The funding trifecta
Do you tick the boxes?
Investors look at a deal from three angles:
- Are you investable?
- Is the deal investable?
- Is the risk investable?
In order for a deal to happen all three boxes must be ticked.
It’s important to remember that many viable businesses do not raise VC funds, as a viable business does not equal an investable business.
There’s a pervasive myth that there’s no funding available for early-stage businesses. There is sufficient capital in the ecosystem and South Africa is not short of great ideas or products. Unfortunately, what we are short of is great entrepreneurs. There are many more R1 million opportunities than there are R1 million entrepreneurs. In particular, there is a shortage of great entrepreneurs who can scale their start-ups into assets of value. There is a key skills gap between the ‘wantrepreneur’ and the scalable entrepreneur.
Here are ten ways that you can beat the odds and build a business that is scalable, sustainable and will attract the attention of investors — if you even need investment after getting the basics right.
Remember: Many great businesses have been self-funded.
1. Find and craft your dream team
Investors back the jockey before they back the horse. As talented as you may be, it’s unlikely you have all the skills required to launch and build a successful business on your own. And even if you do, you won’t have the time and energy to do so, especially as your company begins to grow. Investors invest in people and not ideas or products and services.
Investors also prefer to invest in teams over individuals. Have you put the right team together? People are far more important than the idea or product. Whilst many entrepreneurs have a great product or service, they do not demonstrate the business skills to build a successful business around that product or service.
Don’t be a solo founder. Except for some very isolated examples, most entrepreneurs will have little chance of raising money unless they have a team. It may be a team of two, but the solo entrepreneur raising money can be a red flag.
First, no single person can do everything. We’ve never met anyone who can do absolutely everything, from product vision to executing a plan, engineering development, marketing, sales, operations, and so on. There are just too many mission-critical tasks in getting a successful company launched. You will be much happier if you have a partner to back you up.
2. Understand that raising capital is time consuming
This time could be better spent on getting customers and developing your market. Rather invest the initial time in obtaining product-market fit than trying to raise money too early.
Raising capital does not validate your business model, only customers do.
This makes it vital to get paying clients before you pitch to investors. No one will fund you if you are not solving a problem. It’s that simple. And it’s hard to prove that you’re solving a problem without paying customers.
3. Bootstrapping is non-dilutive customer funding
Some of the most successful start-ups have self-funded their businesses through the simple act of selling. Conclude a distribution agreement through a large distributor, reseller or OEM. Pound the pavement and sell your product. Get customers — and adjust your model or offering if you haven’t found product-market fit.
This is how early-stage entrepreneurs figure out how to get their businesses off the ground. Every entrepreneur owns one very valuable resource: 100% of their equity.
Use it wisely and try not to dilute it too early. Bootstrap your company before you try and raise institutional capital.
4. Begin discussions with investors before you need the money
A soft introduction to an investor is an effective way to start a conversation about your business. Grow your network at every opportunity and then leverage that network. I am a firm believer that an entrepreneur’s network is their net worth.
Once you’ve made a connection with an investor, you can keep them updated on your progress. In this way you’re showing them that you’re setting goals and milestones and meeting them. This creates a very different discussion down the line when you are looking for growth funding.
5. Not all money is created equal
There is a difference between ‘smart’ and ‘lazy’ capital, and you want smart capital. There’s no shortage of money looking for a home, but if you’re looking for investment capital to truly build a scalable, sustainable business, then you need all four types of capital from your investor: Social capital; financial capital; human capital and mentorship capital.
6. Make your business attractive to an investor
In order to present an attractive deal, you need to think like an investor. Put yourself in their shoes, and understand their business model.
Investors look for scalable businesses and to raise finance you need to show how you will scale. A good idea does not equal a good business model or an investable business. You need to show investors how you are going to make money.
They need to see a clear ROI for their investment. You must quantify the risks your business faces and show them how you will mitigate them. You also need to show them how you will use the funds raised. High salaries, flashy cars and swanky offices are not what investors want to pay for.
7. Be realistic about your valuation
Investors are not gamblers and business is not about taking unnecessary risks. It’s about mitigating risks. There are a number of key areas that investors focus on, including proof of product-market fit, consumer acceptance, first rate management, the potential and ability for high growth, whether it’s a high margin business, if there’s a viable risk-reward relationship and if there are obstacles to competition. Most start-ups fail because they don’t get one or more of these ingredients right.
