What is seed funding in South Africa and what does it mean for entrepreneurs?
Early-stage businesses often need to purchase expensive equipment, rent an office, and hire staff. More importantly, they need to grow. They need additional financial resources to achieve your growth plans.
If you are in the process of growing your business, you might need to raise funds from investors or venture capital firms in South Africa. The cost of starting and growing a business is often high and time consuming. In order to start your company, you might need to devise a plan of how you would raise seed capital from investors and what type of incentives you are likely to offer in exchange.
This is not intended to be an exhaustive guide on fundraising, but it should offer all of the basics that most new entrepreneurs will need. The information comes from our experience in working with start-ups and investing in early and growth stage businesses, as well as advising start-ups over the past 40 years. The team at Caban Investments have gained a lot of experience in corporate finance and we would like to share some of these insights.
What is Seed Funding and How do you Get it?
Without funding, most start-ups will die. Starting a company usually requires much more money than even the founders and friends and family can provide. High growth companies need to spend money to sustain growth before they become profitable. Some companies can successfully self-fund, but they are the exception.
When is the time right to raise money? For start-ups, a war chest can often be a competitive advantage in important aspects, such as public relations, marketing, and sales. This means that most start-ups will want to raise money sometime during their lifetime. The process may be long and arduous, but it is necessary for companies, especially new ones.
What to consider when deciding if it’s the right time to raise seed funding
Investors write checks if the idea presented is compelling, if the team of founders can realize its vision, and if there is a large opportunity available. When founders want to raise money, they should invest in themselves. The experts in raising money know this and recommend it too.
For most founders, customer adoption is key to success. Software today has advanced to allow for a mobile and web app to be made quickly, cheaply, and with low effort. Hardware can also be prototyped easily so that you don’t have to build the next great thing from scratch.
Investors need convincing that there is product market fit and growth before they are able to commit. A product needs to be seen, used, or touched for it to convince investors that there is a need for the service it offers.
Investors expect founders to have a product that is matching customer needs and being used at quick enough rates before they will invest. To impress investors, founders need to have things such as figuring out the market opportunity and targeting their customers, along with having a product that can be used at often an on an ongoing basis. That’s is the ideal.
How Much Can I raise for my business?
Ideally, you should raise as much money as you need to reach profitability, so that never have to come back for more fundraising. If you can do this, not only will the fundraising process be easier in the future, if things get tight financially you’ll have a way to keep going without new funding. That said, certain kinds of start-ups need these follow-on rounds: those still working on hardware. Instead of trying to raise all their money at once, they should aim to take what they need from one round of funding and keep going until they either reach their next fundable milestone or their cash runs out.
You need to be considering a few factors when deciding how much to raise. The most important variable is the amount of progress you can make and your investors’ level of trust. Depending on your management experience, you might be prepared for up to 10% dilution, but it may be in your best interests to try for less than 20%. When presenting your pitch, remember that the difference between whatever amount you received and the full value doesn’t really matter; what matters is how quickly you grow.
To estimate how much you need to raise in your first round, think about how many months of operation you want to fund (18 to be safe). For this amount of time, you will need R10.35 million (with an average employment of 5 engineers at R150k per month). If you have other positions that need funding, don’t worry! The estimate will be enough for whatever mix or amount of employees you hire.
There is a difference in the distribution of money raised by companies. We’re concerned here with early stage raises, which usually range from a few hundred thousand Rand up to twenty million Rand. Most first rounds seem to cluster around four million Rand, but increases in interest from investors have led these rounds to grow larger over the last few years.
What is Seed funding and what other types of funding are there?
Understanding the basics of venture financing is essential for start-up founders. There is no single paragraph that can serve as a complete summary. But here are some basic questions you need to ask yourself before seeking capital and ensuring your investment will be worth it.
Ventures usually follow a specific order of rounds. Seed rounds come first, Series A comes next, Series B comes after that and the cycle continues until acquisition or IPO. None of these rounds are required because some companies start with Series A financing
Most seed rounds in Sub-Saharan Africa are either convertible debt or are structured as simple agreements for future equity.
Convertible Debt
The idea behind convertible debt is that the investor lends the money to a company using an instrument called a convertible note. The intention of the note is that it converts to equity when the company does an equity financing round. This note will have a Cap or Target Valuation and / or discount which determines how much convertible debt investors pay per share in comparison to other investors. And convertible debt may not be called on deposit until the maturity date, with earned interest usually able to extend maturity dates by negotiation.
Equity
When you’re issuing an equity round, you want to make sure to work with a lawyer to help avoid being misunderstood. This is more complicated and time consuming than issuing a convertible note, which is why they are popular for early stage rounds.
There are many components to an equity round, including liquidation preferences, anti-dilution rights, and option pools. These components are negotiable, but you should be aware of these issues before agreeing on a valuation with your investors.
It is best to use known financing documents. These documents are fair for founders and investors.
How to determine the correct valuation for your company
It is impossible to determine the objectively fair asking price for a company. The only way to set an asking price is to find out what people think it’s worth and what somebody is willing to pay. The more interested investors are, the higher your company’s value will trend.
