The South African venture capital market, although small by international standards, has seen strong growth in recent years. In 2017 for example, the number of venture capital investments increased by nearly 40% from 114 in 2016 to 159, while the value of investments rose by 33% from R872 million in 2016 to almost R1.2 billion in 2017. In fact, 2017 was the first time the sector surpassed the R1 billion mark which is impressive given what was a very tough year in South Africa both economically and politically .
Fighting for a piece of a small pie
However, the ratio between South Africa’s venture capital industry and GDP is one of the smallest in the world; as a percentage of GDP, South Africa’s venture capital industry ranks in the world’s bottom decile. Entrepreneurs are therefore fighting for a slice of a relatively small pie in an industry where deals are not as visible as they are elsewhere in the world. According to Robert Fihrer, CEO of alternative asset manager Capricorn Capital Group South Africa, this issue poses the biggest challenge to the country’s entrepreneurs.
“South Africa’s venture capital environment is in its relative infancy when compared to some of the larger developed markets”, he says. “The structures and pathways in which deals can find funding homes is less defined and thus presents ambiguity for entrepreneurs looking to find the right funding partners. Founders often either waste a lot of time, or simply have no idea where to go”.
For entrepreneurs looking to embark on the venture capital funding route, it’s therefore imperative to understand exactly what funders are looking for and how they can position their budding businesses in the best possible light. Fihrer, who co-founded Capricorn Capital Partners in 2003, Charlotte Koep, investment associate at 4Di Capital, and Johan Bosini, partner at Quona Capital, have some advice.
Approaching a venture capital funder
1) Is venture capital funding the right money?
“First and foremost, you need to understand whether venture capital funding is the right money for you”, Koep says.
Funders will generally have a number of requirements that you must be able to demonstrate you can meet. For example, you’ll need to be comfortable with the idea of a long-term partnership, handing over a significant ownership stake of the business over time, undergoing a number of funding rounds and generating a substantial “venture capital rate of return” to compensate the funder for the high risk your business represents. This can range from between 10 times and 100 times the venture capitalist’s overall investment.
It can be difficult for South African entrepreneurs to achieve these types of returns because the domestic market is relatively small. “The vast majority of South African start-ups and entrepreneurs should have global growth prospects, or at least ambitions to expand into the rest of Africa, if they want to be able to achieve the types of returns required by venture capital funders”, says Koep.
You also need to be prepared to invest a lot of time and effort into securing venture capital funding. It’s a lengthy process during which the funder will ask you tough questions and conduct extensive due diligence to ascertain whether your business is worth the risk and whether there is likely to be a good funder-entrepreneur working relationship. This process can be highly disruptive and put a lot of strain on a business that may not yet be well established.
2) Use your network connections
If you do decide that venture capital funding is the right route for you though, the best way to approach a funder is through a mutual connection. “Most of the opportunities we come across are introduced to us by people we already know. It’s rare for us to form a relationship with a start-up on the basis of a cold call or email”, says Koep. She suggests ensuring your network is wide and comprised of high quality and diverse connections that would be happy to introduce you to venture capital firms in their own networks. “A personal recommendation is the first badge of approval a funder needs to see. It’s an invaluable signal that you are a credible entrepreneur with a reputable business”, she says.
3) Chemistry in the founder-funder fit
But you can’t just approach anyone; you need to undertake extensive research into the funder you want to approach to make sure you are the right fit. “The due diligence process should work both ways”, according to Bosini. “I would highly recommend that you undertake reference checks on your investors. A venture investor is a partner, and the deal terms, structure, governance and network needs to be stage-appropriate to give the business the biggest chance of success. The earlier-stage the business, the more important it is to find investors that really understand what it takes to build something great”.
Koep’s advice strikes a similar tone. “You have to really understand who you’re talking to: what their priorities are, what their investment mandates stipulate, what they look for in an investment and how their investment process works”, says Koep. “Most importantly, there has to be chemistry between funder and founder. In particular, it’s crucial that you ensure your objectives are aligned, whether they are financial return objectives or impact objectives. This way you’re all on the same page about what you want to achieve and how you’re going to go about achieving it”, she says.
