Generally speaking, there are two instances when businesses seek investment from external sources: at start-up, and just before embarking on major expansion or a new product launch. In business as in life, convincing someone to part with their hard-earned money can be difficult.
Due to the level of risk involved, a business in its early stages has fewer available financing options, and the entrepreneur behind the business will have his work cut out for him to secure an investment. “SME finance can be regarded, from the financier’s point of view, as a high risk,” said Gerrie van Biljon, executive director at Business Partners. “It is for this reason that the focus for most financiers is on larger businesses where the perceived risk is lower.”
STARTING POINT
Catherine Wijnberg, small business specialist at Fetola, said: “While there is no shortage of money per se, there is a great unwillingness by the commercial sector to risk financing small businesses. The days of putting out your hand and getting a couple of million seem to be over.” Wijnberg added that start-ups still struggle the most, so starting lean and mean, and relying on friends, family and “fools” for early capital is still the most frequent source of funds.
While the experts agree that it is difficult for a start-up to access finance, it is not impossible. There are investors willing to give a young business the kick-start it needs. In South Africa and selected African countries, specialist risk finance company, Business Partners, invests in start-ups as well as expansions, buying of businesses, management buy-out and franchises. Van Biljon explained that for the company’s Venture Fund, consideration is given to early-stage investments after the research and development phase, where the product or concept is market-ready.
The criteria for securing finance varies and Business Partners provides guidance on the application process. However, there are two essential requirements when applying for finance. Like most financiers, Business Partners requires a business plan to be in place. Having “skin in the game” is usually non-negotiable too. “Although there is no minimum requirement regarding own contribution, the lack thereof places strain on the gearing of the business and thus affects the viability of the project,” said Van Biljon. According to him, potential investments are assessed on the viability of the business, which comprises two important elements: the business and the entrepreneur.
Wijnberg said that impact investors, tech-hubs and SME-accelerators, venture capitalists, and crowd funding all offer potential funding sources for good ideas and dynamic business visionaries. While she believes business survival or sustainability is the most critical aspect, there are other considerations. “A good financial history is essential, as is a realistic business plan with well thought-through financial projections. Assets and collateral, partnerships and credit history all strengthen the case for finance,” she said.
NO MONEY, NO PROBLEM
Van Biljon says international research has indicated that SMEs regard access to finance as the number one hindrance to starting or expanding a business. “The reasons are vast but some would include the lack of own contribution, inadequate collateral, poor financial track record, inability to prove serviceability of the debt and credit worthiness,” he said.
Failing to secure an investment should not deter entrepreneurs from starting their own venture. On the Virgin Group’s website, founder Richard Branson is quoted as saying that there are far more important factors than money when it comes to getting a business up and running. He explains that substantial financial backing can actually slow or stop an entrepreneur from identifying the business’s problem areas and finding their solutions. “In many cases, it can be better to start with very little money, since the skills you’ll develop as you overcome the challenges of growing your business will be invaluable. You’ll notice your mistakes earlier and adjust more quickly, which will make for a healthier company,” he said on the site. He further noted that when starting a business, drive, determination, passion and hard work are more valuable than a pot of cash.
STEPPING IT UP
For more established businesses, access to finance is not as big an issue because there are significantly more options available, ranging from government institutions and venture capitalists to financial institutions such as banks.
Tom Stilwell, head of business banking at Mercantile Bank, said that Mercantile only provides finance to established businesses – for example, a business that has been in operation for two to three years, with an annual turnover of around $465,000. The business must be solvent and display proven affordability to repay the requested debt. “When a business owner approaches the bank to secure finance, we like to see that the owner and shareholders play an active role in the business operations and that it is liquid and solvent,” Stilwell said. “The business must also provide sufficient tangible security to cover the requested funding, but this depends on the type of finance and what the financials of the company reflect from an affordability perspective. We also look at cash projections, for example, and if there are new contracts that could have been secured that would increase the turnover of the business.” Other factors considered include the geographic location of the business’s premises, business size, stability of the labour force, the client’s market share, and the level of competition in the relevant industry.
According to Stilwell, some of the information required from the prospective client includes, but is not limited to, last annual audited financial statements, updated management accounts, debt age analysis, a group organogram, a cash flow forecast for the coming 12 months, and bank statements from the past three months. “We don’t use a blanket approach for financing requests – each application is assessed individually on its own merit,” he added.
Although many of the requirements are similar for different investors, the industries they are willing to finance as well as their approach may differ. “Wherever an entrepreneur considers obtaining finance, they should firstly do research on the criteria to prevent disappointment and wasting time,” says Van Biljon.
USE IT WISELY
Simply securing finance does not guarantee that a business will benefit from it. Many entrepreneurs have mismanaged the funding, spending it on personal items or non-essentials such as expensive offices. If financial management is not a business owner’s strongpoint, it is advised that they seek assistance from the funder if this is offered, or through a mentorship programme.
Van Biljon said: “Unlike a large business with a full infrastructure, small business owners are out there to fulfil the role of all disciplines in a business. In a large business, there are probably specialists employed such as a marketing director, CFO, HR manager and an operational director. A small business is confronted to take on all these responsibilities. It is uncommon to find a perfectly balanced entrepreneur who is competent in all the required skills.”
FIVE TIPS TO CONVINCE A VENTURE CAPITALIST TO INVEST IN YOUR BUSINESS
Erika van der Merwe, CEO of the South African Venture Capital and Private Equity Association, provides the following advice for entrepreneurs looking for funding from a venture capitalist:
- The people: a venture capitalist will do thorough background research on the entrepreneur and his business. They will consider things such as business experience, training and successes. The venture capitalist wants reassurance that the entrepreneur and his team have the ability to carry out the company’s big plans.
- A fresh approach: investors are on the lookout for fresh approaches and solutions that are disruptive, can be scaled up quickly and can be successful in an international setting. Entrepreneurs need to be sure of their differentiators.
- Crunch the numbers: entrepreneurs need to do the necessary research to convince the investor that there is demand for their product or service and that this demand is sustainable.
- Avoid the trap of over-optimism: investors hear pitch after pitch and know that the valuation a business owner usually places on his idea is hugely inflated. They will walk away quickly if a business’s numbers are too unrealistic.
- Stay humble: do not expect to draw a large salary for yourself. The investor wants to see that an entrepreneur is willing to give what it takes to make the enterprise succeed in the long run. Save living the high life for after the idea has proven itself.
By Chana Boucher
This article first appeared in the Ventures Africa magazine, Volume 11, 2014.
