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How to Win Funders Over
So, you have an idea for a business.
Business ideas are not only cheap, they’re a dime a dozen. That said, you believe that you don’t only have an idea, but a viable business plan. So where can you access funding? According to Pavlo Phitidis, the assumption that someone else should give you money is your first big mistake. He is a firm believer that funding should start at home, at least in the start-up phase. “The bootstrapping phase is an essential ingredient to the overall success of a business,” he insists. “If you put everything you own into a business, and then proceed to ask friends, family, your book club and everyone else you know for additional funding, you will think very carefully about how you spend those resources. This will make you a better business owner, running a business that is already more likely to succeed, and it will make you far more attractive to banks and financiers when you need additional funding to grow the business.”
Indeed, many entrepreneurs waste a huge amount of time looking for funding which they could otherwise be putting into their businesses. A good case in point is a local seamstress who applied to the National Youth Development Agency (NYDA) for funding to produce matric jackets. While the finance was approved in principle, she needed to prove that she had orders and there was a demand for the product first. “She ended up approaching scholars and collecting deposits for their orders,” says Lebo Gunguluza, founder of the South African Black Entrepreneurs Forum (SABEF). “The deposits gave her enough money to actually manufacture the jackets, and then she received the remainder of the money for each order upon delivery — all before she actually received the funding she was looking for.”
The lesson is simple: the belief that a business can’t get off the ground without funding means entrepreneurs focus on securing finance instead of innovative ways they can get cash to launch their businesses.
“This entrepreneur actually got her company off the ground faster than she managed to secure funding,” says Gunguluza. “Don’t wait around for finance simply because you think that’s the only option open to you. Think out the box — your goal is to get cash. How can you do that? If you stop focusing on finance alone, you might be surprised by what you come up with.”
Gunguluza calls it ‘pre-selling’. If you need cash to fund your business, get that cash by pre-selling your product or service. In other words, get your clients to pay you before you deliver the goods.
There does come a point in the lives of many businesses, however, where future growth is not possible without funding. In order to make yourself an attractive prospect for financiers, Phitidis recommends first bootstrapping, and then taking the time to ask what you have to offer the financier.
The secret to finding funding
Don’t think for a moment you are alone in the financier-financee relationship. In fact, according to Alexandra Fraser, research analyst, Invenfin Venture Capital, the average funding partnership in the US lasts longer than the average marriage. So it’s important to be on the same page from the word go.
“No-one takes the time to ask the simple question, ‘What does a financier want from me?’” says Phitidis. “Entrepreneurs are always so busy thinking about what they want from financiers, that they forget that finance houses are businesses as well, with specific mandates that they must follow. As a business owner, before you start looking for finance, do your research and recognise that there are different types of funding that have specific criteria and mandates that must be met. Ask yourself which financier suits your business and industry best, and vice versa. No amount of moaning, sulking and bashing down doors will work if you are approaching the wrong financier. Figure out what they want, establish if you suit their profile, and then show them why you are a suitable candidate for their funding.”
Christo Fourie, IDC Venture Capital Unit, agrees. “Each fund has a unique mandate,” he explains. “You can’t change that mandate.
Move on and find a fund that fits, rather than banging your head against the wall and wasting your time.”
So what do financiers want?
According to Alexandra Fraser, the first thing funders want is for entrepreneurs to validate their ideas before they even pitch them to investors. “This can be as simple as starting with a Google search,” she says. “Did you research your idea and your market? Yes, innovative ideas are great, but not all ideas are as innovative as entrepreneurs seem to think they are, and many are simply not feasible. Is there a need or a want, and is there a market? That’s where you need to start.”
Fraser offers two examples. The first is Coca-Cola’s marketing success. “People were not dying of thirst before Coca-Cola hit the market. The brand needed to find another need or want to attract customers. It’s vitally important that you know what that hook will be. You can’t simply say: I have a product and people will buy it. Why will they buy it?”
