The last few months have been quite hectic. We have had some interesting mandates to raise 3rd party funding and have also invested in and/or launched some start-up businesses ourselves (with various partners).
And time and time again we have bumped our heads against what I call the “1-for-40” club.
South Africa (and Africa, to be true), faces a rather dispiriting funding gap. There is a hole in the funding universe for SMEs, start-ups and growth companies, which require anything between R500k and R50m (circa $38k to $3.7m). A few points:
- Yes it is a large spread (and perhaps there is an argument that anything less than a R100m investment faces difficulty) and that is because we lack Angel and VC investors. Big time
- Anything north of these numbers is more than adequately covered by a quite vibrant PE community
- Probably the most difficult gap exists between R2m and R10m. A cheque in that range is like a unicorn (no pun intended), because no-one ever sees them
The 1-for-40 crowd
Based on our experience in trying to raise funding, whether for our own companies or not, together with plenty of anecdotal evidence from the entrepreneur and SME universe, this is the pretty standard answer we get from our local Angel and VC investor community:
“I will invest R1m for 40% of your company”
Hence my “1-for-40″comment. Sure, there are some variations on this, and sometimes the terms are worse – it is also fairly common to see that 40% to be “50% plus 1”. It is also fairly common for additional security to required (such as a house or two, cars and other assets). This is not VC investment, by the way! This is more akin to debt finance…
Sure, an Angel or VC can ask for liquidation preference rights in the event of the company going under, but asking the entrepreneur for this additional security should be resisted.
In the US, as an example, a typical Angel investor typically invests $500k for typically 10%. One well-known US Angel invests as follows:
- You have a sound idea – $500k
- You have a working prototype – another $500k
- You have a sound management team – another $500k
- You have a strategic relationship that should help with revenue, growth etc – another $500k
- You already have product rollout and sales – another $500k
And that doesn’t mean if you have everything he will invest $2.5m for 50%! Now, of course our market is not the same as the US, but the above should provide some context to you valuation discussions.
So what can the local entrepreneur do?
Well, if you can find a non-local SA Angel or VC to listen to you, try to get them to invest. The discussions will be much more mature and will be more along international guidelines than the 1-for-40 club.
However, a few words of caution:
- These people are quite difficult to track down and engage with. Especially from the southern tip of Africa
- Also, like it or not, an investment into a South African entity, at this point in time, is not a particularly attractive option. It just isn’t
- A truly pan-African play is much more interesting to them
- Even more so if the play can be taken to other emerging markets and/or globally on a more general basis
- So, you need to think of creating an offshore structure where you can raise some funding and only invest into South Africa what is required, with the balance going into other global areas
- But be very careful in doing this. South Africa has strict regulations when it comes to tax, exchange control and IP protection. Do it properly and by the book
Finally, don’t get sucked into the 1-for-40 and added security nonsense. I know this is difficult and sometimes you may just run out of options, but you need to network as much as possible. And never forget that driving sales and cash-flow and funding yourself is never a bad option, especially in the early stage when these valuation discussions are so difficult. The 1-for-40 club must be a last option.