Funding From Synergistic Company
Yeigo: Chasing Big Investors, Refining their pitch and nurturing relationships paved the way for funding for this telecoms start-up.
Rapelang Rabana, founder and managing director of Yeigo Communications, knows how tough it is to get funding. It took perseverance and business suss to get her company’s great idea in front of an investor who would recognise its potential. But in the end, she and her team tasted success – in the form of a multi-million rand investment.
“We sought investment for most of 2006. We spoke to some of the government agencies, the banks, the IDC, and considered some of the VC / private equity funds but didn’t actually approach them,” she recalls. Like countless other start-ups, she battled to get anyone to invest. “There is always interest and support from most people you speak to, but seldom a firm commitment,” says Rabana.
She believes there were two major reasons why Yeigo couldn’t secure funding through the channels it initially targeted. “Firstly there is insufficient availability of funding for start-up companies: government has tried to set up a number of agencies to support small businesses but the caps on these funds are extremely low, usually peaking at around R250 000. So for a company needing millions, they are not a feasible option,” she says. To get access to larger capital, Rapelang points out that start-ups inevitably have to approach banks and other financial institutions. But this often ends in a dead-end street: “As a new graduate with no assets, you cannot meet the banks requirements,” she points out.
Of venture capital or private equity funders she remains sceptical: “There are some fledging VC or private equity funds that might consider a start-up, but you will find that because capital markets have not yet matured, their approach is not conducive to a prosperous relationship, and they often take hugely aggressive equity stakes that leave very little incentive for the people working in the company.”
The second reason she puts forward is the insufficient availability of skills to assess risk in software research and development, or in companies whose value is largely derived from intellectual property. “Even as more capital becomes more readily available, without the analysts who have skills to assess risk, value and potential in technology-based companies, investors cannot reach a decision. The banks couldn’t assess our risk – they told us as much,” she says.
The company did eventually obtain a development grant from the IDC through the SPII (Support Programme for Industrial Innovation) but, as Rabana points out, “It was a retrospective grant that requires you to spend the money first before the IDC pays out, so it doesn’t help at all with cash flow for a start-up. Furthermore a bank still won’t fund you to the tune of the grant even though the IDC signs a contract committing to payout.”
However, she learned valuable lessons from the long process of rejection and lack of success. The biggest of these she describes as, “Wasting time with groups who did not have the capacity to fund us because of either of the two reasons I mentioned, and writing business plans that were too long.”
She believes her eventual success in finding an investor in Ivan Ferrar was as the result of three things. “Firstly, we knew how to commercialise the technology. We had business models before we had a product, while most technology companies work the other way round. Then we were addressing a serious need and were overthrowing old business models. Disruptive technologies inherently have significant growth potential,” she says. Her third reason is an interesting one and relates to her team. “I think it’s definitely more compelling when a group of people have been working on something for over a year without pay, than if its just one person. Being alone, in my view, can be a serious vote of no confidence, but as an initial group of three, we had already attracted two top graduates for no pay and grown to a team of five. The intellectual capital in the company was already quite high and it was clear we had momentum.”
The contact with Ferrar came not out of any explicit action on the Yeigo team’s part, as Rapelang explains: “It was more about finding mentors and advisors and building a network in the belief that there must be other options, other people who would understand and appreciate what we are trying to do. And eventually you end up meeting the right people.”
Her advice to entrepreneurs follows a similar line. “It’s all about relationships, especially at the start of your first venture. Spend more time building relationships, talking to people, having lunches that don’t really seem necessary and going to events that are well out of your comfort zone. Just get out there!”
What To Learn From Yeigo
- Persevere and find an investor who recognises your potential
- Don’t waste time with groups that do not have the capacity to fund
- Work with a strong team
- Work without pay shows strong commitment
- Build relationships, especially at the start of your first venture.
Spend time talking to people, having lunches that don’t really seem necessary and going to events that are well out of your comfort zone
Self Funding & Equity Sacrifice
High risk debt finance reaps high reward for IT guru Vinny Lingham who risked everything to fund his business.
Getting investors to see the potential in your idea can be a frustrating process but one that almost every business owner looking for investment has to contend with. It’s one that Vinny Lingham, founder of Internet search engine marketing and technology company incuBeta, remembers ruefully. When he approached the banks to fund his business idea, they didn’t understand what he was talking about. “They wanted to see ‘stock’,” he laughs, looking back, “It was clear that they just didn’t understand what Internet search marketing was and how it could make money.” It’s a common complaint of start-ups operating in the IT sector; it’s precisely because their ideas and products are so far ahead of the game (and therefore represent a great investment opportunity) that traditional funding institutions fail to grasp the concept and therefore reject their applications.
