Venture capital is often regarded as one of the most attractive and sought-after sources of financing for start-ups, and rightly so, especially due to the range of value-added services that a venture capital firm can provide to help the start-up grow and succeed.
For any founder considering venture capital, it’s important to keep in mind that there are many driving forces behind the scenes for the venture capitalist, which may cause problems for the founder team and the start-up. This could be anything from pressure from the VC’s own investors, or other deals that have gone wrong for the VC in the past.
Not all VCs are created equal
A point that was commonly brought up by founders is how their expectations have not been met. Not all venture capitalists are the same, and they vary in terms of the extent to which they are able to provide value-added services.
There were several cases from the start-ups interviewed who stated that their expectations had not been met. In certain instances, this is a result of the venture capitalist not living up to their word, but it is often because the founders’ expectations are not set at the correct level.
Your move: The best way to manage this is by doing extensive research on the venture capitalist you are engaging with. As a founder, you should not be afraid to speak to other entrepreneurs who have dealt with the VC to gain an understanding of what to expect if you engage with this particular firm.
Chasing funding is time consuming
As a founder, it’s important to manage your time carefully, and getting involved with VCs makes this even trickier. Generally, founders will need to go to countless meetings before they are able to get any investment. Over and above meeting with investors, the process of fundraising can be very time-consuming, especially if you enter a due diligence phase with investors.
You should not underestimate the time required for this, which is further elaborated by the founder of a firm that went through several fundraising rounds: “It was really a strain on the business during the fundraising period due to the time and effort involved in engaging with VCs. And actually, a lot more than we thought. It really took a lot of time and work to get the money and I think that’s the most disruptive thing to the business.”
Once you have VCs on board, another time element is introduced. Of course, a lot of time would be spent on productive tasks with the VC, which is beneficial to the company. However, several founders criticised the amount of time that they felt was wasted on non-productive tasks — the type of administrative tasks and reporting that VCs generally require. This requirement varies amongst firms, but it’s understandable. They have their own investors and reporting requirements.
As a founder, you generally will have key roles across the board, and your time is extremely valuable. If you become involved with a venture capitalist, the non-productive time spent with them generally can’t be avoided, but it’s something that should be taken into consideration, and a key part of your planning.
Your move: Approaching multiple investors, conducting due diligence and reporting to your VC if you close a deal are all extremely time-consuming tasks. Does your business need the funding, or would your time be better spent building the business while you bootstrap it?
Who holds the control?
From the perspective of the venture capitalist, one of the most important aspects is control. Although loss of ownership and control for yourself as a founder may be obvious, there are several implications to consider.
First, a VC with less than 50% ownership of a company (which is often the case) does not necessarily mean they have no control in your firm. They usually have a variety of control mechanisms, which, in practice, give them control of many elements of the business.
A VC can, under certain circumstances, replace the CEO or founder team, even if they don’t have majority control. This can happen for a variety of reasons, such as a lack of growth, internal conflicts, or a high employee turnover rate.
Second, as has been seen in several VC-backed firms, when the venture capitalist has control and is able to influence decisions, this potentially leads to several conflicts. One of the founders interviewed had this to say: “We were at a point where we needed to make a critical decision on the strategy of the business. Our venture capitalists were pushing for a change; one that I was not happy about. This caused a lot of conflict and confrontation. In the end, the venture capitalists were able to enforce the change by convincing some others on the board. Ultimately, this decision didn’t work out and the business suffered substantially.”
Your move: The ability of a venture capitalist to enforce a decision is dependent on numerous factors, and especially the investment contract. The structure of the investment contract is critical, as it can determine the future relationship with your investor. Consider all these factors as you enter into an agreement.
The problem with too much money
A point that may seem counter-intuitive at first is that receiving venture capital can actually put a sin into your business model. Why? Because a big cash injection can distract you from your core business operations. You’d think that suddenly having lots of money (when you’ve been trying to get an investment) is a perfect situation.
Generally speaking it is; but there’s also a very real danger that not managing that money correctly can put you and your business in a situation where you’re even worse off than before receiving it.
Inexperienced founders are the most likely to experience this problem. Many start-ups interviewed talked about how they initially wasted money, overspending and putting it into the wrong areas. The classic problem is that in order to grow your business and improve your results, you hire people, but you don’t necessarily grow a business by hiring people. It’s absolutely essential to manage this money wisely and to avoid the money serving as a false sense of security.
Your move: In almost all cases, it’s advisable for any new entrepreneur to bootstrap for as long as possible. Don’t see funding as the first option. Try to raise as much as you can yourself, get revenues as early as possible, and focus on your fundamental business operations. It’s amazing what you’ll learn about business when you have to be very careful with your cash — and be cash generative as quickly as possible.
The exit question
Venture capital investments are generally governed by a life-cycle based on when to enter and exit from investments. These are typically around ten years.
When the fund gets close to the end of its life cycle, the fund managers, or investors, will be under pressure to gain liquidity for their investment. An important consideration for a founder is how old the fund is.
The closer the fund is to the end of its life cycle, the more challenging things can become, due to this additional pressure for liquidity.
