Updated: Feb 16, 2019
As an African start-up, when you hear stories of the likes of Paystack raising $8m in Series A funding, or logistics start-up Kobo 360, raising a $6m round, you might be thinking you want the same for your business?
Remember when you quit your day job to pursue your dream and build a start-up? You were full of excitement, had a bit of savings, an idea and maybe a product.
So, you’ve been executing on your business plan, doing everything you should, from product development, marketing, business development, customer support, to everything else you need to do to run your start-up.
Having built some initial traction, you have a clear opportunity to grow the business and serve more customers.
Despite working yours socks off day and night, you realise you aren’t growing, partly because you don’t have the resources (staff, tech systems etc) to meet this growth opportunity.
Every business can always use more cash. Preferably, the cash should come from your profits, but there are times when you might require outside financing to unlock growth opportunities, but there are downsides.
There are many types of investors that work with start-ups. These include angel investors, venture capital investors, friends & family, crowd funding platforms, and so on.
Today, we’ll look at venture capital and 5 things African Start-ups should consider before raising outside funding from venture capital investors.
Venture capital is financing that investors provide to start-up companies that are believed to have long-term growth potential. This could come in the form of debt or equity (or both).
Debt is the cheaper form of financing, but comes with interest payments, which put pressure on your cashflow.
When you raise equity, you sell shares in your company and end up with a smaller piece of the pie, but you don’t pay any interest on the funds raised.
Hopefully, the investor's funds will then help you grow the business, and as it grows, the value of your shares should grow in proportion to your equity ownership.
Here are 5 things you should consider before seeking venture capital.
Do you have a growth opportunity?
This is probably the number one reason why a start-up would raise venture capital. It could be that you have an idea for an app and need capital to develop it and market it to customers. Or you might want to expand your fast-growing service to a new market e.g. from Nigeria to South Africa. This might require capital to hire a team, build a product and pay your expenses.
Whatever the case may be, when you decide to raise venture financing, weigh the pros and cons. Does the potential future growth in profits outweigh the cost of raising venture capital?
If raising venture capital allows you to grow your business in a sustainable way, then it might not be a bad idea.
Does your start-up have the potential to become a $100m business?
For some entrepreneurs, building a $10 million or $20 million-dollar business might sound like a great idea, but venture capital investors typically want a lot more. Considering that 7 out of every 10 venture capital investments fail, the investor would want to know that each start-up he or she puts their money into will return 10 times their investment, or more.
This is why venture capital investors look for entrepreneurs who think big, have a big market opportunity, and plan for big outcomes.
If you are not confident that your business will grow into something really big in future, you might want to consider angel investors, who might be open to a lower return on their invested capital.
Do you need subject-matter expertise?
Sometimes, cash is not the most important thing a venture capital investor brings. The right investors will have important contacts in the market your start-up is operating in and will offer networking and mentorship opportunities.
They also typically have experience of what building a start-up entails and will be able to advise your young company, especially when you need to navigate challenging situations.
In many cases, an investor who offers you money and a lot of help with running your start-up, is more valuable than one who offers you more money, but no help.
Are you happy to run a business that has a high chance of eventually being sold?
Venture capital funds have a life of 7 – 10 years, meaning they need to earn a return and pay back their investors within 10 years.
The way for this to happen is if you either sell your company for cash or equity and pay back the investors or if you one day IPO (go public), so the investors can sell their shares to the public and make a return.
This means if you don’t plan to go public in future or if you want to run your business by yourself forever (and not sell), venture capital might not be the route for you.
Do you mind reporting to someone?
Not all start-ups have a board of directors, but if you raise venture capital, they will require you have a board.
Investors who lead an investment round would usually require a board seat as part of making the investment. This means as the CEO, you would now report to a board, who could fire you, if you're not doing your job properly (think Steve Jobs).
Not all investors are the same, but it’s possible to bring on an investor whose interests are not aligned with yours. For example, you might want to progress at a certain pace but might have an investor who wants you to grow quicker and cranks up pressure.
In some cases, this leads to tension between the entrepreneur and the investor, which is never a pleasant experience, and why it’s important to do extensive research on a particular investor, before deciding to work with them.
To conclude, raising venture capital might be necessary for companies that need to spend a lot of money to get off the ground or expand into new markets. But be realistic about your expectations of the future of the company, and if you find that you can achieve your mission in a bigger way, with the help of a venture capital partner, then by all means, give it a go.
How we can help
If you are an African Start-up and would like to understand if venture capital is right for your start-up, book a free consultation with us here and we’d be happy to help.