Startups need at least 10x in 5 years to be good investment – VC, angel investors

Want to get investment from an angel or venture capital (VC) investor? You’re going to have be able to grow the valuation of your startup by about 50% year on year and return to investors 10 times what they invested in your company — all in just five years.

Most South African based VCs Ventureburn spoke to this month say they look to return to investors 10 times their initial investment and grow the value of an investment at about 30% to 40% per year for about five years.

“To achieve 10X in five years you need to be growing at above 50% year on year,” says Angelhub Ventures lead partner Brett Commaille (pictured above, lower right).

After five years, the Stellebosch-based VC fund — which has been operating since 2014 — looks to generate for investors 10 times their initial investment, with a minimum of 25% return offered in fundraising formal documents usually, says Commaille.

Commaille says while all six of Angelhub Venture’s present investments are growing at differing paces, they are all making “good growth”. However, two early stage small investments were not working and closed, he added.

To achieve 10X in five years you need to be growing at above 50% year on year, says VC fund manager

“Just because an investee is losing money does not mean an investment is doing badly. Many companies are running at a loss as they put all their funds into growth. But they may still be growing well and the growth is thus funded by investment,” he said.

“Sometimes a business just hits the right market and the right time and takes off,” he says. “Most of our portfolio has not yet exited. But big exits come from timing (the right business at a time when it’s a hot sector) and a great team.”

Of the six investee companies, half have had second or third follow-on rounds. “It depends entirely on circumstances at the time — sometimes we (do) follow-on (funding). We’ve been the lead investor and let others invest if it was best for the company,” says Commaille.

How then are investments doing?

‘274% year-on-year growth’

Pretty good (for at least one investment) for VC fund and registered 12J VC fund Kalon Venture Partners. The VC fund is just over two years old and has had no exits so far.

CEO Clive Butkow said one of the portfolio’s four investments, fintech i-Pay, grew 274% YOY for their financial year ended 28 February this year. In November last year the startup announced it had received a R10-million investment from Kalon Venture Partners. The startup was also named by Ventureburn as one of 8 Gauteng startups to watch in 2018.

“This company is currently raising a large amount of capital for global expansion at a circa 50% increase in the pre-money valuation from what we invested at,” says Butkow.

The VC aims at an overall return on the capital invested in its fund of between 30% and 38% internal rate of return (IRR) per year and to return to investors 10 times their initial investment after five or six years.

Read more: Fintech startup i-Pay secures R10m investment from Kalon Venture Partners
Read more: 8 Gauteng startups to watch in 2018 [Digital All Stars]
Read more: We’ve hit burst of NOS from Fast and Furious – i-Pay CEO ahead of $5m raise

Angel investment group Jozi Angels founder and director Abu Cassim (pictured above, upper left) said when it came to the performance of the current portfolio “roughly 40% are failing or have failed, 20% of businesses are surviving, 10% are making revenue but running out of runway, 20% are growing and looking up and 10% are doing really well”.

He says those investments that are doing well as a strong team able to get passed roadblocks, a good group of early adopters or partners and business owners who have what he calls a “good grounding or hustle prior to looking for funding”.

For angel investment group Jozi Angels each company should have the potential to return 20x to 25x,”. The group usually takes equity of between 15% and 20% and looks for a return on the entire portfolio of between five percent and 10% in excess of the listed stock exchange.  The network has not had an exit yet.

Read more: Jozi Angels made 15 investments worth R6m in last 3 years – Abu Cassim

Why do some investments then do better than others?

‘Success equals knowledge, networks, funding’

Knife Capital partner Keet van Zyl (pictured above, upper right) says it comes down to the execution capabilities of the whole team to scale a product-market fit in a beachhead market into other markets globally. Success comes in combining knowledge, networks and funding, he points out.

The Cape Town based VC fund usually in an equity stake of between 15% and 30%, and the investor looks to exit after four to seven years. The VC’s targeted minimum IRR is 40%. “This is an annualised return or discount rate where NPV is zero,” says Van Zyl.

Knife Capital has had some successful portfolio exits through the years to the likes of General Electric and Visa. As well as successful management buy-outs.

Knife Capital has exited Red Five Labs (to the FedGroup), predictive analytics company CSense to General Electric, fintech Fundamo (to Visa) and radar launch monitors company FlightScope (the fund exited to management in a structured management buyout).

“Historically around two-thirds of our – realised and unrealised – portfolio companies have significantly over-achieved on investor targets; 25% not meeting target but surviving along and 10% failures,” he said.

Read more: How Knife Capital once turned down JoJo Tanks because VC ‘didn’t see use case’
Read more: SA sports scale-up achieves self-exit from VC
Read more: Are these the 10 all-time biggest exit deals for SA startups? [Digital All Stars]

He says there are various reasons why some investments do better than others. Some of this comes down to luck and timing, or to investing at the right valuation (as a good business does not necessarily equal a good investment), aligning of shareholder interests and building a sustainable business, but with the exit in mind.

‘Backing right people’

For 4Di Capital’s Justin Stanford (pictured above, lower left) a rule of thumb in VC around the world which is that more often than not good investments correlate to backing the right people.

“Although outcomes can vary substantially up or down for a myriad of reasons, such as the aforementioned issue of timing, often a key element in long-term successful outcomes seen through to a good end is the founders and the team,” he said.

Started in 2011, the VC has so far made 14 investments. Stanford could not comment on the specific performance of 4Di Capital’s portfolio, but said his fund aims to return 35% IRR or three times investors’ initial investment within the typical 10 years of a fund.

“A typical VC fund lifespan is 10, plus two years (10 years and the option for two years of overtime for late exits). Our first fund started in 2011 so it’s still got a way to go,” says Stanford. The VC typically takes around 20% to 30% of a company.

Read more: New 4Di Capital VC fund raises R256m

But “really good growth” is hard to determine, he admits. This is because it could be in R&D terms that the company is growing (say, advancing and growing its patent portfolio), growth in users or customers, or it could be simply in sales revenue.

“I would say in basic sales terms you want at least 50% and 200% revenue growth per year to be considered ‘really good growth’. You also get exponential growth, where the rate of growth itself is climbing, which is the ideal dream in a true scaling opportunity,” he says.

Going big it seems, is key — at least if you want to get funding from these investors.

Read more: HAVAÍC holds onto five investments despite two offers, says Ian Lessem [Q&A]
Read more: Jozi Angels wants R8m return from R400k invested per startup [Q&A]
Read more: Market readiness key when investing in startups – 4Di Capital founder [Q&A]

*Correction (24 May 2018): We initially said startup founders would need to grow the valuation of their startup by about five times a year and return to investors 10 times what they invested in your company — all in just five years. We meant to say “50% year-on-year”. We regret the error.