VENTURES: Too Much Too Soon Can be Detrimental
Recent Western Cape Business News
While local and foreign investment into growing South African businesses is critical for the stability of our economy, too much outside investment in a company too soon can be detrimental to entrepreneurs.
This is the view of Julia Long, CEO of Here Be Dragon (HBD) which is the venture capital company set up by Mark Shuttleworth.
Long points out that accepting a big capital investment too early in the business cycle can strip the entrepreneur of a large portion of the equity in his or her own business.
“Getting the right investment at the right stage of a business is critical to success,” says Long. “The reason for this is that if not enough tangible value can be shown in the early stages, then entrepreneurs generally need to give up a bigger part of the ownership of the business for a smaller investment amount. Whereas if the entrepreneur has used his or her own means to take the business as far as possible, then he or she will be able to have developed more value in the business and ask a higher investment amount for a smaller stake.
“By way of tangible example, an idea is difficult to quantify but value can more easily be attributed to a patented idea. One could get funding at this stage, or the entrepreneur could go on and develop a prototype and perhaps even acquire an initial perhaps even acquire an initial customer to add further value before seeking funding.”
“Once the business is sufficiently built up, venture capital has an important role to play in the SA economy,” says Long. “Without it, small business would stay small forever.”
Long’s advice to SA’s entrepreneurs is to build slowly, learning along the way, and to let their own funding take them as far as it can. Thereafter they should look at the various funding options available to them and pick the appropriate funding for the business stage, size and desired speed of growth.
To understand the importance of all these stages, Long explains the steps in the business cycle:
The idea: The entrepreneur is always the first investor, usually investing both his time and a little money in birthing the idea and getting it off the ground. This stage should be funded from an entrepreneur’s savings or by additional part time work.
Research: It is worth spending as much time as possible on research. Entrepreneurs should go onto the internet, and talk to as many people as possible about the idea. One need not spend an enormous amount of money on research, and people are usually happy to give their opinion. The more research that is done in early stages the more stable the later stages of a business will be. One can never test the market too well, and this process is also important to affirm that an idea is solid. Long advises not to go for too much funding to soon, just what is required to get the business through the next few months. This stage of the business typically costs in the thousands or tens of thousands of rands and is often funded by friends or family.
Taking the idea to the next level: This stage usually requires a little money to build a prototype, patent an idea, develop the business concept further, and grow a team of competent people to take the idea forward. For this stage, one would typically look at what is called an angel investor – someone with excess cash - or alternatively this may be the time to bring some partners on board. Partners should be able to add value, by contributing skills that are complementary to those of the entrepreneur. Investment at this stage may not only be in the form of money - perhaps a skilled friend can help with a patent, or contribute IT or accounting skills. The trick is not to try and do it all alone. Typically, the amount of investment at this stage can be in the hundred thousands and possibly a million or two.
Venture capital: By this stage, a little red tape has developed, and the value of the idea needs to be quantifiable, supported with structures, and include some formal reporting on activity in order to approach companies for further investment. While there need not be any revenue or profits yet, an investor of this amount of money would need to do some due diligence on the business and would expect some type of prototype and sometimes initial revenue. This is often the venture capital market or loan funding stage, with investment being from millions to generally in the lower tens of millions.
Later stage investment: Once a business starts to have profits, the options change. An entrepreneur at this stage could get financing from the bank, so debt becomes a viable option versus equity. And then later if more than around R50-million is required, private equity could be a good option – whether through acquisition, management buyout or a private equity deal. For this later stage investment, a business would certainly need a sustained revenue stream and have a track record of profitability.
Long concludes that one of the most risky of these stages is the venture capital stage, which is most lacking in South Africa, despite the fact that it is a crucial stage to get a business off the ground and to a size that is big enough to attract foreign and local investment.
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