Related: New Ways SMEs Can Find Funding
As many founders have experienced, the topic of an exit, or liquidity event, can often be a difficult one, especially if the founders are not ready to exit. “The discussion around the exit was a major confrontation because they wanted to sell, and we didn’t want to sell,” says one founder. Who makes the final decision is dependent on a variety of factors, and especially the terms that are written in the investment contract.
Your move: Carefully consider the life cycle of the fund that will be investing into your business. If you’re just at the beginning of your start-up journey, selling too soon could cost you a lot of money. Rather find a different VC firm or funding route, and hold onto your equity for longer.
Bringing it all together
All in all, venture capital is a great source of finance and its value should not be discredited.
There are numerous benefits to venture capital, and receiving professional mentoring, assistance and resources from people who have the knowledge and experience can be an invaluable tool.
Just the fact of having your firm backed by venture capitalists serves as a type of ‘stamp of approval’ for other players in the market. The points mentioned above do not necessarily represent every venture capital investment, but it is important to understand some of the potential impacts of going the venture capital route, and with this knowledge in hand, you can better prepare yourself for the process.
Taking A Business Public Can Unlock Its Full Potential
How can business owners continue to create shared value and drive growth beyond the venture capital funding rounds to attract new investors and customers, and unlock the inherent value in their business?
In the context of entrepreneurship, a great deal of emphasis is placed on the start-up phase of a business. But what happens beyond that?
Listing on a stock exchange is often the best way for a business to realise the next phase of its growth ambitions and create opportunities for shareholder and investor diversification.
Listing a company provides a more effective tool to access capital and enhance liquidity than private equity markets, as there is a much larger investor base to tap. Importantly, this pool will also include institutional investors, such as pension and investment funds, most of which are mandated to only invest in listed entities.
Reasons to list
Raised capital can be used to fund expansion or research and development, or meet other capital requirements for acquisitions. Listing creates exit opportunities for founders, shareholders and early-stage investors, and helps to spread the risk of ownership. Other growth opportunities become accessible as lenders can more accurately determine a company’s market value to determine loan-to-asset ratios.
Valuations for potential mergers or acquisitions are more objective. In this regard, a share issuance can be offered as a suitable exchange of value, rather than using cash to make a purchase or acquisition. Listing a business boosts its credibility and brand equity, which is beneficial from a customer perspective.
It helps to attract and retain the best talent from an employee perspective through the implementation of an employee share incentive scheme.
But before a business lists, it is important to consider the commercial benefits and, consequently, if this is an appropriate next step. In this regard, the leadership team must first review the strategy and agree on where the business is in its lifecycle, and where it is going. For any business to be successful, the shared beliefs and purpose of its leadership team must align and there must be consensus among shareholders that the time is right to list.
Consider the trade-offs
Once this point is reached, consider the implications of taking a private company public. Firstly, business owners must understand that they are effectively giving up control of their company. They must also acknowledge that the transition from a private to public company can be difficult, with increased compliance and transparency.
Listing on a stock exchange also raises the public profile of the company. This includes greater oversight from external stakeholders, with strict reporting and disclosure requirements required by the exchange and regulators. These aspects are mandatory to ensure greater transparency, which translates into greater protection for investors.
Meeting compliance requirements
Arriving at this decision therefore requires a thorough due diligence process. This entails meeting financial reporting and minimum regulatory compliance requirements, which have potential cost and administrative implications that can prove challenging, particularly for smaller businesses.
However, it’s imperative to meet these requirements, as this ensures the business will stand up to market scrutiny and that the entity delivers exactly what it promises to investors. It also ensures the business meets the exchange’s corporate governance requirements, complies with the Companies Act, and operates in line with industry best practices.
This due diligence process is also vital if a company hopes to adequately demonstrate value to investors in the open market. This will help listing advisors and sponsors, whose job it is to market your company to potential investors, to more accurately determine if there is appetite for your business.
Institutional and retail investors will use this information to interrogate the business’s value proposition to ascertain the potential for growth following a listing, and determine whether the business model will deliver adequate and sustained returns over the medium to long term.
Need Funding For Your Vision? Give ‘Tasteful Persistence’ A Try
Zuko Tisani’s Legazy is a company that plans six international immersions for mainly start-ups, executives and members of the public. He has managed to grow his business from floundering for funding, to attracting large corporate investors. Here’s how your business can follow suit.
Legazy was launched with the aim of playing a leading role in the South African digital economy by stimulating the trade on African innovation. Legazy is well on its way to increasing the success rate of entrepreneurs through exposure to market access, partners, media and investors. “Before we were consumers and bystanders of industry 4.0,” says founder Zuko Tisani.
“We work with large corporates and Government, speaking their language by understanding what is important to them and not promoting what we think is important,” Zuko explains.
“Our narrative is tailored to fit the specific corporate we speak to. A lot of companies make the mistake of shooting in the dark and send a generic proposal to as many people as possible.
“We also realised the return on investment for content was huge. We are well documented visually and with the corporates that sponsor our projects it makes it easier to get funding because we can tell a unique story, a big story and an emotive one that goes hand-in-hand with our proposal and separates us from others.”