Your forecasts are at best a bunch of hypotheses or guesses, so bear all of these points in mind. Wild valuations that discount these core areas will show investors that you haven’t done your research and you aren’t in touch with your numbers.
Start-ups that are attractive to investors understand that they need to be able to articulate their market research and how they will achieve traction.
For me, there are three critical ingredients that determine start-up success:
- Do you have the best team on the planet (people)?
- Are you selling something customers want (product-market fit)?
- Are you able to get and keep customers (in other words, are you adding value to their lives)?
These three elements are more powerful than an over-inflated valuation will ever be. In fact, over-valuating your business will do you more harm than good.
8. Sell the deal to the investor
Raising money is about selling. No business skill is more important than the ability to sell. If you can’t sell your idea, product or service you won’t raise the required capital for growth, convince your prospective investors of your vision (and subsequent valuation) or achieve the deal terms you want. Selling is critical.
But be careful. Dilution is less important than success. 100% of nothing is nothing. Many entrepreneurs want funding, but they don’t want to give equity away for that funding. If that’s the case, rather choose the debt funding route. Investors are looking for equity, it’s that simple.
If you choose this route, then the best way to approach investment is with an abundance mentality. Together you will build a bigger business, and everybody wins.
9. The business model — and not the plan — is one of the critical steps in raising capital
You need to present a business plan when you pitch to an investor, but what they’re looking at is the business model contained within that plan.
Research and prepare a good business plan that is tidy and easy to read. Package it from the investor’s perspective and not yours. Your plan should be a roadmap from where you are today to where you are going to become profitable. We call this a clear path to profitability, and it’s an essential component of your presentation.
Focus on the one to three-page polished executive summary and elevator pitch and assume it’s the only document your investors will read. Remember, you must validate your financial figures and show that you have achieved product-market fit.
10. Master the pitch
Finally, make sure your pitch is perfect. I have never heard a pitch that was too short. On the other hand, I’ve sat through many, many pitches that were too long.
The best pitches show the investor what your business does. They include demos and prototypes. A 60-slide PowerPoint deck is the exact opposite of this. Be ruthless in removing information from your deck to get only the essentials across. The purpose of a pitch is to stimulate interest, not to close a deal. If the pitch is short and to-the-point, you can start a more in-depth discussion. A long, rambling pitch will just lose investor interest and close the door on a potential deal.
The foundation of a great pitch is the research you do before the meeting starts. You need to know your audience, what they care about, and what will pique their interest.
The best pitches follow the 10/20/30 rule: A PowerPoint presentation should have ten slides, last no more than 20 minutes, and contain no font smaller than 30 points.
The 10-slide PowerPoint presentation
- Problem: The pain that you will be addressing (avoid looking like a solution searching for a problem).
- Solution: The painkiller that you have developed and how it will alleviate the pain (ie. the scratch for the itch, aka the product).
- Business model: Explain how you will (or do) make money.
- Underlying magic: Explain your technology, the secret sauce or magic behind your product or service.
- Marketing and sales: Explain how you are going to reach your customers.
- Competition: Provide a (realistic) view of the competitive landscape.
- Team: Describe the key team members as well as the board and investors (must sell yourself first and your team).
- Financial projections and key metrics: These include number of customers, conversion rates, cost of customer acquisition, lifetime value of customer.
- Status/progress and timelines: Status of your current product or service, what the future looks like and what the money will be used for.
- TOP RULE: Use slides to lead not read.
Access To Finance In SA: What You Need To Know
Finfind’s inaugural SMME Access to Finance Report reveals some of the biggest challenges SMEs face when trying to get finance. Understand the landscape, and you can adjust your business to obtain more finance.
Access to finance is a primary challenge for the majority of SME owners, particularly in the early stages. Without an understanding of the complexities of SME funding and the challenges experienced by both the providers and seekers of finance, it’s impossible to address the obstacles that are hindering increased deal flow.
Many countries have transparent data from lenders on a number of SMEs applying for loans, the reasons they are applying, financing terms, the interest rates, rejection reasons and rates, non-performing loans and factoring volumes. However, this information does not exist in the public domain in South Africa, even though it is crucial for policy-making. There is an urgent need for quality data and increased transparency to map SME’s access to finance and understand their funding challenges so that practical solutions can be developed.
Finfind has responded by publishing South Africa’s inaugural SMME Access to Finance Report. As an innovative fintech company that provides SMEs with a free funder matching service and an up-to-date database of over 420 finance products from public and private sector SME funders, Finfind has comprehensive data on the providers and seekers of finance. The report has enabled us to provide valuable insights about SME funding that can benefit policy-makers, funders and organisations involved in SMEs.