It can be difficult to find an investor to tell you what you’re worth. That’s why it sometimes helps to look at companies with a similar valuation. You should remember that if you’re over-optimizing, then you won’t get the best deal out there. Your goal should be finding a valuation with which you’re comfortable, that will allow you to achieve your goals and stay in control of your company. Valuations for seed investments usually range from R2mm-R10mm.
Angel Investors & Venture Capitalists
The difference between VCs and angels is that VCs invest other people’s money, whereas angels invest their own on their own terms. Although some angels may approach decision making like a professional, most are more like amateurs. They can make the call on their own, and emotions will play a larger role in this decision.
Meeting with a VC can take a lot of time. They have many partners involved in the final decision, and they see most of the deals.
There are a variety of different avenues and opportunities for seed funding. The ecosystem is more complex than ever and there are numerous VC firms that will invest in companies at their earliest stages. Some traditional VCs will also invest in the very early stages of a company’s life cycle, while some new angel investors offer could provide up to R500k or more to individual companies.
What About Crowdfunding?
There are a lot of new crowdfunding sites that people use to raise money for their business. If you want to launch a product, run a pre-sales campaign or find venture funding, these crowdfunding sites can be useful. Crowdfunding is changing rapidly and it’s difficult to determine when or how to use these new sources of funds, but they may be best suited if you have difficulty raising through more traditional means.
Read This Before Meeting Investors
At an investor meeting, your goal is not to close. Instead, it is to get the next meeting with investors. Investors will seldom choose to commit on the first day they hear you pitch, regardless of how brilliant it is. This means booking more meetings than usual. Remember that the last barrier is getting money in the company and that means working hard to amass funds as soon as possible (i.e., be greedy).
There are a few rules to follow when meeting with investors. First, research the investor’s preferences and figure out why they like to invest in certain things. Second, simplify your pitch by emphasizing what makes them different and why you specifically are qualified to work on the project. Third, listen carefully to the investor’s feedback and do what you can to connect with them. You can create a good connection by researching their preferences first and trying to see things from their perspective.
What matters when pitching to investors is your compelling story and how well you communicate it– who you are and how much evidence supports your dream. Find a style that’s natural to you, practice as much as needed, and present with confidence.
A balance between confidence and humility is important in your meeting with an investor. Both being too humble nor too arrogant will not make a good impression. You should be open to intelligent counterpoints but also stand up for what you believe without being too much of a pushover.
When you are at an investor meeting, make sure to leave with the future plans of the company discussed. Do not walk out unclear or without a close.
The essential elements of getting a deal done
It is an advantage to use standardized documents, as it will reduce the amount of negotiation time needed. Negotiation can again go back and forth on just a few variables.
There’s no recipe to building momentum behind your deal other than telling a great story, and persistence. You may have to meet with dozens of investors before you get an agreement. But to build momentum, you just need convince one of them. Once the first money is in, each subsequent investor deal will become easier.
If the investor agrees to do business, use a handshake and then quickly close the deal.
Negotiation tactics to get seed money
Take negotiations and requests away with you to get help from advisors or legal counsel. Ask for clarification if there is a difference of opinion. Remember that the valuation set at this stage in your company’s lifecycle will rarely have an impact on its success or failure. Once you reach a deal, do not delay. Execute the contracts, wire the funds, and get their signature ASAP. Safes are popular for quick closings because contract signing is as simple as signing a document and transferring funds.
Documents you need to have before seeking seed funding
Do not spend too much time on diligence documents for a seed round. Many investors would want to do their own due diligence studies prior to investing. You will probably want an executive summary and a slide deck to use when meeting with investors.
It is possible to create an executive summary that is one or two pages in length. The summary must include product, vision, and team information.
Generally, when creating the slide deck for a presentation, the most important thing is to outline the story and visuals. Images and graphics are very useful in illustrating the story more clearly than words. Remember that there is no set rule for formatting or order, but usually slide decks contain several sections. When creating the pitch, think about how you present yourself and what you want to portray your company as.
In general your slide deck / pitch deck will include the following:
1. Business Name and Branding
2. The ultimate aim of the business –also called the vision
3. The Problem – What is your problem and what are you solving for the customer?
4. Who is the target market? (user personas, niche) and how will you reach them?
5. The Solution – What you have created and why now is the right time.
6. What does the marketing and competitor landscape look like
7. What have you done so far?
8. How does the business generate revenue – or the Business Model
9. Who is involved – Ideally the team adds value to what the business aims to achieve. This is a crucial section. Many investors will consider the team first, then followed by the idea itself.
10. How much have you raised so far?
Additional Thoughts
The process of start-up investing is rapidly changing, and it is likely that this guide will soon become obsolete. Stop by to learn more about raising venture money and the several sources available including what is listed at the end.
To raise funds for their start-up, founders need to endure a painful process with defined steps.
Get to fundraising over as soon as possible, and leave the company building for later.
Don’t stop fundraising too early, even if your fundraising is difficult. Fight and stay alive, so that you can continue to raise money.
When trying to close sales, be greedy: prioritize the deals that are more likely to close. Consequently, reach out to as many people as possible and give them your offer.
Always work hard. Even if you are the hottest deal of the hour, you need to be working just as hard as everyone else to get investors interested.
