Getting access to the right seed and growth finance is critical to the success of most emerging technology companies. But finding the right investor can be a daunting task for any founding team. Different mandates, big egos, various terms, long lock-in periods just to start discussions and so many boxes to tick. In working on over R300 million worth of seed and growth finance deals for our clients, our team has seen it all. Without significant direction, founders can spend months worth of crucial time and energy in pursuit of an investor instead of focusing on growing the company and its value.
Founders need to know where in the investment cycle they fit, what types of mandates are applicable to them and where to find those investors. A working knowledge of the various types of investors is critical. Let’s unpack the most significant ones:
Angel investors and angel consortiums
Angel investors are high net worth private investors that seed fund entrepreneurs at a quite early stage. They will normally invest on their own or in a group. Angels are usually successful entrepreneurs who have built and sold their own companies over many years. They understand what it takes to build a business from the ground up, having done so themselves. They can also spot others who will likely be successful at doing the same.
Angels normally built their companies or spent their corporate careers in a certain industry which they understand in depth. It’s normally in this industry or a complementary industry that angels would look to invest. As the term “angel investor” suggest, traditionally terms set by angels are very generous, like a shareholder loan with long repayment terms or low interest for a small piece of the pie. In SA, because the angel community is still so small and access to early stage finance so limited, in many cases angel terms range from relatively generous to extremely onerous. Angel ticket sizes will generally range from as little as R100,000 to about R2-4 million, with almost all such investments originating from personal relationships.
A large concentration of angels can be found in the Stellenbosch area. The nodes of Johannesburg, Cape Town and Durban also have established angel investor circles. Connecting with the South African Business Angels Network will also put you among some of the parties who are interested in angel investments.
My top tips for dealing with an angel investor would be to make sure that it is someone who can (and is willing and available to) actively add value to your business. Also try to never sell too large a steak in the company at this early stage, as this will limit your ability to raise future equity rounds.
Venture capital funds are investment entities with a specific mandate to invest in a certain type of company. Being formalised investment entities, they normally have shareholders or investors who capitalise the fund, a management team that identifies and monitors opportunities and an investment committee that makes the final call on proposed transactions. Their mandates range from early stage companies with proof of market acceptance to much more established companies that are still growing at a high rate, with general ticket sizes in SA ranging from R2m to R15m.
Venture capital companies invest at a stage where the company’s risk has been lowered by the fact that it has traction in the market, with a proven product and a strong team. They do still take a big risk at this stage, as the company’s future growth is still uncertain. VCs will only invest in companies that have scalable business models and defendable intellectual property with the ability to scale to five to twenty times the value at which they buy in at within a five to ten year timeframe. SAVCA, the South African Venture Capital and Private Equity Association, publishes a list of most major VCs.
Top tips for engaging with VCs would be to make sure that you fit their mandate. Most would publish this on their site. It’s no use knocking on their door if you are not in the right industry, stage of growth or ticket size that they look for. Again, personal introductions or relationships with VC managers has a much better chance of getting their attention than e-mailing them a slide deck. Lastly, be very sure of your company’s value before entering into negotiations, as these guys are experts in driving down your price to get a good buy-in.
Private Equity Funds
Private equity funds are very big, quite sophisticated and highly regulated investment entities. They will generally only consider investments into established companies where the risk is much lower than early stage VC. Their ticket sizes generally range from R15m to upward of R500m, with investments being made for the free cash flow generated from profitable, established companies.
With limited such investee companies in the market some PE firms are starting to look at somewhat more early stage opportunities, which is exciting for emerging entrepreneurs. A top tip to consider before taking on a PE investor is whether you are ready for the corporate structures and intense reporting that would come with such investment, as this could stifle growth and flexibility in the process of trying to create sustainable, predictable cash flow earnings.
Government funds warrant a chapter instead of a paragraph, as there are quite a few out there. I’ll touch on some of the most notable ones. For early stage technology commercialisation, Technology Innovation Agency has three funds that invest in science and technology development pre-seed stage. You’ll also find SEFA (Small Enterprise Finance Agency at the early stage of the spectrum, with loans and investments of up to R5m. The DTI and IDC fund more established companies, with various mandates applicable to different industries.
When approaching a government fund, make sure that you understand its criteria before going through the application process. Most funds have detail criteria based on years of establishment, percentage black ownership, supported industries and more. Also make sure that you are patient, as unlocking government funds can take months to years.
Enterprise and Supplier Development Funds
The BBBEE codes have led to various funds being set up to channel corporate enterprise and supplier development funds to emerging entrepreneurs. Edge Growth’s story with its ASISA fund is tailored to the financial services industry is a good example. These funds are normally mandated to invest in emerging black-owned companies with turnovers either below R10m or below R50m. Being able to fit into the supply chain of the corporates that are the ultimate financiers would be a plus. These funds can normally structure debt and equity transactions across a broad range of ticket sizes.
The need for fast, continuous innovation required in the market paired with corporate giants’ general inability to easily innovate in-house has led to many corporates entering the market for emerging tech companies. It’s often easier and less costly to buy a large or controlling stake in an innovative company than it is to innovate within existing structures.
Different corporates will have different mandates, but all of them would invest in companies in their industry or that would complement their industry. Corporate pockets are deep, so price tags and go well into the tens of millions. Make sure that you know which companies would be interested in your business and why. Also take heed that you do not end up selling your company and working for your investor if this was not your intention.
Lastly, various international investors are setting their sights on SA. Even though political and economic junk status and our fluctuating currency do not help us much, SA still represents a good stepping stone for international investors looking to access African markets. We still pose a much less risky investment opportunity compared to most African states.
There is also a big discount on equity investments here versus other global start-up hubs. In San Francisco, you can barely buy into a pre-revenue start-up with a million dollars. In SA, R13 million would get you a big stake in an established emerging company that has strong revenues and market validation. Apart from good value low buy-in opportunities, operating costs here are a lot less than in most start-up hubs in the world. Companies that are able to earn international revenues and pay salaries and overheads in Rand do exceptionally well. The lifestyle here is also attracting funders and investors alike. A top tip for taking in international funds would be to make sure that any debt is repayable in Rand. Otherwise you might find yourself on the wrong side of currency devaluation.
As our eco-system matures and more sophisticated angel, VC and other types of investors enter the market, entrepreneurs that are building high quality companies that solve real global problems should have a lot to look forward to in years to come. Always make sure that you partner with the right type of investor at the right time and that it is done on mutually beneficial terms.