Some of the key findings of the report include:
High demand for SME finance
The SME funding gap in South Africa is estimated at between R86 billion and R346 billion per annum. It provides a compelling, largely untapped market opportunity for innovative funders who are able to develop new lending models and risk assessment tools tailored to address the challenges of this complex and burgeoning market.
Funders require new risk assessment models
Banks currently struggle to serve SMEs as they treat business (big and small) as a single market, and apply traditional lending methods that use collateral and conventional financing scorecards as a one-size-fits-all approach. These traditional instruments are detrimental to micro, very small and small businesses securing finance. For funders to close the credit gap, innovative new credit scoring models that enable more accurate risk assessment need to be designed specifically for this target market.
There is a lack of SME credit record data in South Africa
South Africa has comprehensive consumer (personal) credit record data that is well organised and regulated. However, this is not the case for SME credit record data. The credit bureaus in the country have little, and in some cases, no credit history data for SMEs. There is no regulation of SME credit record data, and no standard means of data collection (or a framework for credit records) for SMEs.
This poses a major challenge for SME lenders as they use the credit score in their risk assessments. Funders request credit reports (credit checks) from the credit bureaus to assess a business’s historic credit conduct. In the case of SME lending, funders request the credit report for both the owner and the SME, even though they are two separate legal entities.
The current system does not uphold legislation that distinguishes between the owner and the business, which means that when SMEs apply for finance, lenders rely on the credit records of individual owners to assess the risk of lending. This prejudices SMEs that might be extremely creditworthy but have owners with compromised personal credit scores.
The lack of SME finance readiness is a major hindrance to securing finance
The qualitative research shows that many SMEs are unable to access funding as they cannot provide funders with proof that they are bankable and can afford the finance they are requesting. Funders need to examine the SME’s financial records to determine that the business is viable and to assess their ability to repay the funding. To do this they require access to the SME’s latest financial statements and up-to-date management accounts including income/cash flow projections and outstanding debtors, tax clearance certificate, VAT statements and business plans amongst others.
Financial record-keeping is a major challenge for many SMEs and they are not able to produce these documents. Without these, they are unable to access finance, and are ill-equipped to make sound decisions in their business or properly manage their cash flow. Poor cash flow management often results in SMEs falling behind on VAT and PAYE commitments as they are unaware of what is owed. Many viable businesses are liquidating due to liabilities owed to SARS and other creditors as a result of poor financial record-keeping and an inability to secure funding.
Further to these key findings, the report provides valuable insights into the supply and demand for SME funding. It profiles the SMEs seeking finance by geographic location, turnover, age of business, sector, job creation, financial need and amount of finance required, amongst other key indicators. It also profiles the funders, and considers the supply and demand matches and mismatches, highlighting some of the funding gaps and opportunities in this critical sector.
About the smme access to finance report
Finfind launched the report in partnership with the SA SME Fund and its findings have been made freely available to stakeholders in the SME ecosystem. The report identifies providers and seekers of SME funding in South Africa, and the associated challenges, gaps, opportunities and potential solutions to increase funding success in this vital sector. While ground-breaking in terms of the information it provides, this initial report did not answer all the questions in this complex environment, but provides an excellent start to understanding the landscape.
The report is based on independent analysis of Finfind’s funder and SME finance seeker datasets in 2017, the largest SME access to finance research sample to date. In 2017, Finfind had a total of 126 916 visits to its platform, 81,2% of which were unique visitors. The average time spent on the site was more than five minutes per user.
The report analyses comprehensive data from more than 10 000 SME funding requests that were matched with a base of 148 funders and 328 finance offerings. Comparisons of the Finfind data with data from SARS, GEM SA and StatsSA studies show that the Finfind data is representative of the SME market and that the report findings can be generalised for SMEs in South Africa.
Looking For Funding? Try Manufacturing
There are over 200 national incentives for the industrialisation of South Africa. Can you tap into grant funding to grow your business?
Many people ask me why the focus of public investment in SMEs and business is so heavily weighted on the manufacturing sector?
The reality is that investment in industrialisation results in a multiplier effect in jobs, foreign earnings through exports and increased tax revenues. Countries that focus on industrialisation have proven its potential to stimulate economic growth and address social challenges.
If you’re looking for opportunities and the support needed to realise these opportunities, manufacturing is a good place to start. The Department of Trade and Industry (DTI) offers several manufacturing-based incentives and grants.
