Venture capital is often seen as the holy grail for start-ups. Very few companies manage to secure it, but everyone wants it. Entrepreneur chats to attorney Adrian Dommisse about the truth behind VC, and cautions those looking for funding: Is VC really the answer for you?
Is venture capital the answer to every start-up’s dream?
In some cases it is, but it’s very dependant on your appetite for risk as a business owner, and how much equity you are willing to give away. Your VC investor is taking on a lot of risk for the potential promise of high returns, but the earlier they come in, the bigger the risk and the higher the reward they will expect — which means more equity.
What mistakes do start-ups who secure VC funding often make?
Imagine how you would feel if you suddenly had R20 million in the bank. Many entrepreneurs become very starry eyed. They find the big offices, get settled and forget the rules of being a lean start-up. They don’t pay attention to their cash flow and start losing money without even realising where it went. The number one rule of VC finance is to remember that it comes at a cost.
What is that cost?
You need to deliver. You’ve secured the funding based on an idea or a prototype. Now you need to prove it works. VCs don’t just give start-ups cash and walk away. They have a timeline and strict deliverables, and you need to understand that they may even sell your company to recoup as much cash as possible if you don’t deliver.
You aren’t working from your garage anymore. You need board meetings, a strong management team, auditors and lawyers. You can’t just shoot from the hip anymore — you become a structured business almost overnight.
Is this always the case?
VCs are not in the business of breaking up companies. They do want you to succeed, and they will be very involved in the overall management of the business to give their investment every advantage. They understand that they are taking a big risk, and that if it works they will make five, even ten times their investment.
But this is still a business deal for them. It’s not a dream they have been nurturing for years and years. They are realistic in all their decisions, and you need to be too.
What kind of deliverables are in place?
The deal will include certain growth projections and markers. For example, certain goals will be agreed upon and if those goals are not met in the allotted time, as the founder you will need to answer to your investors. You will need very good reasons why your objectives were not met. When you accept VC funding you accept all the responsibilities that come with that funding.
How does this affect second round funding?
It’s particularly important in this case. If you have met and exceeded every goal post, and worked well with your investors, you are far more likely to secure second round funding than if you have consistently missed your mark. Remember, at some point your investors will cut their losses as well.
What are the two most important things to consider before approaching a VC?
First, make sure VC and equity funding is for you. Do you really need the cash, or is it a nice to have? Many businesses can be bootstrapped. If you fall into this category, think carefully before approaching an investor. Second, choose the right investor.
You won’t be given cash and then ignored, free to do as you please. You will be answerable to your investor, who will be involved in your business. They will bring business acumen and a lot of experience with them, which can be a huge plus in growing the business, but if you don’t want outside involvement, think carefully before taking this route.
Finally, make sure you get along with your investor and your goals and values align – you’re going to be spending a lot of time with each other.
Player: Adrian Dommisse
Company: Dommisse Attorneys
Expertise: Corporate finance and acquisitions, structured finance and commercial law
Contact: www.dommisseattorneys.co.za; +27 (0)21 671 1550
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Private Sector Funding Directory. Click Here
Financing That Backs Entrepreneurs
The SME landscape is fast and flexible. It requires financing that understands how entrepreneurial businesses operate. Through its unique processes and assessments, Spartan’s finance solutions are geared to do just that.
It takes an entrepreneur to know entrepreneurs, which is why Kumaran Padayachee and his team at Spartan are dedicated to financially backing an often-underserviced sector: SMEs.
“We’re fast, we’re flexible, and we’re understanding,” says Kumaran. “Every single person who works here is SME-centric. We hire for fit, looking for empathy and alignment in every position. All of our processes and assessments are done with empathy and understanding towards SMEs.”
Becoming funding ready
Thanks to these systems, processes and the team’s unique way of assessing SMEs, Spartan typically grants finance within seven days, although the fastest approval has been six hours, with the longest 15 days.
“How quickly we can approve finance is determined by how prepared the business owner is,” explains Kumaran.
“Do they have all their basic documentation ready? These include financials, management accounts, debtors age analysis and creditors age analysis. From a working capital context, this information makes it easy to assess the health of the business. Every business owner and financial director should be on top of these figures.”
Finding a funding fit
Not every business needs funding. Some can grow organically and draw on their own cash reserves. Others choose an equity route.
Spartan is a debt funder. However, even as a debt funder, the team’s aim is to back entrepreneurs and help them grow their businesses. They evaluate what the finance will be used for, and if the return is greater than the repayments.
“There are numerous ways that finance can be applied incorrectly by SMEs,” says Kumaran. “One of the first flags we look for is debtors age. If the industry norm is payment in 30 days, but a business is typically paid by its clients in 60 or 120 days, then we know there is something wrong with their internal processes. Either the company is too shy to be assertive with clients, or it lacks the capacity or capability to invoice clients and collect cash efficiently. Either way, the result is a shortage of cash.
“Business owners in this situation apply for a loan in order to be able to pay the bills, when they should be reviewing their own business, pulling one or two levers, and improving their cash flows.
“A customer project or contract is an example of an expansionary and positive need for finance. These cases are ideally suited to bridging finance. The problem is that there’s a lead time gap. You need to start the project, spend cash to hire people or purchase equipment, build internal capacity, deliver on the project and then the customer only pays you. Working capital and bridging finance allows the entrepreneur to do just that, and the company grows as a result.”