“The paperwork was onerous as well and I could see that the process was going to be very lengthy and time-consuming. But I didn’t have time – technology develops so quickly and the market was getting ahead of itself so I had to get off the ground,” he adds. Impatient to get going, Lingham did something most people wouldn’t dream of – he sold his house to fund the business.
He knew the risk he was taking was substantial but he also believed so strongly in incuBeta’s ability to be successful if it could only be given the chance. “I sold the house because I knew I had two options in life. I could either marry my fiancé and pursue a family life and normal career, in which case I would never start my own business because the risk would be too great and I’d have children depending on me. Or I could take a huge risk while I was young, with no children. I just knew that if ever there was a time to take the risk it was now,” he relates.
Did the thought of failure ever cross his mind? “Certainly it did, but I thought if I lost the house and the business failed then I’d just get a job and rent accommodation for the rest of my life. To me the thought of not owning my own business was worse than the thought of losing my house and never being able to buy another one,” he replies philosophically.
As it turned out, failure was something Lingham didn’t have to face. He combined the R125 000 from the sale of his house with another R75 000 from his credit cards and poured it into incuBeta, which made profits almost immediately.
“Although the business made profits from day one it also had cash flow problems from day one, because it grew so fast and we would have to wait to be paid,” adds Lingham. In order to overcome these problems, Lingham started giving away equity in return for funding early on, initially bringing in two friends as founding partners, one of whom the business owed R700 000 at one point. Through one of these partners, Eric Edelstein, he made contact eight months later with an angel investor, giving away approximately 13% in equity in exchange for a further R700 000.
“I always had the philosophy that you grow a business a lot quicker if you give away equity for investment,” says Lingham but adds a word of advice in this regard, “Be careful of giving away so much that you don’t feel as if you own the business at the end of the day. The question you need to ask yourself is what percentage you do need to retain in order to feel ownership of the company. The rest is dispensable to get you where you want to go.” Looking back, he says, “I don’t think I made bad decisions but in some cases I could have held on for longer. The longer you hold out for investment the less equity you need to give away.”
What To Learn From Incubeta
- Don’t allow frustration to get the better of you. Persevere
- The paperwork is onerous but see it as a part of the process
- Be prepared to take a personal risk such as selling your house
- Use all necessary means of funding such as credit cards
- Be prepared to give away equity (only if critically necessary) and hold out longer to improve cash flow and hence to give away less equity
Funding Through Cash Flow
Creative media company RE:Public finds success and funds growth through cash flow.
How many times have you heard people say that their business ‘funded itself’, that the cash flow generated in the business provided the capital needed for it to continue to exist? How do they do it, you may wonder. And before the business started generating cash flow, where did the ‘seed’ money come from? After all, everyone has to start somewhere and you can’t create something out of nothing, right?
Wrong. It is possible to start a successful and sustainable business without external funding. It’s not easy, but it is certainly possible. People like Sacha Matulovich and Pepsi Pokane, co-founders of creative media company, Re:Public, are testament to the fact. The company’s turnover this year is expected to be in the region of R25 million. It’s been in operation for only four years. And it has never had an external funder.
From day one, Re:Public has funded its own growth with cash flow, thanks to some hard work and creative risk-taking on the part of Matulovich. When he started Re:Public in 2003 doing design and branding work, he targeted start-ups. “My angle was to create brands from scratch for these companies who needed marketing. Being small struggling businesses themselves, many of my clients couldn’t pay cash for the work I was delivering. But instead of seeing this as an obstacle, I approached it as an opportunity and took a profit share in the businesses I was branding. So I worked on risk instead of being paid,” he relates.
It was a risk that paid off. One of the companies whose brand he had created in return for profit share started making money and it was this income that funded Re:Public’s early days of growth.
When Pokane joined the company Re:Public received its first contract with the SABC and the pair thought that funding would come rolling in. But, like many entrepreneurs, they were to be disappointed. Matulovich remembers: “We thought, ‘Oh great! We have an actual contract – time to go to the bank!’ But the bank just looked at the contract and said ‘That’s fascinating. What securities do you have?’ At that stage, I was 24, didn’t own property and had nothing except for the cash flow in the business.”
So Re:Public went back to funding itself through cash flow. Not a capital-intensive business, its biggest cost was salaries. Matulovich and Pokane often didn’t take salaries or waited a couple of weeks to draw them. “You are forced to make every cent you receive work for the business in terms of capacity, equipment, training or new business development.”
Re:Public managed to avoid cash flow catastrophe by accepting that some aspects of the business would have to wait for funding. It forces you to run a tight ship, expenses-wise, and that can be frustrating but it’s essential,” he concludes.
What To Learn From Re:Public
- Be creative to find ways to fund your business through cash flow
- Sacrifice salaries to save on cash flow
- Only buy what’s critical to running the business – forego fancy furniture and other luxuries
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.”
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