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Angels & Demons: What To Know When Negotiating Equity Funding For Your Start-up

It is important that you don’t treat equity funding lightly. A few key points are discussed in this article for you to consider.

Daniel Van Zuydam

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Getting your start-up off the ground and scaling it up usually requires an injection of capital to ensure that you can get past the lean years. Many a start-up has been left to starve in the proverbial desert seeking the promised land of an equity funding raise and many start-ups have drunk from the poisoned chalice of a poorly aligned investor relationship. It is important that you don’t treat equity funding lightly. A few key points are discussed in this article for you to consider.

Hold onto your equity, it is precious

Equity may seem like an attractive way to raise funding for your business, it is easy to “create” and it doesn’t really require that much effort to exchange it for funds, but remember that with each share you give away, you are giving a little more control and value in your company away.

At first, this may not seem significant, but the more funding rounds you go through, the more you are going to wish that you had held on to more equity, especially if your company’s growth is in line with your aspirations! Ideally, an equity raise should be one of your last options for raising funds until you have at least developed your ‘minimum viable product’. An equity raise should only be used if you are really in need of funds to keep going or to jump your production to the next level; even then, only give away as much equity as you need to.

Related: Want Funding? Finfindeasy.co.za Founder Says You Must Learn To Speak The Language

Know what stage your business is at

This is really a simple principle. If you are pre-revenue and trying to create a minimum viable product, if you have to raise funding, you should seek out “Angel” or “friendly” investors who are willing to give you very favourable terms generally at a high valuation (meaning you give away less equity and control), these are often friends or family members. If you are post-revenue, you may wish to seek out venture capital funds or institutional investors to invest in your company.

He’s just not that into you

Make sure that your investor is serious about investing into your company. For institutional investors, the way that you will know when they are serious is when you receive a letter of intent or “term sheet” from them. It’s the venture capital equivalent of asking you on a date.  They are trying to say that they’d like to see how things go, but they are not committing to anything serious just yet. If after a few months of discussion, you do not get a letter of intent, move on, there are more fish in the sea.

Related: New Fund For Small Businesses To Be Developed

Know who you are doing business with

It is better to struggle through months or even years of bootstrapping than it is to have an investor relationship with someone who is completely incompatible with your business or who is going to add no value other than money.

An investor relationship can make or break your company. Don’t simply hand over your equity to the first bitcoin millionaire with a Colgate smile who approaches you.

Look for investors who want to invest in your industry and who have good connections in that field, this can be more valuable than the money that the investor is putting into your company.

Get good legal and commercial advice

It’s important to remember that an institutional investor is just as much a business as you are. They are always going to be biased towards getting the best return on their investment no matter how altruistic they may come across. This means that the commercial and legal terms, if left to them alone, will be weighted in their favour.

You may be tempted to avoid the expensive lawyers and commercial advisors, but too many startups make the mistake of being penny wise and pound foolish here. Unfortunately, commercial investment terms can be very complex and it is always advisable to have someone on the commercial and legal front sitting squarely in your corner.

Related: The Investor Sourcing Guide

In short, equity is an effective arrow in the start-up’s quiver to use when raising funding, however, it is not the only one available. If you do decide to let it loose, don’t do so aimlessly, pick a target and aim it in that direction. The more strategic you are in negotiating your equity fundraising, the more likely you are to get favourable valuations and investment terms.

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.

Venture Capital

3 Mistakes To Avoid When Running A Crowdfunding Campaign

There are plenty of Cinderella stories but also just as many cautionary tales out there. How to make yours the former, not the latter.

Roy Morejon

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When Retro Computers turned to Indiegogo for crowdfunding, it promised $100-level funders a handheld gaming device called the Vega+. With promises from the company that the device would come equipped with more than 1,000 games, the console quickly gained a following, and more than 3,600 people pledged $100 each to receive one.

The successful campaign gained U.K.-based Retro Computers more than half a million dollars.