Bridging finance, in particular, is high risk and requires a large amount of flexibility, which is why more traditional funding institutions shy away from it. Spartan, on the other hand, offers revolving bridging loans to customers the team has worked with. “We understand this space, and our aim is to support the entrepreneurs within it,” Kumaran concludes.
Alternative finance solutions
Spartan is a 36-year-old Non-Bank Finance Company — that specialises in financing Small and Mid-sized businesses by providing:
- Growth Finance [structured finance for expansion]
- Specialised Asset Finance [equipment/machinery/technology/software/office fit-outs/energy/etc.]
- Working Capital Finance [bridging finance & medium term loans].
Bridging Finance is available for one to three month terms and is ideal for contract or project-based businesses. It is a solution that assists businesses with solving cash flow issues due to growth related challenges in their business and is either for a once-off need or for revolving business use.
Spartan is an Authorised Financial Services Provider 47631 and Registered Credit Provider NCRCP8669.
Is Venture Capital Right For You?
Take this online test to find out if venture capital is what your business needs.
It’s important to know the ins and outs of venture capital before applying for backing as it may not necessarily be the right solution for all entrepreneurs, or for the particular stage your business is at.
To help prospective businesses determine if they are suitable candidates for venture capital funding, Mark Shuttleworth’s local venture capital company, Here Be Dragons (HBD), has compiled a venture capital readiness test. To check your readiness – visit the South African version of the site – Knife Capital below.
Take the VC Test
The HBD test is quick and practical, designed to educate and prepare potential applicants for what they can expect from venture capital.
The test guides applicants through an umber of important decisions and points they will have to consider carefully should they wish to embark on a partnership with a venture capitalist. Consisting of three deal breakers and another 15 questions, it looks at the components of a venture capital investment.
Questions such as: “Will your revenue grow by at least 30% each year?” and“Are you prepared to part with a significant ownership stake in your business which may result in the loss of control?” are tough choices that need to be made ahead of time. Your answers will determine whether you are on the right track for venture capital.
Take the test at Knife Capital.
5 Key Questions To Answer For Raising Funding
As your business grows, should you be raising capital or focusing on organic growth?
There’s a nagging question that lingers in the back of the mind for many entrepreneurs: Should I raise funding? The answer is never simple and the truth is that there is no single answer to rule them all. It all depends on your business, the industry you’re in, how your business is performing and if there are even investors in your field.
Here are some key points to consider as you weigh up the options within your personal growth journey.
Is investment right for me?
The media in larger markets like the US and Europe have turned raising funding into some kind of sport. Funding events are extremely well covered by the media and often glorified as some kind of victory.
I’ve raised money from all kinds of investors over the past decade and can confirm that not all money raised is equal. Money comes with strings attached and a lot of formality that may not have existed in your business before.
Once you’ve taken external funding of any kind you immediately take on a fiduciary responsibility outside of just ‘If I screw this up, I walk away’. You are tied to your company and investors until the money dries up or you make everyone rich. Neither is a simple process.
Don’t get me wrong, there can be a lot of value in the raising of strategic capital, but it is not to be seen as some form of victory. When you raise money you should have a clear path to profit and a clear strategy on how you are going to use the money and what the potential of recouping it is. Without these things you’re just taking other people’s money to spend and pay your salary. That’s not cool.
The Different Kinds of Investment
If you don’t know what’s out there, it’s easy to think that banks are the only institutions with money. They’re not. Often they are the worst kind of money to raise and come with very formal strings attached that you cannot break free from. However, if you have a relatively straight-forward and stable business, banks can be a useful option to get a loan and then pay back the money relatively quickly.
I always suggest that the first port of call for funding should be sales. So if you think you need funding, what you are really saying is you need money and money comes from making sales. The best place to start for sales? The three Fs: Friends, Family and Fools. Sell to everyone and anyone you can find. A lot of young entrepreneurs will raise small amounts of investment from the three Fs too. This is very risky because you are putting your relationships at risk if the business collapses and all of your friends and family lose money because of you.
You can then graduate up into angel investment. Angels are high net-worth individuals who are looking to find very early stage start-ups with small batches of money. Usually this is a round of less than R500 000 for a pretty decent chunk of equity in your business.
Out of angel investors grow institutional venture capital firms. These companies will give you a lot of money for a lot of equity and help you grow. They’ll sit on your board (or formulate one if you haven’t) and they will drive you to grow your business at near-exponential rates. This level of funding is all about return on investment. If they put in R1 million, they expect to get R10 million in five years. It’s your job to make it happen.
Overall, with investment comes pressure and formality, but also the potential to grow something mammoth and meaningful very quickly.
My favourite kind of funding is the oldest kind out there: Profit. If you want to maintain control of your business and grow it, then you need to be profitable and reinvest the money in your company, not your cool new car.
Is there a right time to raise funding?
In my experience there are a multitude of situations when your business might require external funding. The ‘right’ time can only be decided by the person running the show. If you are raising money out of desperation, perhaps it’s not the right time to raise. However, finding funding at this point may save your business.
On the flip side, raising growth capital is perhaps the safest time to raise funding. Your business should have profit and traction, it should be showing incredible value in the market and you should have a very clear plan to increase profits and growth exponentially.
If you take this plan to a variety of investors you are able to shop for the best terms and the best partners. That’s the kind of money you want. But bear in mind, if things take a turn for the worst your investors can become your worst nightmare. Just ask Travis Kalanick at Uber who is being sued by one of his major investors.
Raising funding is an extremely personal decision that business owners should think through carefully and plan for the worst as well as the best-case scenarios.
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