead of focusing on growing the company and its value.
Founders need to know where in the investment cycle they fit, what types of mandates are applicable to them and where to find those investors. A working knowledge of the various types of investors available is critical. Let’s unpack the most significant ones:
Angel investors and angel consortiums
Angel investors are high net-worth individuals that fund entrepreneurs at a quite early stage. They will normally invest on their own or in a group.
Angels are usually successful entrepreneurs who have built and sold their own companies over many years. They understand what it takes to build a business from the ground up, having done so themselves. They can also spot others who will likely be successful at doing the same.
They have usually built their companies or spent their corporate careers in a certain industry for which they build an indepth understanding of. It’s often in this industry or a complementary industry that angels would look to invest.
As the term “angel investor” suggests, traditionally terms set by angels are very generous, like a shareholder loan with long repayment terms or low interest for a small piece of the pie.
In South Africa, because the angel community is still small and access to early-stage finance is limited, in many cases angel terms range from relatively generous to extremely onerous. Angel ticket sizes will generally range from as little as R100,000 to about R4-million, with almost all such investments originating from personal relationships.
A large concentration of angels can be found in the Stellenbosch area. The nodes of Johannesburg, Cape Town and Durban also have established angel investor circles.
You can also connect with the South African Business Angels Network (SABAN) to get in touch with some of the parties interested in making angel investments.
My top tips for dealing with an angel investor would be to make sure that it is someone who can (and is willing and available to) actively add value to your business. Also don’t try sell too large a stake in the company at this early stage, as this will limit your ability to raise future equity rounds.
Venture capital (VC) funds are investment entities with a specific mandate to invest in a certain type of company.
Being formalised investment entities, they normally have shareholders or investors who capitalise the fund, a management team that identifies and monitors opportunities and an investment committee that makes the final call on proposed transactions.
Their mandates range from early-stage companies with proof of market acceptance, to more established companies that are still growing at a high rate, with general ticket sizes in South Africa ranging from R2m to R15m.
VC companies invest at a stage where the company has gained some traction in the market, with a proven product and a strong team. They do still take a big risk at this stage, as the company’s future growth is still uncertain.
A VC will only invest in a company that has a scalable business model and defendable intellectual property with the ability to scale to five to 20 times the value at which they buy in at within a five to 10-year timeframe. The South African Venture Capital and Private Equity Association (Savca) has a list of the main VCs.
In engaging with a VC the best is to ensure that you fit their mandate. Most would publish this on their site. It’s no use knocking on their door if you are not in the right industry, stage of growth or ticket size that they are looking for. Again, if you have personal introductions or relationships with VC managers you will have a much better chance of getting their attention than e-mailing them a slide deck.
Lastly, be very sure of your company’s value before entering into negotiations, as these guys are experts in driving down your price to get a good buy-in.
Private equity funds
Private equity (PE) funds are large, quite sophisticated and highly regulated investment entities. They will generally only consider investments into established companies where the risk is much lower than early stage VC. Their ticket sizes generally range from R15m to upward of R500m, with investments being made for the cash flow generated from profitable, established companies.
With limited investee companies in the market, some PE firms are starting to look at somewhat more early-stage opportunities, which is exciting for emerging entrepreneurs.
Before taking on a PE investor consider whether you are ready for the corporate structures and intense reporting that would come with such investment, as this could stifle growth and flexibility in the process of trying to create sustainable, predictable cash-flow earnings.
Government funds really warrant a complete chapter instead of a paragraph, as there are quite a few out there. I’ll touch on some of the most notable ones. For early-stage technology commercialisation, the Technology Innovation Agency (TIA) has three funds that invest in technology development in the pre-seed stage.
You’ll also find Small Enterprise Finance Agency (Sefa) at the early stage of the spectrum, with loans and investments of up to R5m, and the Department of Small Business Development (DSBD) which also provides small grants.
On the other hand the Department of Trade and Industry (DTI) and the Industrial Development Corporation (IDC) fund more established companies, with various mandates applicable to different industries.
When approaching a government fund, make sure that you understand the funding criteria before going through the application process. Most funds have detailed criteria based on how long your business has been in existence, percentage black ownership, supported industries and more. Also make sure that you are patient, as unlocking government funds can take months to years.
Enterprise and supplier development funds
The Black Economic Empowerment (BEE) codes have incentivised large companies to set up various funds to channel corporate enterprise and supplier development funds to emerging entrepreneurs. A good example of this is Edge Growth with its ASISA fund tailored to the financial services industry.is a good example.
These funds are usually mandated to invest in emerging black-owned companies with turnovers either below R10m or below R50m. Being able to fit into the supply chain of the corporates that are the ultimate financiers would be a plus. These funds can normally structure debt and equity transactions across a broad range of ticket sizes.
The need for fast, continuous innovation, paired with corporate giants’ general inability to easily innovate in-house has led to many corporates entering the market for emerging tech companies. It’s often easier and less costly to buy a large or controlling stake in an innovative company than it is to innovate within existing structures.
Different corporates will have different mandates, but all of them would invest in companies in their industry or that would complement their industry. Corporate pockets are deep, so price tags and go well into tens of millions of rands.
Make sure that you know which companies would be interested in your business and why. Also take heed that you do not end up selling your company and working for your investor if this was never your intention in the first place.
Lastly, various international investors are setting their sights on South Africa. Even with its current unstable political and economic environment South Africa still makes for a good stepping stone for international investors looking to access African markets. The country is still a far less risky investment opportunity compared to most other African states.
There is also a big discount on equity investments here versus other global startup hubs. In San Francisco, with a million dollars you can barely buy into a pre-revenue startup.
In South Africa, the same amount would get you a big stake in an established emerging company that has strong revenues and market validation. Apart from good value, low buy-in opportunities, operating costs in South Africa are a lot lower than most of the world’s other startup hubs. Those companies that are able to earn international revenues and pay salaries and overheads in rands can do exceptionally well.
The lifestyle here is also attracting funders and investors alike. A top tip for taking in international funds would be to make sure that any debt is repayable in rand. Otherwise you might find yourself on the wrong side of currency devaluation.
As South Africa’s funding ecosystem matures and more sophisticated angel, VC and other types of investors enter the market, entrepreneurs that are build high quality companies that aim to solve real global problems should have a lot to look forward to in years to come. But remember, always make sure that you partner with the right type of investor at the right time and that it is done on mutually beneficial terms.
Louw Barnardt is the founder and managing director at Outsourced CFO, a financial management company that specialises in unlocking growth and raising finance for emerging technology companies. He is also a founding director of Glenheim, a venture capital company.
Featured image: Caleb Roenigk via Flickr (CC 2.0, resize)