Knowing what an investor is looking for is often the key to securing the finance your business needs. But different investor groups are driven by different needs and you need to make sure you tailor your application to match these as closely as possible. Dave Murray of Cape Venture Partners tells us how.
Perhaps the four most common sources of start-up investment are angel investors, venture capital funds, equity funds and government funds. Each is looking for something specific. Murray starts with angel investors. “This group wants to make a massive return – about ten-fold on the investment they put in,” he says, adding “And they’re happy to accept big risks – if the potential returns justify it.” Typical scenario – a start-up with a groundbreaking idea or product that will take the market by storm if it can only get its hands on some funding.
Sounds great, so how do you find them?
Unfortunately, as Murray points out, “Angel investors generally invest in people they know, or those who are part of their network.” However, they also invest in industries and sectors they are familiar with and where they can add value over and beyond their financial clout so it’s not impossible to access angel investors if you don’t have a contact base of wealthy people looking to do something with their money. For starters, build up a network of contacts in your industry. Entrepreneurs are often insular in this regard and see other players in their space as competitors as opposed to potential sources of contacts and growth opportunities. There are many instances of start-ups receiving funding because somebody told somebody who told somebody else about the opportunity for investment. Angel investors often have a portfolio approach and are looking to invest in a number of ventures with the expectation that some will fail and some will be very successful. So knowing a similar industry player who they’ve invested in could be your in.
Murray advises, “Seek wealthy entrepreneurs who have already succeeded in your industry – especially if they have exited their business and are looking for something to get involved in.”
Once you’ve found them, it’s essential that you don’t blow your first (and only chance) but pitching to them in the wrong way. Murray says that it generally helps to have introduction by a mutual acquaintance. Going in cold is seldom successful – another reason to start working that contact network. “Only pitch an executive summary at first – get them interested and asking you for more information. It should be short – maximum 20 to 30 pages – and should include exit opportunities,” he adds.
It’s also important to be aware that angel investors typically want to be involved at Exco level and will expect regular management reports and updates – unsurprising given that they’re usually taking a risk. So if you’re looking for someone to provide you with cash and leave you to get on with it, this investor is not for you!
Seed funding is one of the most difficult types of finance to access so you may need to achieve some results first before you find an investor. Once you’ve done so, venture capitalists (VCs) may prove an easier route to getting the capital you need. They want to see some evidence of success but they’re still interested in early-stage funding. As Murray says, “Venture capitalists generally want early stage but post-revenue opportunities that have already achieved good successes, but whose growth is constrained by inadequate funding/ working capital.” In other words they can help take your business to the next level, providing the capital boost it needs to really enter the profit zone.
Murray’s advice on securing venture capital funding is to put forward a powerful executive summary and introductory letter that covers all the major points. “Ensure it covers all key bases, including competitors, market potential etc. Avoid “hockey stick” projections and arrogance such as ‘We have no competitors’!” Many VCs are members of the South African Venture Capital and Private Equity Association (SAVCA) and their criteria are listed on the SAVCA website (http://www.savca.co.za/) so go check it out. However, Murray cautions, “Avoid mass mailing all the members – these go straight into the bin. Have a covering letter that shows you have done your research on the VC, and understand why you are potentially a good fit.”
Also on the SAVCA website are a list of equity funders. This group differs to VCs in that these are investors who will only invest in well-established, proven entrepreneurs. They will not invest in seed or early stage ventures so don’t waste your time targeting them if this is what your business needs. If on the other hand, you have for example, already succeeded in the South African market, and you need funds in order to go global, then an equity funder may be interested in you business. How do you get hold of them? “They find you, not the other way around,” says Murray, advising that the best way to attract this form of investment is to become a successful entrepreneur in a field with huge growth potential.
If you’re looking for government funds on the other hand, you’d do well to avoid global or international aspirations. “Government funds are looking for job creation and BEE empowerment. For these reasons and because they are not trying to make money out of investment, they are happy to accept low returns. But they want South African businesses that stay in South Africa,” says Murray. He warns that the process of applying for government funding is generally very slow: “Over a year would be normal – so be patient!” He also adds that with so many different areas of government with different departments that have different criteria, you need to do a lot of homework. Find out what the departments’ various social development imperatives are and see if these have a fit with your business.
Finding Partners in Funding
The funding road can be a tough and lonely one to walk but there are companies that specialise in helping entrepreneurs to find what it is they are looking for. Cape Venture Partners is one such entity. Made up of people who are passionate about entrepreneurs, they are involved in helping technology start-ups to realise value by putting them in touch with an extensive network of potential investors. As Dave Murray, explains, “We support high impact technology entrepreneurs who need hands-on business advice and mentorship to accelerate their development. They must have innovative technology with high growth potential. We also provide access to local and international investors, including VC, private equity, angel investors and institutions.”
He continues, “We seek dynamic entrepreneurs in the TMT field (Technology, Media, Telecommunications). Our definition of technology is broad and a business that is technology-enabled, for example, would qualify. The business must have high growth potential (in excess of 100% per annum).” It’s important to note that CVP does not support what they call ‘lifestyle entrepreneurs’ – those businesses that only serve to support the entrepreneur and their family. They are looking for talented, driven hardworking individuals who preferably have demonstrable achievements under their belt. You should also have clear and realistic expectations, and know where you need help. “They have what it takes to compete on an international level,” says the company’s website.
CVP’s role is very hands-on and extends beyond funding. They provide business advice and mentorship, help with sourcing new markets and customers and deal with the challenges of high growth, helping SMEs to recruit the right talent and implement the necessary systems and procedures. “Our fee structure is risk based,” explains Murray, “We generally take a significant portion of our remuneration as equity.” If the company helps your business to secure investment from one of their many contacts, they would also charge a success fee.
To contact David Murray call 021 4471887, go to http://www.cvp.co.za/ or visit their premises at 3rd Floor, Old Warehouse Building, Black River Park, Observatory, Cape Town.
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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