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Equity Crowdfunding In SA Explained

Here’s a brief snapshot of what it is and how it could benefit your business.

Daniel Van Zuydam

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As an entrepreneur, finding the right funding for your specific start-up is hugely important.

With momentum around crowdfunding growing on a global scale, there is talk about equity crowdfunding becoming a viable option in South Africa. This is very good news indeed, as it has the potential to significantly boost economic growth.

Here’s a brief snapshot of what it is and how it could benefit your business.

Equity crowdfunding is a simple concept: Members of the public (the crowd) are offered equity (shares) in a company (generally a start-up) in exchange for funding. The company then uses that funding to kick start the business.

Related: Quick Shift Deva Kate Emmerson On Crowdfunding

Donations-based crowdfunding and rewards-based crowdfunding have started to gain some traction, with local players such as Thundafund (rewards based) and Backabuddy (donations based) leading the charge; however South Africa is still lagging behind much of the rest of the world, mostly due to the lack of precise legislation around crowdfunding.

The Financial Services Board are yet to decide how they will regulate crowdfunding in South Africa, and so interested parties have been hesitant to engage with crowdfunding, with no-one attempting equity crowdfunding to date.

Another major hurdle is that private companies are not allowed to offer their shares to the public, and the difficulty of registering as a public company is simply too great for a start-up to even bother with. The reason for such stringent requirements though, is to essentially stop fraudulent schemes. The last thing you would want to do is fund an extra round of piña coladas in Mauritius for the opportunistic con-man – the government is therefore right in trying to regulate this area.

Related: Kickstart Your Business Through Crowdfunding

Uprise.Africa

There is, however, light at the end of the crowdfunding tunnel – a new start-up Uprise.Africa aims to launch towards the end of this year. Uprise.Africa will be the first of its kind in South Africa in that it will offer the man on the street the ability to invest in a startup of his choosing and receive equity (shares) in exchange for that investment. This is great news for start-ups, as the public will have a vested interest in the success of the business.

Take the example of a microbrewery wanting to launch their brand and get off the ground: Instead of the public (crowd member) receiving a reward in the form of a case of beers for their contribution, they will receive shares.

They will (probably) order a case of beers from the microbrewery and tell their friends to order beer from the microbrewery, as they will get a financial benefit if the microbrewery succeeds. The microbrewery, as a result, receives funding three times over instead of once – which is a powerful tool for growth.

Essentially, the crowd will be a business partner with the start-up, and in so doing, the first customers of the start-up are already waiting in the wings.

Related: 6 Resources For Start-Ups Looking For Alternative Funding

The World Bank recently predicted that the market potential in Africa for crowdfunding will be up to $2.5 billion by 2025. Equity crowdfunding in South Africa will hopefully tap into that and unleash significant potential in the startups that are based here.

The hope is that the regulators, when they do eventually regulate crowdfunding, do it in such a way that it is not a death knell for the system that has the potential to significantly boost our economic growth.

About Daniel Van Zuydam: Daniel joined Dommisse Attorneys in 2017 as an associate in the Transactional Team. His areas of focus are corporate finance, mergers and acquisitions, and corporate restructuring. Having come from a background in commercial litigation, he has learnt the ins and outs of trust and company interrelated structures and has a passion for structuring enterprises in dynamic ways to suit the needs of each client.

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Are You Struggling To Find Financing For Your SME? Try Alternative Finance

If you don’t qualify for traditional funding or if it isn’t the right fit for your SME why not explore alternative funding? We specialise in alternative financing options by providing in-depth and custom plans for you and your business needs.

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Alternative Finance is finance beyond the traditional – it is defined by the financiers’ area of specialisation – by what they specialise in, whom they serve, and how they provide their funding. It does not replace traditional finance but rather functions as a complementary and additional form of funding.

Alternative financiers are specialists – they focus on a particular need and on a specific audience. As a result their ‘how’ is customised to deal with their chosen target market and for this targets unique needs. This applies to the funder’s processes and to their level of flexibility around things such as collateral.

An example of this is that a SME may have an existing R1 million overdraft (their traditional finance) secured by R 1.5 million collateral but suddenly they need R5 million for some kind of contract or bridging finance – they need it fast and don’t have that extent of collateral.

The traditional funder cannot provide what they need, their process is too long and their flexibility is too low. An alternative financier providing bridging finance and specialising in SMEs is ideally positioned to fill this gap.

One of the most significant differences between a traditional funder and an alternative financier is in their process. In the case of the alternative financier, they have often chosen to deal exclusively with a particular customer base, for example SMEs. As a result, this funder has both an affinity and contextually relevant empathy in working with SMEs.