But when the time came for those backers to receive the handheld devices, Retro Computers wasn’t able to deliver. Legal battles and production issues caused hiccups. The promised September 2016 delivery came and went. Users began getting upset – more and more publicly.

Finally, after unwanted media attention and, just this month, a lawsuit, Indiegogo intervened. The crowdfunding platform announced on June 6 that it was siccing debt collectors on Retro Computers in an effort to reimburse its donors.

Despite that tale of woe, entrepreneurs can’t ignore the potential of crowdfunding. Kickstarter has hosted nearly 150,000 successful projects, raising $3.7 billion since 2009, and Indiegogo has raised more than $1.5 billion since 2008. Done correctly, crowdfunding could provide the perfect building block for your next venture.

The ups and downs of crowdfunding

Crowdfunding’s popularity is not all hype. It can yield benefits beyond financial backing, helping your company build a loyal customer base and establish credibility before you’ve even launched. But you can’t just set up a Kickstarter page and watch the money roll in. The right strategy is essential to reap the rewards.

Pebble shows how it can and should be done. One of Kickstarter’s most successful campaigns of all time, the company raised more than $20 million from 78,000 backers – exceeding its goal by 4,068 percent. Pebble turned that consumer confidence into more than 2 million sales of its smartwatch and was ultimately bought out by Fitbit.

Related: CrowdFunding As E-commerce In South Africa

But when it comes to crowdfunding, there’s more to consider than whether your project will meet its fundraising goals. Even a successful campaign without serious forethought and planning can encounter challenges that will sink a business before it gets off the ground.

Coolest Cooler, on the other hand, might be one of the most disastrous campaigns in Kickstarter history. The company raised $13 million, but it wasn’t prepared to operate in the wake of such success. Coolest Cooler couldn’t fulfill rewards for its 62,642 backers.

Remember: It’s not just about hitting the goal. Even in successfully funded projects, 9 percent fail to deliver on promises to backers. That’s a hard hurdle to overcome in the beginning stages of any new business.

Campaign mistakes to avoid

It’s easy to think of crowdfunding as easy money, but campaigns should be hard work if you’re doing them correctly. If you want to start your project on the right foot, avoid these common mistakes:

1. Kicking off without leads in place

Crowdfunding campaigns have short time lines. What’s more, campaigns rely on a momentum of interest. You’re going to have difficulty hitting your goal if you don’t have leads in place ready to back your campaign on day one. Not gathering enough leads before launching is the problem partially to blame for nearly every failed project.

Set up a landing page ahead of time describing your product and promoting your upcoming project. Include a contest in which people can enter their email address for a chance to win your product. This will give you a list of already interested folks to reach out to the day you launch your campaign.

2. Ignoring Facebook for potential conversions

Platforms such as Kickstarter and Indiegogo have large audiences, but if you rely solely on the backers already there, you probably won’t hit your goal.

So, look elsewhere. Facebook advertising is one of the most cost-effective ways to reach a highly targeted group of people that is likely to convert.

Consider the PEEjamas Kickstarter campaign, which my company mounted. That project hit its $14,000 goal early on, but my company wanted to see how far we could go. Funding increased from around $26,000 when we started the ads, to $227,469 by the time the campaign closed. I highly recommend working with a team of Facebook Ads specialists who can make the most of your ad budget.

Related: The Dangers Of Crowdfunding With Coolest Cooler Founder Ryan Grepper

3. Failing to consider scale

You might have a goal in mind, but what happens if you exceed it? Is your business model scalable? Are you going to be able to fulfill rewards? Don’t be Retro Computer or Coolest Cooler.

Make sure the price of each of your rewards is sufficient, whether you hit your goal exactly or raise more than you anticipate. Have a plan in place for shipping and fulfillment. Examine your profit margins closely as you set your funding goal, and determine product pricing. Consider factors such as minimum order quantities, manufacturing costs, marketing costs, platform fees, shipping costs and more.

