You have just quit your high-paying corporate career. You’ve been flung into a world of uncertainty, brimming with a lack of security and full of unknowns. Maybe you over-stayed your welcome on a friend’s couch (like I have), barely pulled a salary for 12 months, or firmly established yourself as the number one customer of any establishment with a two-for-one special. Why? Entrepreneurship…
That niggle in the back of your mind to solve a problem close to the hearts of a specific segment of people or potential customers. That’s why.
Recognising that a number of different ingredients go into the creation of successful ventures, one such ingredient is suitable finance.
In Zero to One, Peter Thiel’s book on entrepreneurship, the following observation is made: “The 12 most valuable technology companies are all venture backed. Together, those 12 companies are worth $2 trillion — more than all other tech companies combined.”
The short of it is that finance, or getting funded, matters. According to the 2015 South African Venture Capital Association (SAVCA) survey, assumptions about funding availability in South Africa were confirmed. Dry-powder capable of being deployed by some of South Africa’s most eminent venture capitals and funds is being kept locked away in chests, buried deep and well out of the reach of prospective entrepreneurs and portfolio companies of such investors.
While the number of venture funds has increased by 40% (from 22 to 31) over the course of the past four years, average independent deal values over the same period have decreased by more than 7,5 times, from R25 million to R3,4 million per transaction, and total value invested in the particular ‘asset class’ by more than 45% (from R281 million to R146 million).
Why? Having started a number of entrepreneurial ventures, worked with South Africa’s most established venture capital fund, and currently assisting entrepreneurs to raise finance, some interesting patterns emerge.
Entrepreneurs are flagging the lack of available and ample risk capital, while investors point at a lack of quality entrepreneurs. Exposure to both perspectives can only lead to one conclusion: tThere is hope. If anything, the last six months have served to reinforce what was initially believed: through En-novate, (a venture recently co-funded and co-founded by Dan Brotman and Natan Pollack, in association with Investec), I have had the great privilege of gaining access to South Africa’s top entrepreneurial talent, which is far greater than often believed.
From the murkiness, a question emerges: if there is plenty of capital to go around, what is the key to unlocking interest in getting your business venture backed? More apt perhaps: how do you get funded?
Anecdotally, the following is important:
Venture returns are not randomly distributed; they follow what is known as a ‘power law’, where a negligible or small segment of a portfolio generates all, or the largest proportion of funds’ returns.
But the fact remains that 20% of investments drive more than 80% of returns. Investors are exclusively looking to find, back and grow this 20%. Your job is to convince any prospective investor that you are worth backing, and by virtue, fall within the ambit of the highly regarded 20%.
How to get funded
The following observations are drawn from my experience at the coalface of venture finance in South Africa; be it through unsuccessful five minute pitches, or long-nights around dimly lit boardrooms late into the early hours of the morning, ultimately yielding success.
1Foundations are key
Venture capital has always been good at funding the future. What does this mean?
The world’s most valuable companies have, among many, one thing in common — making peoples lives better: Important problems, being solved for a large base of sufferers in need of particular and fitting solutions.
100% of the world’s smallest market does not mean anything. You need to fundamentally understand and articulate why your solution exists, why it matters, and why it is going to get BIG. Technical talk splayed over a meaningless solution to a non-existent problem won’t fool anyone, especially astute investors who look at investments for a living. Moreover, some of the world’s most profound business models with the deepest of economic moats have come as a result of the ruthless pursuit of impact, not the other way around.
The entrepreneurs who get funded by the top investors understand this better than anyone.
Tip: Find those investors who are intent on making the future better, articulate your existence in that version of the future, and think about how your product, solution or service will assist in realising that future.
Venture investors have their own base of investors to answer to, and to generate returns for. (Investors into venture funds are commonly known as Limited Partners, given the proclivity for venture funds to be housed in partnership structures.)
Furthermore, with so few venture-backed companies returning entire funds, you need to think about and construct your version of 10x.
Tip: Be able to answer why your business will generate a return of at least ten times the money investors initially look to provide. To some, this might seem out of kilter with known-knowns. The reality, however grim, is that very few investments make it big, and that investors need to look for and find those companies that ultimately will. Hence the need to understand why your company will be crucial in making the future better, be valuable for that very reason and therefore return multiples on money initially invested.
We often see entrepreneurs fixated on their product, their market, or perhaps the unit economics underlying the ability of their enterprise to capture economic value. For the most part, entrepreneurs forget the single constant in all venture-backed businesses: great people and the drivers behind their success.
Looking at the websites of some of the world’s most successful venture funds, or talking to any local investor, you will find one thing — it’s all about people and the founding teams that drive entrepreneurial ventures.
It’s not hard to see why…
The funny thing about early stage companies is the desire of such businesses to change and evolve over time, often way beyond the scope of what was initially envisioned. Investors know this better than anyone and look to find those people who will succeed above all else.
Great people shape the DNA of great companies. Without people, DNA does not exist.
4The three Ts
Team, Team, Team — Enough said.
As venture funds have become more widespread, and the asset-class accepted into the mainstream, an interesting pattern of fragmentation has started to emerge.
Among many, funds are being created and developed around frameworks that relate to the following: to gain exposure to specific industries; to acquire minimum ownership stakes; to become active in managing and running portfolio investments; or to apply capital for social good.
Moreover, clear beliefs about investment stages, cheque sizes and qualifying criteria exist among South African investors.
Tip: Allow your investment requirement, the stage of your business and your business’s industry application to drive and dictate your strategy in finding suitable investors. Just as ‘product market fit’ is important, so too is investment and investor, i.e. selling your business and vision to the right buyer or recipient. For the most part, information pertaining to investment requirements is to be found on the websites of venture funds.
Whatever the unique parameters of your situation, or that of your company, it is imperative to optimally match you, your company, and any investors you are looking to onboard. In short, this means understanding where respective interests lie, and ensuring that they are aligned with those of investors.
Instead of sharing your marketing materials or your financial model with the first result returned by a generic
Google search, think about:
- How much equity you are willing to give away and why
- Your industry, what your company would need to succeed (in addition to capital)
- Strategic benefits that particular investors are able to provide in helping you ‘make it’
- Whether you are looking to grow and exit from your business in the near-term, or create value for the long-term
- How your business fits in with the existing portfolios of potential target investors
- Your desire for investors to get more hands-on and deeply involved in the operation of your business.
And while the outline above is no guarantee to getting funded, thinking about these questions deeply and meaningfully is sure to get you better prepared, assist you in crafting a story that will resonate with the frameworks and language spoken by investors, and ultimately drive a higher probability of receiving a cheque from an investor that is burning to see you succeed.
If there are any takeaways to be had, it is this: think deeply about the process, your business and resist the noise. The most important asset you can have is the ability to think independently, however painful this
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.”