Zuko offers these top tips for start-up funding success:
How do you get people to care enough about your idea to invest?
1. Be very clear about how assisting you benefits them
Human nature is selfish. Win-win is not enough. Think more 51% to 49% — give more than you get. How is your sponsor going to be the winner of the day by supporting you? Always bring it back to the bottom-line. Whether it’s tax benefits, market exposure or adding value to their supply chain, be careful not to oversell because it can close an opportunity before it even opens. Do your homework to find gaps to fulfil or to enhance existing projects. Once you have emailed a specific request, lay out end-to-end how you will use the money and how it will benefit them.
2. Be persistent not pestering
Sending mails to busy stakeholders without response is a norm — try to find other stakeholders, who are more junior and would also have an interest in your project, to assist. Tasteful persistence is mostly rewarded — be delicate but direct in what you want; keep demonstrating you can add value and deserve the sponsorship.
3. Make the vision big and the ask small
It’s important to gain and build trust so take what you are given and build on that.
What steps can your start-up apply when approaching corporates for funding?
1. New is hard to sell and often has tentative buyers in the beginning
However, it’s worse to enter an over-saturated market where differentiation is difficult to see. A lot of entrepreneurs focus on the complete market and say things such as, ‘It’s a $10 billion industry’. Can you skew your value proposition to make a buyer believe it’s unique? And can you capture an upcoming market such as Generation Z (the coming economically empowered generation) in your offering?
2. Paper trails
If you are looking at partnering with a corporate find out where they have put their money before, and what it took for the start-up to gain access to those funds. Also look at the companies similar to yours that are succeeding — where is the money in your sector? This will also inform where you will be wasting your time.
3. It’s all seasonal
Keep a tight watch on when budgets are allocated. A lot of companies will inform you that they’re not in a good position to allocate money. Find a non-financial resource that you can be offered and leverage their partnership to gain financial support with another sponsor.
4. Know the lay of the land
The winner is the one who has the most information. If you are trying to tap into being a supplier for a corporate, know the decision-makers; know the key influencers. Your business is reliant on relationships.
As connection with anyone becomes easier, it’s easier to create solid relationships with decision-makers who can help your business with a signature. But always ensure your proposal offers the greatest value and that you do not only know the decision-maker, but everyone else who is part of supporting the sponsorship.
If You Have A Great Business Idea, Who Ya Gonna Call? Hint: Not A VC
As customer development expert Bob Dorf advises, “For as long as humanly possible, avoid investors as best you can.”
If you have the next billion dollar start-up business idea that is going to change, even revolutionise, an industry, what is your next step? Should you:
- Formulate a business plan/canvas model?
- Do extensive market research?
- Bootstrap and spend your own savings to build a minimum viable product (MVP)?
- Get a cofounder?
- Talk to an investor?
Say you’re an experienced entrepreneur who has already thought about all the important metrics for starting a business.
Those metrics might include:
- Barriers to entry for rivals
- Initial start-up costs
- The regulatory environment
- Questions as to whether/how to patent your idea
Once you’ve got the answers to these questions, how do you start?
Here’s a tip: The first step is not to think about money. Instead, next time you find yourself ruminating over a particular idea, first validate audience demand.
Related: Is Venture Capital Right For You?
Why it’s important to think about your audience as your first step
Raising VC money has been all the rage and hype for the last decade or so. And, with so many up-and-coming start-ups getting funding each month, people may think venture capital is the obvious path to take.
I’ve often seen people on Quora saying, I have this great business idea; how should I approach potential investors? Whom can I speak with about my idea?
One of the answers to that question, which was upvoted, caught my eye. That commentor wrote, “Talk to your ‘potential’ consumers or your target audience.” Potential consumers, the writer pointed out, will help you:
- Understand your idea better
- Find mistakes and areas of improvement
- Evaluate customer interest and willingness to pay
- Understand market potential and size
- Understand the buyer persona better.
All these things will help you at later stages, the writer continued, in reference to fund-raising and shaping your business.
Why you shouldn’t talk to a venture capitalist first
VCs can be useful and smart. If you run in entrepreneurial circles – like networks and conferences – you may find it useful to talk to VCs because they’ve probably already entertained 20 different businesses pitches before your idea arrived this morning. Undoubtedly, too, VCs are in a position to offer a diverse perspective.
So, if you get the chance to meet one, talk to him or her without an agenda. Your only goal is to learn something new.
In fact, you can get amazing insights, such as marketing practices going on around you, what’s working and what’s not; operational nightmares, expansion difficulties, hiring disasters.
A great VC will have an interesting story or two on practically every single facet of business, including starting, scaling and managing a startup. Even more important will be the fact that a VC investor can help you get the pulse of market/investor sentiments.
Yet, despite these positive attributes, VCs are not your first call. In fact, I would not recommend at all that you talk to a VC at the outset about your nascent business idea – and not because the VC will steal your precious concept or not fund your “idea” since it’s just that – an idea.
When you have a proven concept that is based on actual numbers rather than projections, it may then be time to talk to VC investors. But before that point, first talk to your potential consumers and get some traction.
This article was originally posted here on Entrepreneur.com.
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