One last thing to consider: Kickstarter and Indiegogo both have a 5 percent use fee and a 3 percent to 5 percent processing fee. Factor this into the goal you initially set.

Platforms such as Kickstarter and Indiegogo have broadened the horizons of start-ups and consumers alike, but getting the most value out of crowdfunding requires forethought and planning. There are plenty of Cinderella stories out there but also just as many cautionary tales. Avoid their mistakes to make the most of your fundraising endeavour.

This article was originally posted here on Entrepreneur.com.

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Company Posts

How This Alternative Funding Solution Can Solve Your Business Growth Problems

Are you struggling to access finance from traditional loan providers? Swype Financial Services has the ideal solution for you.

SwypeFin

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Did you know that SMEs with access to credit can grow faster and achieve optimal size sooner, while those with limited access to finance potentially remain stagnant and smaller in size? This is according to the Finmark Trust study, released in 2016. 

“Working capital is essential for the day-to-day operations of a business,” explains Shayne Burnstein, director of SwypeFin, an alternative funding solutions provider. “More often than not, business owners lack sufficient working capital to meet their daily cash flow requirements or expand their operations. This can ultimately lead to the failure of the business.

“It’s common for a business to borrow capital and by using the basic principles of leverage, they can invest in assets that generate higher returns.”

Working capital when you need it most

Are you currently experiencing cash flow constraints due to:

  • Unforeseen expenses
  • Purchasing more inventory
  • A need for new equipment
  • Revamps and refurbishments
  • Employing more staff
  • General maintenance
  • Retail seasonality. 

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

Growth capital can be used in any industry and any-sized business, from a dentist or doctor’s business to a clothing manufacturer. “Advancements in 3D printing technology enable dentists that historically relied on outsourcing a technician to make dental crowns, for example,” says Shayne.

“This process typically takes a few weeks at a considerable cost. By borrowing capital to purchase 3D printing equipment, the dentist can bypass the technician and make the crown in an hour, allowing them to see more patients, which would significantly increase their turnover.

“As a business owner, you need to critically consider what will help you grow your business: Is it new equipment, bigger premises or marketing spend? What can you invest in that will grow your turnover and your profit margins? That’s where financing makes sense.”

Revenue is vanity. Profit is sanity. Cash is reality

As business owners themselves, Swype Financial Services understand how critical cash flow is in the daily operations of your business. They also understand the challenges in trying to access funds to address immediate cash constraints. 

“Currently retailers are trading under very challenging conditions. With VAT and the price of petrol increasing, consumers have tightened their belts,” says Shayne. “Under these conditions suppliers are offering retailers trade discounts for COD payments. It often makes sense for them to borrow the capital to take advantage of the trade discounts, enabling the retailer to increase their margins.”

What services do SwypeFin provide?

  • Quick and simple access to capital without providing collateral security
  • Flexible repayment terms
  • An upfront fixed fee with no penalties for early settlement. 

Related: Funding And Financial Assistance For SA Women Entrepreneurs

How does the process work?

SwypeFin purchase a portion of your future sales and provide you with an upfront cash advance. The amount that they purchase, of your future sales, is collected by taking an agreed fixed percentage of your daily sales (There is no fixed term or fixed instalment).

To apply, your business must be registered and owner-operated for a minimum of 12 months and have a minimum of R50 000 in turnover per month.

How to apply?

Call Swype Financial Services to book an appointment on 087 135 3020 or visit www.swypefin.co.za for more information.

Please note that Swype Financial Services do not finance start-up businesses.

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Venture Capital

Venture Capital 101: The Ultimate Guide To The Term Sheet

Make sure you get guidance from a legal team that is specialised in commercial and start-up law from the start.

Ya-Fan Wong

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The importance of a term sheet in the context of raising funds through venture capital should not be overlooked. If you think of the ongoing relationship between you and the investor as a marriage, then you can think of the term sheet as the antenuptial agreement.