Not only do they speak the same language the funder also has an appreciation for the time and material constraints of the SME and has developed their processes to cater to this market. This applies most notably to the turnaround time of the funding need and to the assessment aspect – where flexibility around things such as collateral is vital in making the finance happen for the SME.

A traditional funder is unable to meet the deadline of a bridging finance need, submitted on an urgent basis, where the finance is needed as soon as 2-3 days from time of application. A specialised or alternative funder is able to do exactly this. A traditional funder is also unable to find creative methods in solving the SMEs lack of high-value collateral in applying for finance.

This SME has generally already used their high-value collateral for traditional credit facilities but now needs funding for growth or resolution of a temporary cash flow challenge. An alternative financier is able to look at such an application in a different way, and has most likely already established alternative ways to make this happen for the SME.

Related: 5 Key Questions To Answer For Raising Funding

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Ways To Raise Capital To Expand Your SME

John Whall shares some of his insights about raising capital, despite tough economic conditions.

John Whall

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Times are tough, we all know that. As revealed earlier this month by StatsSA, South Africa is in a recession. But as history tells us, recessions don’t last forever and as a business owner you need to stay focused and continue to look for ways to grow your business, because business growth means economic growth.

John Whall, CEO of Heartwood Properties has been in the business of commercial and industrial property development for many years. He has experienced more than one recession in his professional career. In order to expand, companies can raise capital in two main ways, through debt or equity. Debt involves borrowing money, while equity means to raise money by selling shares in the company.

Whall shares some of his insights about raising capital, despite tough economic conditions.

Debt Financing

Bank funded expansions are a very common option for many SMEs. The one thing you must consider is that it could limit you in terms of how much you can borrow based on your credit history and available assets. You will also be liable for repaying the full loan plus interest. Right now, interest rates remain the same, but it may increase in 2019. Debt if used correctly and not to aggressively is a great way for SMEs to grow and expand, however debt should always be used conservatively and the business owner must ensure that the cash generated by the business can easily repay both the interest and the capital to the bank.

Related: Seed Capital Funding For South African Start-Up Businesses

Government funding

The South African government supports a number of funding programmes to encourage the growth of small, medium and micro businesses in South Africa. You can contact Department of Trade and Industry (DTI), SEFA, NEF,  Khula Finance Enterprise.

Crowdfunding

Used in the startup phase mainly, this form of financing uses your network of friends, family or acquaintances. The Internet is used to spread the word about your campaign to reach larger amounts of people. Equity-based crowdfunding has become a popular alternative for startups who don’t want to be dependent on venture capital investors. This has proven to be very effective in developed markets.

Equity Financing

If you require more capital than you can raise or borrow yourself, and you want to avoid aggressive debt funding then you may want to consider equity funding. This can open up a number of avenues that will offer you capital to grow your business. Very popular amongst startups are angel investors and venture capitalists.

Angel investors are people (business owners) who contribute their time, expertise as well as their own personal finances and in return expect to own a share of your business and receive a share of any future profits.

The opposite are venture capitalists and private equity investors, who are investment companies or fund managers who provide very large sums of cash in return for part-ownership. These type of investors do usually have a say in the management of the business and also agree to a five to seven year exit plan for their investment. This type of funding suits a business who needs a once off equity investment, but does not continuously need to raise capital to grow the business. The election of the investment partner is critical for the business owner and their medium to long-term strategy for the business must be aligned.

Related: 3 Mistakes To Avoid When Running A Crowdfunding Campaign

Going public

Established businesses usually do a public listing to raise ongoing capital in hope of expanding. Not only does this help to strengthen their capital base but it makes acquisitions easier, ownership more liquid for shareholders and allows the business to continuously raise capital to grow. Up until two years ago, the only option for a company to list publicly was through the Johannesburg Stock Exchange (JSE), which required a minimum capital amount of R500 million for a primary listing.

In 2017, the Financial Sector Conduct Authority (FSCA) issued four new exchange licenses in South Africa, all of which are already operational, which is not only providing an alternative to the JSE but is also offering opportunities to smaller businesses and driving down the costs of listing and share trading.  One of these new exchanges is the 4 Africa Exchange (4AX) whom Heartwood Properties is listed with. They are the only exchange apart from the JSE which is licensed to trade across all asset classes, including both equity and debt as well as special-purpose vehicles and real estate investment trusts.