Fihrer also highlights the importance of asking the right questions of your funder. “All too often, we find founders are too deal-oriented and overly focused on matters like valuation and equity structures”, he says.“What they should really be asking is: how I can work with the funder? Are our cultures aligned? Does the venture capitalist have the skills to help pivot the idea if it initially fails?”
Once you have identified that venture capital funding is right for you, and you’ve earmarked a suitable funding partner through your network connections, you need to be able to prove why and how your product idea is a worthwhile investment.
What are funders looking for?
For Fihrer, there are three things Capricorn Capital Group looks for when making an investment. “Firstly the people, secondly the people, and thirdly the people”, he says. “Our philosophy is based on partnership investing. At the end of the day, no matter how good (or average) an idea is, its ultimate success is determined by the skills, integrity and work ethic of those at the helm.”
Bosini shares a similar view and believes that as a founder, your primary job should be to focus on attracting and retaining the right people. “Business is about people, and the number one job of a founder is to attract the best people, which includes your team, but also your customers and investors”, he says.
Koep agrees that high-quality, experienced leadership is arguably the most important aspect from a funder’s perspective. “It’s not just about backing the right ideas, it’s about backing the right people”, says Koep. “Second or third time founders with complementary skills and experience are the ideal candidates for venture capital funding as they’ll be able to show where they’ve had some traction and what lessons they’ve learned along the way”. She also points out that the product and addressable market are key considerations for 4Di.
Your funder needs to be convinced that your product has what it takes to generate the returns they need to realise on their investment. They are generally looking for a highly differentiated, possibly disruptive product that solves a real user problem and gives your business a clear competitive advantage. “It goes without saying that your product has to be highly scalable. A well articulated and credible growth strategy for it will go a long way to persuading the funders of your ability to scale”, says Koep.
Fihrer also advises keeping your product simple. “Often we are presented with incredibly complex (and impressive) ideas, where founders are looking for a lot of capital to build out a very complex product offering. Instead, we challenge the entrepreneurs to test a simpler version on a few customers, whether these are family, friends, or the man on the street,” he says.
On a similar note, Bosini recommends that founders are very clear about exactly what problem their product is solving. “I often see companies hiding behind their amazing technology, algorithm or cryptocurrency”, he says. “This is all well and good but they should focus more on what problem they’re solving and the business model that will make it into a real business that can have a real impact”.
You also have to show that the addressable market for your product is large and that you will be able to tap into a sizeable pool of potential customers. “A big and growing market is able to support new entrants and is vital to your ability to grow your business at the rate required by venture capital funders”, Koep says. Furthermore, Fihrer advises that you prove to your funders that there is an authentic need for your product and genuine longevity for your idea. “You have to show that there is a true desire for your product and a lasting hunger for more”, he says.
Just start…even if you fail at first
That said, you don’t need to have a finalised, perfectly polished product to present to a funder, according to Fihrer. “Start simple, and just get something together”, he says. “Investors don’t need to see the final product on day one. They want to see (and are happy to see) a product concept that is drenched in the blood, sweat and tears of the founders”.
Bosini has a similar viewpoint. “Done is better than perfect”, he says. “I would recommend that you just start. You think you need to raise money, or fine-tune the idea, or design a better website, but you really don’t. Just launch something and let the customer feedback guide the next steps of your idea”.
It may well be that you fail at first, but failure is a natural part of the entrepreneurial journey and admitting to failure won’t necessarily make you less desirable to a funder. It may, in fact, make you a more credible investment opportunity. “Don’t be afraid to be candid about your failures. As long as you can prove that you took something meaningful from the experience, funders will appreciate your honesty. It’ll also help them better understand your journey which is an important part of the investment process”, Koep says.
It’s not just about the money
At the end of the day though, venture capital funding is about so much more than just the money. It’s about working with an experienced firm that can open doors for you by offering you expert advice and support, and introducing you to their own network of industry influencers, market leaders and potential customers. But it’s not the right solution for everyone and you should carefully consider whether venture capital funding fits in with your own goals and whether it’s the right route for your business.