The initial funding stages for a start-up can be exciting, frustrating and a lot of hard work – all in equal measure.
But what entrepreneurs need to keep in mind is that what happens during those early stages can have a big impact on your company’s ability to mature and secure additional funding further down the road. So it is imperative you set your start-up for success from the beginning.
With that in mind, here are five common mistakes I see entrepreneurs get caught up in during the early funding rounds. Learning how to avoid these can make your later rounds of funding go much more smoothly.
1. Raising too much money
It’s natural for first-time entrepreneurs to be hyper-focused on getting money in the bank and really happy when it gets there. But every new company CEO must remember that an initial funding round is just the first step in a long journey towards building a large, successful company.
Raising too much money in the early seed or angel phase, can create a difficult funding dynamic later on.
The reason being, if you’ve raised a lot of money, and then spent it, the dollar amounts it took you to reach a certain point may raise questions about your leadership, product-market fit, and/or your economic model.
Additionally, the more money you raise, there will be more preferred stock in relation to common stock, which might hurt a future investor’s returns (as well as impair the value of common stock held by founders and management).
2. Raising at too high of a valuation
More isn’t always better. A high valuation may seem a good route to take early on, but you could be setting yourself up for problems later. High valuations early on may set expectations for ensuing funding rounds which may be difficult to reach.
You might not have grown into your valuation yet and may find it difficult to top your initial valuation, which could result in the next round being flat or a down round. There’s also the question of managing early investors’ expectations.
Seed and angel investors will likely expect an appreciation of their money, while later investors could think the company’s value is inflated.
As it is, during the early seed/angel stages, you lack the proof points to confidently claim you have the ability to spend efficiently, which can also raise concerns about over-valuation. Rather than shoot for the moon, here’s a better idea: Raise smaller amounts and perform rapid testing for proof of concept.
Keep in mind, the goal is to bring in the right investors at the right time, not the highest valuation right away.
3. Not being selective about who you want investing in your business
My general rule is the fewer investors, the better. Managing a large cap table (a record of all major shareholders) can be troublesome when everyone may have different time horizons and expectations.
Do you really want to deal with a cap table with 50 shareholders, 50 levels of expectations and 50 forms of communications?
Institutional investors can be great. They can also be high maintenance. But if you understand what you’re getting into, they can also be very helpful. Alternatively, small or individual investors may be more agile, but can require time consuming hand-holding.
4. Choosing the wrong angel route
The best angel group is a small one, with each individual offering a big cheque. To avoid a situation where you’re spending too much time answering to too many different stakeholders, establish one point person who has proxy for that shareholder base.
It’s also a good idea to choose people who have experience as angel investors and who have invested in your industry before. You want to find people who can be helpful and understand that the process will be a slog and a lot of work.
5. Not feeling comfortable fully leveraging your investors
The early funding stages are the time when you should learn to lean on your investors. Their purpose isn’t simply to throw money at you but also to help you make your company as successful as possible.
This means asking them to open up their contacts, make connections and introductions and share their experiences.
The key when “hunting” money is to set expectations early. If all you’re looking for is someone with a checkbook, look for a person who’s willing to invest with little involvement. But if you want someone who can and will be more involved, let them know what you’re looking for from them up front.
Don’t be scared of telling them, “I’m excited about bringing you on-board. I know you have these great contacts, and I’d love it if you would connect us.”
When you’re building a business, don’t get obsessed with funding milestones. Your focus should be on building a great company, your long-term vision and creating value.
By keeping the bigger picture in mind from the start, you’ll be in a better place to avoid dealing with the consequences and fallout of hasty early-stage decisions later on, which will make for a better-balanced company and better peace of mind for you.
A Comprehensive List Of Angel Investors That Fund South African Start-Ups
To get your start-up off the ground you’ll need money. An alternative is to ask an angel investor for that initial capital injection to give your start-up a better chance at success.
An angel investor is usually a high net-worth individual or group that provides capital to start-ups. They are referred to as angels because they are willing to invest their personal funds into a struggling higher risk business, when no one else will. Just like funds and incubators, some angel investors will focus on a specific industries.
What is an angel investor?
“Angel investors got their name 100 years ago in New York City when struggling playwrights – with limited financial means – had theatrical productions funded by a wealthy and visionary individual usually at the last minute,” explains David Newton, professor of entrepreneurial finance and author of four books on both entrepreneurship and finance investments.
He says that this generosity was associated to angels floating down from heaven with money so the show could go on. However, these angels were astute investors with keen eyes for investments that would achieve high profits. Angels fund a business to get in on the ground floor of an opportunity for financial gain.