An example of poor research is entrepreneurs who do not understand the market they want to operate within. “For example, we have received a number of pitches from entrepreneurs who have developed technology for mobile lotto sales,” says Fraser. “On face value this is a great idea: there is a need and a market. Unfortunately, there is also legislation expressly forbidding lotto tickets from being sold on mobile phones. Before they put time and effort into these pitches and even developing the technology, these entrepreneurs should have done their homework and validated their ideas.”
Ultimately, whether an entrepreneur receives funding or not boils down to market research. “Research can be painstakingly slow, but it’s also vitally important and will save time, money and effort in the long run. Market research isn’t only about creating a marketing plan. It determines everything you do in your business: what will customers pay? What should the business’s revenue model look like? How can the business attract and keep customers? If you can’t answer these questions, you won’t get finance.”
Innovative ideas are by nature ‘big picture’. They are based on the belief that anything is possible. Proper market research grounds the big picture in reality, which decreases risk for investors, and ultimately makes the business viable. “Great business ideas also don’t need to be brand new,” says Fraser. “Creating a market can be incredibly expensive because you need a huge marketing budget to introduce consumers to an unknown product or service. But, if you are offering something that is known, but solving a need or doing it better, you are tapping into an existing market. You simply need to differentiate yourself.”
Securing finance is all about proving to investors that you understand your business, you know who your market is, and you know what you are selling to them, how much you are selling, and what you will make based on those sales. In other words, you have a realistic sales forecast.
Investors aren’t going to be fooled by inflated projections either. “Using the example that there are one billion people in Africa, of whom 95% have cell phones, does not tell me who your market is for an application that lists restaurants in Cape Town,” says Fraser. “An industry and a market are not the same thing. Understand your market and then start from the bottom up.”
Do your homework
According to Daniel Hatfield, co-founder of VC firm Edge Growth, a general rule for all investors is that due diligence has been undertaken by the entrepreneur, which means – among other things – knowing where the sales will come from. “Top down thinking is great for big ideas, but the details lie in bottom up thinking,” he explains. “An entrepreneur who has researched their market, spoken to potential customers and understands what they can buy and for how much, can determine what their sales will be – and through that, how much money will actually be coming through the door. Top down thinking says, ‘I only need 1% of a R15 million market each month to make a profit’. Bottom up thinking asks, ‘How will I make my first three sales, and how will I meet the revenue target of my first six months?’” These are the answers investors are looking for. After all, they either need to see a return on their investment, or, if they are a bank, they need to know you can service the debt.
“The golden rule in partnerships is that a partner with money is very useful, but a partner who will also provide you and your team with the space, time and freedom needed to build the business is a true friend – and that friendship will stand the test of time.”
Richard Branson, Founder of Virgin group of companies
Four things funders look for
Edge Growth co-founders Daniel Hatfield and Jason Goldberg share the four main questions funders ask prospective fundees.
1. The market
Is there a great market for your product? Is it a growing market full of opportunities, or is it saturated?
2. Competitive advantage
Does your business have a competitive advantage? Do you have a value proposition that is quicker, smarter or cheaper than your competitors? Why should your potential clients buy from you?
3. The team
An idea is all fine and well, but unless it can be executed it isn’t worth much. The team is a vital component to the overall success of a business. What kind of experience do the various team members have? What does their network look like? What qualities do the various team members display, including competence, balance, high energy, motivation, determination and trustworthiness. A golden rule here is to do what you know.
4. Economies of scale
Can you start small and expand over time? Is the business scalable? If it is going to make money you need to be able to scale the idea – and you need to show how you plan to do that.
“There are never NO competitors. Tell your funder that there aren’t, and you come across as naïve, uninformed and out-of-touch with your market.”
Alexandra Fraser, Invenfin Venture Capital
Perfecting your funding pitch
If you have banged on more doors than you can count and are still receiving “no” to your funding pitch, your problem might lie in how you’re delivering your pitch. By Jason Fell
Effective elevator pitches can be crucial for entrepreneurs trying to secure funding from angel investors. The goal of the pitch – written or delivered face-to-face – is to briefly share the ’who, what, where, when, why and how’ of your business, while piquing an investor’s interest. The tricky part is cramming all of that into one explanation that, hypothetically, should be delivered in the time span of an elevator ride.
