Don’t do a startup, build a business

“If we do invest, we will do it for half the price and double the equity”

Tech in South Africa is interesting. We have a relatively sizeable and connected (at least via mobile) population, which makes any internet or web based service relatively accessible.

We have a large English speaking population and thus can immediately download and use the latest apps and web startups churned out by Silicon Valley before they are actually “internationalised”. We also have an active financial services and corporate sector (traditionally big buyers of tech products and services).

Yet despite these positive macro conditions, South Africa is not historically a prolific producer of highly successful, independent technology “startups”.

Now there might be a lot of readers who disagree with that last statement, but allow me the opportunity to discuss my view with examples of what success doesn’t look like.

“If we do invest…”

This is one of the favourite sayings of most South African investors, both professional and personal that I have come across. Never really focused on the bigger picture or the 10x outcome, but the relative size of their piece of the pie. South Africa-based entrepreneurs are simultaneously rife with this mentality.

Startups are relatively low cost to begin. All it takes is a computer, domain, landing page and a good idea. They are, however, notoriously costly to scale: RD, marketing, sales, highly skilled staff and account management doesn’t come cheaply and the list of costs is endless. And when you need upwards of 1 000 users in SaaS or 100 000 in consumer internet to even begin to start making a dent in your cost base you had better have a long enough runway to get there.

The root problem is the media skewed definition of a early stage tech entrepreneur as someone who does startups and not as people who build proper revenue and profit generating businesses.

“Half the price…”

In the case of venture capital, price equates to the company valuation and is usually one of the most contested difficulties in early stage investing. Because, essentially your idea is worth nothing, since if there are no earnings there is no PE ratio. There might be no assets and thus no NAV on the balance sheet.

There might be no benchmarks on break-even spreadsheets because it’s probably an innovative new concept. It’s very difficult to value a startup using a model that results in an outcome that is both satisfactory to the investors as well as the entrepreneurs.

The sad truth is that the general stereotypical investor types in South Africa has often been involved with corporate finance at some point in their careers. This, by all accounts, sounds like a good thing and pretty impressive to most other people.

For the most part when there is a small company involved, it’s basically business broking and the same activity as your average real estate agent simply with a better title and a nicer office reception area. The issue I have, is that these people don’t really care about the company, the idea, the entrepreneurs or the longer term vision at all. They only really care about the “Deal”. And you can’t really blame them.

As a completely statistically insignificant test I asked an entrepreneur friend of mine (CA (SA)) about this topic and he agreed on the problems above with SA investors.

Ironically, this friend also just happened to buy a small apartment as an investment to rent out as a landlord. I asked him if he bought the first one he looked at. Answer: “Obviously not”. (It took him 15 months to find the right one.) I asked him if he paid the original asking price of the apartment. Answer: “Hell no,” he negotiated the price down straight away. I asked him if he cared about where the apartment block was in 10 years. Answer: “Of course not”. I asked him what he hoped to sell it for in a few years. Answer: Double his money. “At least”.

“Double the equity…”

But here is where everything that I have learned about South African investors in their natural habitats falls to pieces.
They have read some business profiles on Elon Musk, watched the Social Network, and heard about the guy who patented the plastic on the end of shoe laces (known as an aglet) and made billions. I personally know some extremely savvy entrepreneur friendly investors and you would be lucky to come across them. Yet, the typical high net worth individual, venture capitalist, corporate investment committee or private investment firm just cannot afford to be.

The risks are too high: either market risk; technology risk; execution risk or founders risk. The expected outcomes are too low: with low historical average PE valuations on acquisitions; low M&A activity for high quality early stage tech companies; and low international VC interest in the general market albeit a few specific companies. There is also a fundamental lack of success stories to point to compared to other countries.

We have Naspers, Mark Shuttleworth, Mxit and many others of course. But of the countless hundreds of startups that have graced VentureBurn’s pages, very few of them have ever hit the big time. So it is hard to convince an investor that you have the next Mxit when they know that Mxit still struggles to fulfil its potential, and they are one of the “successes”.

So what now?

My suggestion is do what those high net worth individuals most likely did to build their wealth in the first place. Start at the beginning, build slowly, keep going and don’t give up. Stop chasing VC Rands; start up growth curves; promises of 10x returns in 5 years instead of 15 years; acquirers that don’t exist; and public markets that won’t tolerate your business model, and rather focus on your customers, they are your best source of funding and the keys to a successful business.

So my advice to all South African entrepreneurs, don’t do a startup: build a proper business instead.

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This article by Gerald Neve originally appeared on Sovtech.co.za and is republished with permission.

Image: Clement127 via Flickr.