The difference between an angel investor and a venture capitalist
Venture capital funding usually comes from a firm with people selected to help your business develop. Venture capital firms are comprised of professional investors. The capital is generated from a variety of sources such as corporations and individuals, private and public pension funds, and foundations.
A venture capital firm is looking for businesses with high growth potential. They will then buy shares and have a say in the future of a business, in exchange they expect a high return on investment.
The pros and cons of choosing an angel investor
The funding an angel investor can bring to the table could make all the difference in getting your start-up off the ground, but there are a few trade-offs you need to be aware off:
- Angel investors are usually entrepreneurs themselves, who understand the level of risk involved in investing with you, and so they won’t require you to jump through as many hoops as with a typical business loan.
- An angel investor will offer you capital in exchange for an ownership stake, which means you won’t have to repay their investment.
- Angel investors bring years of expertise and already understand the challenges your business will need to overcome before reaching success.
- The cons of an angel investor taking on high risk start-ups is they usually have high expectations. It isn’t unusual for an angel investor to expect a rate of return 10 times their original investment within the first 5-7 years.
- Offering up a portion of ownership to the angel investor can limit your start-up’s capability of realising a profit, if you don’t carefully assess the terms.
- The angel will want to take an active part in making decisions, or they’ll want you to explain the reasons behind some of your decisions.
Here is our comprehensive list of 43 angel investors interested in South African start-ups:
- Ernst Hertzog
- Brett Mason
- Avi Eyal
- Joel Gascoigne
- Brett Dawson
- Michael Leeman
- Lawrence T Levine
- Saul Klein
- Mohamed Nanabhay
- Sean Emery
- Vinny Lingham
- Bukola Jejeloye
- Kresten Buch
- Abu Cassim
- Pardon Makumbe
- Charles Lorenceau
- Justin Stanford
- Zachariah George
- Daniel Guasco
- Craig Raw
- Rob Stokes
- Mark Levitt
- Alvin Singh
- Dean Cannell
- Llew Claasen
- Ari Lustbader
- Tommy Chia
- Mark Pretorius
- Henk Kleynhans
- Michael Jordaan
- Dotun Olowoporoku
- Abrar Ahmad
- Michael Greve
- Wayne Gosling
- Jordan Wainer
- Paul Brown
- Dan Stephenson
- Malcolm Gray
- Richard Rose
- Mark Forrester
- Shlomi Podgaetz
- Jesse Hemson-Struthers
- Cassian Coquelle and Hendrik du Preez and Andre Bottger
- Angel Investor Networks
When Attracting Investors Go Ugly Early
When it comes to attracting an investor, use the same strategies in the boardroom as you would in the barroom.
If you want to make money from your idea, you must be unique in your ability to execute it. Sometimes you have a great idea – a game-changing idea; an idea that’s worth a billion dollars – so you start thinking about how to make it a reality and you quickly realise that you don’t have sufficient capital, technical expertise and/or time.
At this point you’re faced with two choices:
Option 1: Be paranoid
Start worrying someone will steal your genius idea. Insist on NDAs before sharing. Start fantasising about selling your idea to a giant corporation that is so lethargic it would never be able to come up with your idea.
Option 2: Share
Start telling everyone about your idea. Share it on Twitter or Facebook. Tell the world!
Option 1 is a dead-end filled with losers. Option 2 carries the small chance that you get ten people who validate your idea and you can take the next step.
Option 1 deprives the world of your idea and leads to you muttering: “I thought of Facebook long before Zuckerberg,” whilst sipping a late-harvest semi-sweet wine with ice. Option 2 gives you a small shot at being part of a bigger story, and at the very least, gives the world a chance to benefit from your idea, even if you enjoy no financial upside (or credit).
Get screwed early
If someone steals your idea and makes a success of it, tough luck. If your contribution is not critical to the realisation of the idea, then the idea is worthless. At the very least, you can identify crooks early on. The world is full of crooks. Giving people an opportunity to screw you early is a great way to filter bad people from your life.
Build a track record
Okay, so you’ve got the idea. Now you need funding — you need a shareholder. First, you need a network. Cold calls rarely work. Investors work on personal references. With luck, your parents or your friends or your colleagues can plug you into a capital network.
If you weren’t born lucky, you have to make your own luck. The shortcut is to marry rich, although that usually results in long-term unhappiness.
The long route is: Go work at a reputable company, build a track record and strong relationships that you can leverage when you are ready to start your own business.
Go ugly early
Once you have access to a network, you need to attract investors’ attention. Getting the attention of an investor is a bit like finding love at a bar. If you’re like me and you always struggled to attract good-looking members of the opposite sex, employ the ‘go ugly early’ strategy.