The pitch has to quickly grab potential investors, who often only read the first few sentences of a written application and then toss half to two thirds of them away. The best pitches however, describe the market the business is in, explain what problem it solves and demonstrate a track record. The worst ones fail for countless reasons.
Here are five of the worst elevator-pitch mistakes entrepreneurs make – and how to avoid them.
Mistake No. 1: You don’t explain what problem your business solves
Some entrepreneurs spend too much time talking about how their product or service works and not enough time explaining what problem it solves. People buy solutions to problems. Don’t tell an investor how your lawn fertilizer works. Tell them about their lawn.
The Fix: Share why customers will buy your product or service
If you don’t understand or can’t explain what problem you’re solving and why customers want to give you money, then investors are probably never going to want to invest in your company. Who’s your best customer? How much money do they make from buying your product? And, how much money will you make from selling it?
Mistake No. 2: You offer too many facts and numbers
Entrepreneurs often use statistics to help explain their business. While some figures – such as your sales and revenue – are important to establish a track record, don’t go overboard. Leave out the ‘step-by-step numerical proof of your market size’ and rather be compelling. Save the reams of facts for later.
The Fix: Tell a story
To capture an investor’s full attention, explain your business by telling a story. Use personal examples about how your service or product has solved a problem in your own life. Or, put the investor into your story. If you’re selling a product for people who are blind, don’t start off talking about the difficulties blind people face. Instead, say something like, ‘Imagine if you or a loved one were to go blind tomorrow…’
Mistake No. 3: You tout sales forecasts
Early-stage sales projections often don’t carry weight with investors because they aren’t supported by actual sales history. As businesses grow, revenue streams, prices and even entire markets can change, rendering preliminary forecasts useless.
The Fix: Focus on the benefit your business offers customers
To help make up for the fact that you might not have a long sales record, it’s better to explain the benefits the business will provide customers and how the company is different from the competition. Answering services companies have been around for centuries, but if yours, for example, uses technology to deliver messages immediately without the client having to call in and pick them up, that solves a problem and has the potential to create excellent revenue and profit. That’s what’s attractive to investors.
Mistake No. 4: You’re too attached to your business plan
For some investors, it’s a red flag when entrepreneurs aren’t willing to work outside the protocol outlined in their business plans. For example, you have a device that monitors electricity and, according to your business plan, you sell that device to customers for a fixed price. But, when a customer wants to lease the device instead of owning it, and you tell them you can’t do that, it might be a problem for an investor.
The Fix: Embrace new revenue opportunities
If there’s a new way to consider packaging or selling a service, a ‘true entrepreneur’ will seize the opportunity to make money. Being flexible and willing to accommodate customers when they want your service in a format that differs from what you already offer is good. The goal should be to make your product as sellable as possible.
Mistake No. 5: You discuss ownership stakes
While it might seem natural to explain how much ownership you’re willing to offer investors, don’t do it in the initial pitch. It’s like the sticker price on a car. If it’s too high, you don’t even talk to the salesman. You just walk off the lot.
The Fix: Save it for the follow-up
Details about who gets what after an investment generally come up after an investor has finished researching your company. If an investor asks about ownership terms early on, you should simply say you’re “flexible.” Remember, your goal in the pitch is to build a relationship with the investor. Get them to fall in love with your idea.
“I invest in a person who understands their subject matter and has a strong passion to succeed. I need to see big drive and stamina to know they are in it for the long haul and won’t give up when there are hurdles, disappointments and difficulties.”
Vinny Lingham, Serial entrepreneur and investor
Improve your chances of obtaining funding
Understanding bankers and knowing how credit decisions are made can mean the difference between getting a loan – or missing one. By David Bangs
Banks typically don’t fund start-ups, but there is a point where your business is generating revenue and you are ready to apply for a bank loan. Here’s a brief guide to what makes funders tick and some tips to help you navigate their world. The main concern bankers have is protecting their capital, money with which their depositors have entrusted them. Consequently, bankers are generally very conservative. Their first priority is to recoup the principal of the loan. Their next priority is to earn a reasonable rate of interest on the loan. And their third priority is that you prosper and open more accounts with them.