Below are the ten key general principles associated with the DTI incentives:
1. Matching concept
DTI grants are based on a ‘matching’ or ‘co-funding’ principle, which requires an applicant to invest a portion of the funds required for the project for which funding is being requested. The DTI will fund a portion of the project qualifying costs (anywhere from 10% to 90% depending on the specific fund) on condition that the applicant can prove a source of the remaining portion. The source of the difference can be debt, equity or any other form of funding.
2. Qualifying/allowable investments or activities
The DTI sets rules for what can be funded by way of a grant (qualifying costs). These may differ based on the incentive, but the general rule is that the main application of grant funding is for plant, machinery, tools and equipment. Land and working capital will not qualify and would form part of the co-funding.
3. Project size
This refers to the full project size and includes all costs involved in implementing the project. All costs include capital expenditure (e.g. plant, machinery, tools and equipment), working capital (e.g. salaries, wages, stock etc.) and other costs including, but not limited to, land, vehicles, business development and certifications.Not all costs will qualify for funding from an incentive.
Projects are evaluated to determine their bankability. The DTI aims to ensure that the principles applied in an application and business plan are realistic and will result in a sustainable business and/or project. In evaluating bankability, the DTI will look at the ability and know-how of the team and will require the applicant to show proof of market.
Proof of market is demonstrated by off-take agreements, purchase orders, contracts or letters of intent.
Incentives are strategic funding and, as such, are not an appropriate source of funding for distressed businesses or businesses with short timeframes. This funding should be viewed as strategic funding. The DTI may provide timelines for processing applications, however, applicants must be prepared for timelines longer than those indicated. Applications may take anywhere from three to 12 months to be processed and approved.
6. Approval prior to investing
Investments made prior to the approval of an application will be non-qualifying investments. This means that an investment made before receipt of an approval from the DTI cannot be recuperated. This will be enforceable even if the investment made formed part of an application that was approved.
7. Milestone based claims
The DTI will make payments based on project milestones as indicated in an application. Each fund may define its own milestone parameters.
8. Rebated claims
Claims are rebated to applicants. This means that an applicant must first invest, in line with its application, and then submit a claim for the approved investment. This principle demonstrates the importance of securing co-funding, which will be used to initiate the project.
9. Tax free grants
Grants awarded and paid are tax-free.
10. Equity substitution in nature
As grants are not repayable, they can be considered equity for purposes of securing debt. Most debt funders require a portion of equity from an applicant to lower the risk of debt. Debt financiers will consider a grant as an equity contribution, allowing applicants to unlock debt that would otherwise not have been available.
6 Steps To Ensuring You Meet Your Funder’s Mandate
Find your funder, approach the right people, and tick all the boxes.
1. Determine why you need funding
According to Quinton Zunga, founder and CEO of RH Bophelo, a special purpose acquisition company with interests in the healthcare sector, many business owners do not understand cash flow and its impact on the operations of a business. “A good idea without enough cash flow is not sustainable,” he says. “You have to prepare the business for the worst-case scenario and ask yourself ‘what if things don’t work out my way? Do I have a plan B?’ Don’t assume you’ll be able to access finance to save the business if your cash flow is poor.”
The reality is that too many business owners apply for funding because their working capital is under strain, customers owe them money or their margins are too low.
“There’s a big difference between funding that will help you grow your business, and trying to plug a self-inflicted cash flow problem,” agrees Kumaran Padayachee, CEO of Spartan SME Finance, an alternative funder.
The key to growth funding can be summarised in one sentence: Will this help me make money? If the answer is yes, you’ve ticked the growth-funding box. If you’re not sure, relook your financials and forecasting. If the answer is no, you’re trying to solve a cash flow problem that will not be fixed by taking on more debt funding.
“As a funder, we care about what entrepreneurs want the money for,” says Kumaran. “We look at business models and strategy. We take a view of the entire picture, which gives us insight into whether the funding will be used in a growth context, or to plug a gap created by a strategy, cash flow, sales, marketing, management or an access-to-market problem.”
The real insight is that it shouldn’t only be up to funders to determine the answers to these questions, but business owners themselves. If you understand why you need funding, one of two things will happen: You’ll realise there’s a problem in the business that funding won’t solve, and you can begin working on it; or you’ll be prepared when you apply for funding, increasing your chances of securing the finance you need.
The reality is that too many business owners apply for funding because their working capital is under strain, customers owe them money or their margins are too low.