The same strategy works when it comes to chasing funding. Instead of chasing the most attractive person in the room, head straight for the hunchback. This will save you time. Also, it will gain the attention of the most attractive person in the room. “That’s weird, why is that guy not talking to me? Everyone always talks to me!”
Here’s the thing: The key to the ‘go ugly early’ strategy is to be noticed. It’s no good chatting up the hunchback if Leonardo Dicaprio can’t see you doing it.
Close the deal
Okay, assuming you can attract interest, you need to close the deal. Get the basics right. Dress smart, have your forecasts on hand, be clear that you’re in it for the money (not to save the world). Most importantly, show your passion. People don’t invest in excel spreadsheets — people invest in dreams. Sell the dream.
If you don’t close the deal, don’t sweat it. Move to the next girl (or guy) at the bar. Remember, the best investors are hard to get. If someone seems too eager to give you cash, think twice. Easy cash is like easy sex. It normally comes with STDs…
Raising money is all about people. Be yourself and the right person will choose you. If you try to be someone that you’re not, you may find yourself in bed with the wrong person. And shareholding relationships are like the mafia: It’s hard getting in, but it’s much harder getting out.
Read ‘Be A Hero’ today
How To Fund Your Business By Taking On New Shareholders
Here are four practical things to consider and implement to do just that.
There comes a time when your business needs an injection of capital to get over that hump. The hump might be the viability test for your product; the road to earning revenue; or the boost to take your business to that next milestone. Whatever it is for your specific company, finding the best way to raise the needed cash is an important and often challenging task.
A conventional way to do this is to bring on a new shareholder. Here are four practical things to consider and implement to do just that:
First up, how do you practically raise funds by bringing a new shareholder on board? It’s important to understand that your company is raising funding. This is done by offering ownership to the funders in the form of shares. The ownership and value of the company is split into fractions (shares) – a new owner puts money into the company, and gets shares in the ownership of the company in return.
2Measuring your company’s value
The natural next question is: how much ownership does the new shareholder get in return for their contribution? Does a R 1 million investment get the new shareholder 50% or 5% of the ownership of the company? As you can expect, this depends on the value of the company before the investment.
How do you measure the value? Luckily, there are whole industries dedicated to doing this – with the essence being: Your company’s value depends on its ability to earn profits for its shareholders.
There are many ways to measure that, but you will essentially need to show a compelling argument of why the company can earn profits for its shareholders.
3The start-up challenge
This is where the early stage start-up company faces a real challenge. The start-up will often have little or no actual revenue – making it hard or even impossible to show a track record of earning profits for its shareholders. The challenge here is to show its potential to earn revenue.
Typically, this comes down to showing a great product, a great management team, reliable research into the size of the market or potential market, and how the start-up’s value offering can crack that market wide open.
4The investor’s risk
Once you’ve convinced an investor to buy 5% of your company for let’s say R1million rand, and you’ve given them a 5% shareholding in your company, what’s the next step? What risk does your investor take?
The starting point is that your investor is now a shareholder, so they take all the risks that you do. If the company fails despite your best efforts, the investor takes that risk and has no claim against you or the other shareholders.
It is common for sophisticated investors (think Venture Capital, Private Equity or Angel Investment Funds) to try and limit that risk. Common tools here include liquidity preference – which is a fancy way of saying that they get their investment back before you do, should the company become insolvent (that is if there is any cash back).
But what do you personally owe that investor in return? This is important – you as a director of the company will owe a duty to that investor to spend their money wisely, in the interests of all the shareholders. You owe them a duty to manage the affairs of the company prudently. You are now the custodian of someone else’s money and your goal is to build the value of the company so that you give all the shareholders a return on their assets. If you breach this duty, you can be held personally responsible for the shareholder’s loss.
Again, sophisticated investors can also require more from you – especially if you and your start up management team are essential to the growth and viability of the business. They can “lock up” your shares in such a way that you can’t sell for a specified period of time. They can also require your shares to “vest” over time so that if you leave before then, the company can take back your shares.
These and other tools are specifically intended to minimise the investor’s risk by motivating you as the founder and director of the company to stay and grow the company’s value.
Planning ‘life after the investment’
It seems obvious that you should prepare carefully for fund raising. It can be a time consuming exercise – but one you’ll never regret. It’s important to know what your potential investors want to see in order to agree to the value of your company.
Also, it’s vital to be very clear on what your obligations will be to the new shareholders once they come on board. Discuss both their expectations of you, as well as your expectations of them. Build the “life after investment” picture very clearly so that you know what your position will be afterwards.
In a nutshell – lay strong foundations with investors for a long term relationship in advance, and your company’s long term prospects will be much healthier.