Your job is to provide the banker with as many reasons to feel safe as you can. You start with a loan or financing proposal – a statement of what you need, why you need it, when you need it, and how you plan to repay it. The documentation should include a description of how much you need and what you’ll do with the loan, up-to-date balance sheets, cash-flow pro formas and projected income statements. All banks have forms to help you prepare these, but using your own business plan increases your credibility.
The nuts and bolts
Applications are rejected for the following credit-related reasons:
- Too little owner’s equity
- Poor earnings record
- Questionable management
- Low quality collateral
- Slow/past-due trade or loan payment record
- Inadequate accounting system
- Start-up or new company
- Other (only 4% of rejections have other reasons)
“If we recognise red flags during the pitching process we won’t give funding. These include a lack of understanding of the industry in which the entrepreneur operates, false claims being made or misrepresentations and a misalignment between the business plan and the entrepreneur’s oral ‘pitch’.”
Keet van Zyl, HBD Venture Capital
The ‘Six Cs of Credit’
What do bankers look for when considering a financing proposal?
1. Character: Character judgement of an individual is based on past performance. Personal and business credit histories are reviewed.
2. Capacity: This is figured on the amount of debt load your business can support. The debt-to-net-worth (debt/net worth) ratio is often used to justify a credit decision. A highly leveraged business with a high debt/net worth ratio is perceived as less creditworthy than a company with low leverage (low debt/net worth).
3. Conditions: Economic conditions, both regional and national, have a profound effect on credit decisions. If the bank is persuaded that a depression is coming, it won’t extend credit easily.
4. Collateral: Collateral is a secondary source of loan repayment. Banks want the loan repaid from operating profits and inventory so you become a bigger, better borrower and depositor. But just in case things go sour, a bit of collateral makes your banker sleep better at night.
5. Credibility: Do you know your business? Can you be counted on to be level-headed? How credible are your plans? Are they a collage of dreams or a carefully reasoned and researched plan? A business plan helps you answer the banker’s questions without hesitation.
6. Contingency plan: A contingency plan is a useful financing tool. Bankers like to see that you look ahead. A contingency plan proves forethought. It is a short worst-case business plan that examines the options open to the business and how those options would be treated. Decisions made in panic are poor decisions. A contingency plan avoids panic.
“It is vital for entrepreneurs to demonstrate a pragmatic and proven approach to getting the product to market.”
Charmaine Groves, Old Mutual’s Masisizane fund
Your funding options
Need cash but don’t know where to look? Here’s a breakdown of funders:
Angel investors: Angel investors are individuals who want to support start-ups financially. They use their own funds, and they tend to back the entrepreneur rather than the business.
Government grants: There are various government funds out there, and they all have their own terms, conditions and mandates. Do your research to determine which fund’s mandate suits your business.
Venture capital: This is not debt funded (ie debt that needs to be serviced, or paid for, like a bank loan). It is funding for high-risk, scalable, tech-related businesses. Venture capitalists are taking a huge risk, so they expect large returns. You will need to prove that your business is scalable and offers those returns. Again, make sure your business suits the fund’s mandate.
Seed funding: Some VC firms will offer seed funding, which is for start-ups.
Private equity: This is a share of the business in exchange for funding, and will usually involve angel investors or VC funds.
Bank loans: Banks specialise in debt products, which means you need to be able to service the loan. If you can’t prove that you can make loan repayments, you won’t qualify for a loan. This means you need to already be generating revenue.
Bootstrapping: Bootstrapping refers to building a business without funding. Why would you need to do this? The type of funding you receive is dependant on the stage of your business. The younger your business, the greater the risk you pose to financiers. As soon as you are successful and generating revenue, it becomes much easier to source funding.
“Funding works on a one in 100 rule: for every 100 business plans we receive, one will get funded.”
Alexandra Fraser, Invenfin Venture Capital