The term sheet is the document that outlines the terms by which an investor (angel or institutional), will make a financial investment in your company. The term sheet is crucial as it usually determines the final deal structure with your investor – it outlines the terms by which your investor will make a financial investment in your company.

Finding an investor can be complex and time consuming. Once you’ve found one with the right strategies and values, you may be tempted to rush through negotiations to access the promised cash injection. There can be serious ramifications if the details of the deal are not negotiated on a level playing field, and this is where the importance of a term sheet comes in.

A term sheet exposes the bare bones of the fundamental commercial terms of the investment. Due to its concise nature, the involved parties are less likely to miss essential details.

The term sheet

The term sheet is intended solely as a summary of terms for discussion and agreement between the parties. Except for the confidentiality provisions, nothing should create any legally binding obligations on the part of the parties until they execute the definitive written agreements, obtain all the corporate and legal approvals, and successfully close the deal by meeting all the conditions precedent.

The advantage of the term sheet in this respect is that it expedites the investment process by outlining the material terms and conditions, and guides legal counsel in the preparation of the proposed final agreements. It also allows you and your investor to get to grips with the terms quickly and provide input from each of your unique perspectives.

Related: The Truth About Venture Capital Funding

What to look out for in a term sheet

venture-capital

Valuation

Your investor will place a valuation on your start-up company based on, among other things, comparisons to other companies in the marketplace and recent transactions. It is common to set the valuation of the start-up company as a “pre-money” valuation (i.e. the value of the company before the investors in the funding round participate). This is, however, not always the case – so be sure to get clarity on this, as investing pre-money or post-money can make a big difference in the equity stake you are giving away in your company.

If the parties are not in agreement about the valuation of the company, consider making provisions for claw-back provisions in favour of the start-up company or payment by the investor in tranches, which will be determined as and when the company’s audited financial statements indicate its valuation.

Type of shares offered to the investor

You will want to understand the type of shares you are giving away to the investor in return for the investment. Will you be giving the investor ordinary shares or preferred shares? Large investors are often only concerned with two things: Control and economics. As such, investors will often insist on acquiring a separate class of preferred shares which entitles them to fixed returns, the payment of which often takes priority over ordinary share dividends.

Liquidation preference

This is what is used to determine how the money is shared once the liquidity event happens. The preferred shares might have a liquidation preference of 1x the ordinary shares. That means that when the company is sold, the preferred shareholders will be paid first and then the ordinary shareholders.

As a start-up founder, you need to know what you are promising your investor.

Related: Is Venture Capital Right For You?

Employee share ownership

These are shares which are set aside to be issued to employees, advisors and others during the investment round. Having available shares for this purpose is important, as they are needed to bring in new talent. This pool of shares is typically part of the pre-money valuation of the business. You need to understand this concept because these shares can dilute pre-money shareholdings.

Founder vesting

The vesting period for founder shares is ordinarily three to four years. From an investor’s point of view, they want to make sure that you, as the founder and key members of the management team, are locked in and stay invested in the company.

It’s worth noting that many of the vesting provisions are subject to the founder meeting pre-determined performance milestones and continuously adding value to the company. After all, the investor took interest and invested in the venture because they believed in the founder team.

Anti-dilution

This is an important provision to look out for as it protects the investor’s investment if the start-up company raises an additional round of funding at a lower valuation.

Your investor may allude to this in the term sheet and require you to include an anti-dilution clause in the final agreements. Venture capital investors take significant capital risks and they will always seek to minimise their investment risk however they can. It’s important that you understand the effect of anti-dilution clauses on both future capital raisings, as well as your interests generally.

Raising venture capital is a crucial, and often fragile, step in any start-up business’ journey to success. Make sure you get guidance from a legal team that is specialised in commercial and start-up law from the start.

Read next: A Comprehensive List Of Angel Investors That Fund South African Start-Ups

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