4AX is ideally suited for unlisted companies with a market capitalisation of up to R10 billion wishing to list. This, however, is not to say that this is a ceiling on the size of the company seeking a listing. The exchange has aimed to make the listing process more streamlined and timely while fully complying with its licence and the prevailing legal framework. Its listing requirements are less onerous and more cost effective than listing on the JSE, making it a viable alternative for smaller and medium sized companies. The other exchanges to consider include: ZAR X, A2X, and Equity Express Securities Exchange (ESSE).

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Why Your Start-up Should Skip The Seed Round

Don’t tell your frugal grandpa, but these days, you can’t do much with the typical $2 million seed round.

Matt Holleran

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When enterprise cloud start-ups meet with us, one of the first questions we ask is: How much capital do you need?

The companies we meet with are typically pre-product with small teams, around two to 10 people. They almost invariably say they need a $2 million seed round, for the simple reason that, today, just about all seed rounds are $2 million.

Our next question is: What can you accomplish with $2 million? If they’re honest, they’ll say, “Not enough.”

We then tell them that we agree. In our experience, $2 million is a little light. At this point, more often than not, they’ll breathe a sigh of relief and say, “Yeah, by our calculations we really need $5 million to get to the next stage.”

So, this raises the question: Why even raise a seed round?

Don’t tell your frugal grandpa, but these days, you can’t do much with $2 million – not in the enterprise cloud realm, anyway. These companies are attempting to build very important products for the enterprise. They are trying to solve weighty problems for business, and getting to their first product offering requires the help of experienced, high-quality engineers who (news flash) do not work for free. There are also early sales and marketing challenges that these start-ups need to get right.

Related: Seed Capital Funding For South African Start-Up Businesses

And yet, so many start-ups are still stuck on the $2 million seed round. That’s what the market expects, so that’s what they’re conditioned to ask for – instead of the larger amount that they really need.

We need a rethink here. In fact, there is no longer a Classic Series A market. That’s because the capital requirements for today’s enterprise cloud companies are a lot different than they were 15 years ago, when cloud companies first burst onto the enterprise computing scene.

In theory, new cloud companies need a lot less capital to get off the ground due to lower upfront startup costs, cheaper technology and a wider range of distribution options. OK, fine. But it’s still hugely important to get the right pieces in place and build a solid foundation. And no matter what anyone says, that does not come cheap.

So, how much is the right amount? For early stage cloud business application companies, we believe the real capital requirement is about $5 million. That’s how much you need to hire seasoned executives, prove out an acceptable level of customer success and really start to refine your customer-acquisition model.

But here’s the other problem: The traditional Series A firms are now so large that they need to put much more money to work – a minimum of $10 million. So, that sweet spot between $2 million and $10 million is not really being addressed in the venture world.

And it needs to be addressed. Today you have that headless syndicate of $2 million to $3 million seed rounds composed of 12 different angels and a few seed funds that have already invested in 70 other startups. This is not a great situation for startups. After all, most of these investors aren’t signing up to provide hands-on advice or help with the hiring of key employees.

Plus, $2 million is just not enough capital to build out a product and team that’s ready for prime time. For enterprise cloud startups, the seed round is simply not that effective or efficient.

So, what’s the solution? My advice is to simply skip the seed round.

That’s not to say there isn’t a place for seed funds and angels. Of course there is! In fact, as a managing partner at a Classic Series A firm, I welcome these investors, because they can play a critical role and add extremely complementary value to the Classic Series A syndicate.

At the same time, they also understand that $2 million is not sufficient for today’s cloud startups. We want leading seed firms and value-added angels to join us as co-investors so they can avoid the headless syndicate syndrome and help provide cloud startups with the capital the really need.

Related: 10 Tips for Finding Seed Funding

The reality is that today’s venture capital market is not really optimised for early stage enterprise business companies. At one end of the spectrum, seed investors are not in a position to provide the long-term capital or board-level support that startups need.

At the other end, traditional venture firms have grown in size and have raised progressively larger funds. As a result, they are looking to write bigger checks of $10 million and above. That means they require startups to have a considerable level of traction and be further along in their development before making an investment.

This is why we need a return to Classic Series A investing.

What the market really needs are venture capital firms that are truly built for early stage investing, and that are led by seasoned operating partners who themselves have been entrepreneurs, who are connected to the top players in the cloud market, and who can provide that kind of insight and advice needed to build global, category-leading companies.

More than ever, enterprise cloud companies need honest-to-goodness Series A investors that can help them accelerate growth and maximise their true potential.

This article was originally posted here on Entrepreneur.com.

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