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Attracting Investors

The Shark Tank Investors On What Makes A Start-Up Investable

It’s a well-known fact that only a very small percentage of start-ups receive early-stage funding. So what sets this minority apart? What makes them investable? We chat to the Sharks to find out what makes them want to give an entrepreneur their cash.

GG van Rooyen

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Finding investors, especially when your business is still very new, is hard. While you might be convinced that your business is going to be a long-term success, investors tend to be, well, a tad more sceptical.

Their scepticism is understandable, of course. Most start-ups fail. Even at the best of times, investing in a brand-new venture is risky. There are almost never any guarantees. Also, remember that investors aren’t looking for the sort of returns they could get by sticking their cash in a savings account. They want a real ROI — the much-vaunted 10x return.

Related: 10 Tips From The Dragons Of Dragons’ Den SA

So, how do you convince a VC to invest in your business? If you want an investor to take you seriously, you need to be able to show the following when presenting at a pitch meeting.

1Know Your Numbers

Don’t even think of pitching to an investor unless you have a very thorough understanding of your business’s numbers.

“It’s very important to understand the basic operating metrics of the business. I don’t expect entrepreneurs to memorise a 36-month plan, but they need to understand the production costs, margins, overheads and cash flow cycles of a business. A lack of understanding of the basics will put off any investor,” says Shark Tank investor Vinny Lingham.

You need, at the very least, to have a basic understanding of what your costs will be, and how much revenue you could potentially generate. If you can’t offer this, no investor will ever give you their money.

Also, it’s important to be realistic. Sure, investors like to see aggressive growth projections, but only if these are actually attainable. Don’t talk about the total potential global market for your product, and don’t discuss international data that has little local relevance. Investors are sick of hearing about the billions of potential customers out there. Stick to the customers you can actually attract in the next year or two.

As the saying goes: under-promise and over-deliver. Do your homework carefully, and then provide an optimistic yet realistic picture of your business’s immediate future.

2Show Traction

marnus-broodryk-shark-tank-investor

It is incredibly unlikely that anyone will invest in your business if it is no more than an idea in your head. Even if your business is still very new, investors will expect you to show at least some traction.

If you’ve been watching the local version of Shark Tank, you will have seen a prime example of this: entrepreneurs asking for money before they’ve actually spoken to customers and proven their business model.

Responding to a couple of entrepreneurs pitching a 3D printing consultancy, investor Marnus Broodryk said the following: “My problem with aspiring entrepreneurs in South Africa in general is that they’ve got an idea or concept, and they expect investors to come onboard at massive numbers. They give businesses an evaluation of millions, but they don’t have anything more than a concept. That expectation is totally warped. If you want a business, you need traction. If you’ve got interested clients and signed orders, that’s a business.”

Related: Dragon’s Den Polo Leteka Gives Her Top Tips To Attract Growth Capital

Don’t ask for money until you’ve shown that your idea has real potential. Ideally, you should already be signing clients and making money. If not, you need to show convincingly that there is demand for your product or service. You want to illustrate that you are solving a burning problem, and that the only obstacle between you and large-scale success is a lack of funds. It’s okay to start small. It’s even okay if you’re not profitable yet, but show some sort of traction in the market. You need to be able to point to actual customers and companies that are willing to do business with you.

“Traction really is about product/market fit — meaning, does the market want your product and is it willing to prove this by paying for it? If you have paying customers, that’s great, but if they are coming back for more, that’s even better,” says Lingham.

3Show That You Can Scale

All scalable businesses are successful, but not all successful businesses are scalable. Just because your business is doing relatively well, don’t assume that it is the sort of business that will attract investors.

As mentioned earlier, investors aren’t looking for a decent ROI — they’re looking for an exceptional one. Offering them a 20% return over five years is not enough.

You might have a solid business, but if it isn’t scalable, it won’t attract investors.

The very first pitch on the local iteration of Shark Tank was a great example. The entrepreneur was selling chocolate printing for special events, such as weddings and corporate functions. Within seconds, a logo or other image could be printed on a plate in chocolate. It was a clever idea, but simply too niche to ever scale successfully. This business requires you to be on the ground, printing chocolate images one plate at a time. How do you scale that quickly and effectively?

Related: Vinny Lingham’s Views On Focus, Changing The World And Why You Should Give Some Of Your Business Away

“You’re going to do well out of this, and you’re going to make a good living out of it. Do I think you’re going to shoot the lights out? Probably not,” said Gil Oved after the pitch. “Is it an investible business? Is this going to be my 10x? I’m thinking, how do I take something that’s here and make it pan-African, global? Is this that business? No.”

Before you ask for investment, you need to figure out how you could successfully scale your business. Look at Facebook, Uber or Dropbox. These tech companies are very scalable because the marginal cost associated with a new user is incredibly small. A consultancy, in contrast, requires experienced (and expensive) employees, and is therefore not nearly as scalable.

“Consulting businesses are typically not investible businesses, because to scale them you need to output more hours, and that takes more people. That’s not the kind of investments I ever want to get involved in,” says Lingham. “A scalable business means that the more you sell, the lower your costs become. If you have to keep hiring people in order to make more money, your business is really not that scalable.” 

4Have A Defensible Position

Facebook was not the first social networking site. Google was not the first web browser. Apple was not the first company to envision a computer for the home. While being first to market can certainly be very advantageous, it by no means guarantees success. There are plenty of examples of companies that succeeded by taking an existing idea and making it better.

So, as a start-up founder, you need to show investors that your idea can’t simply be replicated by someone else. It’s not just about your idea — it’s about you. If you’re not crucial to the success of the idea, you have a problem.

Related: The Tenacious Matsi Modise Has Her Game Face On When It Comes To Funding

Modern technology has made it possible for start-ups to compete with large companies, but it has also made it much easier for competitors to take your idea and run with it. If you launch your business today and it’s a hit, you can be sure that someone will be imitating you within a year. How do you protect yourself against this?

It could be about IP protection, but even this is often not enough. More often it’s about carving out a unique position that makes it hard for others to compete — it’s about the systems, processes, expertise and partnerships you have that others don’t. You need a formula for success that can’t simply be replicated by someone else.

GG van Rooyen is the deputy editor for Entrepreneur Magazine South Africa. Follow him on Twitter.

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Attracting Investors

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.

Darlene Menzies

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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.

Related: Small Business Funding In South Africa

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.

Related: Government Funding And Grants For Small Businesses

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.

Related: How To Get A South African Government Loan

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.

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Attracting Investors

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?

Nadia Rawjee

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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.

Related: How Investors Choose Who To Invest In

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.

4. Bankability

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.

5. Timelines

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.

Related: Who Would Invest In Your Start-up, And Why?

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.

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Attracting Investors

6 Steps To Ensuring You Meet Your Funder’s Mandate

Find your funder, approach the right people, and tick all the boxes.

Diana Albertyn

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rh-bophelo

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.

Related: Government Funding And Grants For Small Businesses

2. Understand the funding landscape

paul-jackson

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.

Related: Attention Black Entrepreneurs: Start-Up Funding From Government Grants & Funds

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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