2. Understand the funding landscape
Different sectors, industries and funders have their own rules and mandates. To understand the funding you’re trying to access, you need to first understand the sector you’re in, and the funding rules that apply.
For example, property is a long-term investment and funders in this space require a commitment of at least five to 15 years. TUHF, which is a specialised residential property finance company, also requires an equity contribution, as it does not offer 100% financing.
“Funding is usually made up of two components: Financing (loans) and equity (owner’s contribution),” says TUHF’s CEO, Paul Jackson. “The purchase price of the property, the costs of refurbishment and the amount of money the client can contribute of his own money are the three main contributing factors that determine how much financing the client will need to apply for.”
More importantly, entrepreneurs approaching TUHF are dealing with industry experts operating within a niche space. This is true of most funders, and should be carefully considered by business owners.
When you’re considering your growth options, focus on what you absolutely need to push the needle, and make do with what you can as you build up your pipeline.
“In every case ask the question: Do the costs involved in accessing the finance make sense? Will this help drive growth? How? Once you’ve ticked those boxes, consider all your funding options. There are a lot of solutions available to you, from bank funding, which is the cheapest to access but requires a lot of collateral, to private equity funding, which involves giving away equity in the business,” says Kumaran.
“Alternative funders like us play in the middle of these two traditional options. Alternative funders tend to be niche and specific, focusing on specific sectors or industries. They carry more risk and don’t require collateral, which is why they’re more expensive than banks, but they bring industry and sector-specific insights as well — and it’s debt funding, which means you aren’t giving away equity in your business. Their processes tend to be efficient as well, largely due to the niche nature of the funder. When you’re ready to grow, find a funder that matches your needs and understands your business.”
3. Start early
“Raising capital patiently is key, because acquiring funding quickly but unwisely could lead to repayment issues,” says Quinton. “Some funding can only be accessed later and you need to be patient, or you may find yourself struggling to pay it off before your business has grown big enough to do so. You need to focus on preparing a business plan and understanding the cash flow impact of the decision you make. Look for an advisor or banker to work with you on the business plan.”
4. Know what funders look for
All funders are looking for specific business and personal traits in the business owners they back. Quinton values integrity and honesty, a good understanding of the business they are in, and personal commitment. “Funding a new business is always tough because the entrepreneur may not have experienced all the sides of the economy and may not be accustomed, mature and ready enough to go to the next level. This is where a steady track record is advantageous,” he adds.
Paul agrees. For TUHF, the entrepreneurial character and competence of the borrower is of paramount importance. “We follow a character-based lending approach,” he says.
“A client that displays certain characteristics is considered a better investment option. These include entrepreneurial qualities; an open-minded attitude that is willing to take advice; someone who is self-disciplined and manages the cash flows of the property to the benefit of the property, and not for personal use. Other sought-after characteristics include someone who keeps their tenants happy by keeping the property clean and well maintained, providing all-round good customer service; is committed to doing everything in their power to ensure the success of the deal; is up-to-date on utilities; and directly involved in the property management, even if there is an external service provider.”
5. Avoid red flags
Every funder has red flags they watch out for and they will walk away from a deal if they find them. “A bad past business track record indicates the business owner’s legal, financial, and HR values,” says Quinton. “These are important to us. Without some ethos and standards, you end up not being on the same page as your investor. I usually ask about the entrepreneur’s previous partnership — how they handled it and why it ended. Desperation is also a deterrent, as is a poor business case.”
Paul agrees. The driving factor in TUHF’s business is the borrower’s aptitude in property. “Real estate competency is therefore a key characteristic of TUHF borrowers. It’s important that the building is properly matched to the skill and entrepreneurial competence of the borrower. Some of the conditions we evaluate include a credit record, ensuring the borrower is not under debt review, or blacklisted; returned debit orders on a client’s bank statement; track record and state of repair of the client’s other properties; having the right risk attitude, which in our case is considered, cautious and patient; taking the time to do due diligence; and property fit — does the size and nature of the project match the client’s talents and experience. It’s a red flag for us if one of these is mismatched.”
6. Don’t give up
The most important step in funding is perseverance. Many business owners knock on multiple doors and make numerous applications before finding a funder that fits. This could be because red flags need to be addressed and financial management accounts followed, but each time you approach a funder you learn something new that you can implement in your business.
“Don’t view failure as a disaster,” says Quinton. “Figure out which stage of the lifecycle your business is in and align that to your commitments.”