The importance of working with the right venture capital partner over a company’s life-cycle

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Written by Ian Lessem, CEO, Havaic

Setting aside reasons for small businesses failing such as a poor idea, incorrect estimation of a potential market, cost overruns, timing, there are times when lack of funds can kill a genuinely well-run business with a good product.

Very few start-up businesses are able to grow into large successful operations by only using the gross profit from sales to cover operating costs, development costs and expansion costs. During every growth stage or spurt of a business, some capital is required for additional marketing, inventory, staff or machinery, and most businesses will at some stage require external financing.

Through our experiences in working with startups, building businesses, capital raising and mergers and acquisitions, we have witnessed first-hand the full funding lifecycle to which a business may be exposed. Unsurprisingly, there are different funding strategies and sources of capital over the lifecycle of a business.

Obtaining funding is undoubtedly hardest when companies are young and relatively unproven, all the more so when the product or service itself is fresh and innovative. This is the idea and concept stage, and you are selling investors a vision and your belief in both yourself and the company’s product or service. However, it is important to note that investment terms agreed to early in the company’s lifecycle can have consequences to accessing capital in the medium- and long-term.  We’ve seen start-ups with 25 different shareholders, 10 advisors and hardly any equity left for the founders, before they have a workable product. This affects future rounds of financing as it can make further dilutions more complex and could reduce the founders’ motivations.

Therefore, it is important for such companies to seek both sound advice and investment from trusted investors from early on. This can be a mentor, an angel investor, an accountant or venture capital specialists like HAVAIC.

In terms of the funding cycle, new company entrepreneurs are compelled to turn to friends and family for funding once they have exhausted their own financial resources. This often entails the aggregation of small sums and takes the form of equity investments or, sometimes, structured loans. To the extent that the business is a success, these investors will benefit handsomely but they are not driven by the desire to make high returns; rather they are driven by the desire to demonstrate their belief in the entrepreneur or the offering. Some entrepreneurs benefit from grants from organisations that focus on nurturing innovations that have a social impact, but this is not an option for most entrepreneurs.

As they gain traction – either in terms of demonstrating the viability of their concept or by delivering a prototype – companies are able to access more formal forms of capital. This capital can be more formal in the sense of the structures that investors typically use, but also in the added value the providers of that capital bring, whether in the form of access to business networks, guidance on strategic business issues or advice on improved processes.  It’s at this stage that you would find angel investors – someone who likes you, likes your idea, is willing to provide support both in monetary and morale, and hopes to realise a meaningful return.

As the business grows, the product offering is solidified or core competencies can be displayed, incubators and venture capital providers are the interested parties at this stage.

Early stage companies seeking funding from venture capitalists or participation in incubation programs need to consider the softer issues as well as considering financial and business-related issues. It’s a working relationship that is for the mutual benefit of both parties. A venture capitalist should not be an partner that is looking to take your house if you fail. And if it is looking to do that, maybe you need to rethink your partner.

Early-stage companies benefit from operational support from incubators, creative collaborative environments in which start-ups can interact and provide access to services and networks which enable the companies to access qualified advice and, potentially, further opportunities. This is seldom accompanied by a direct financial injection, and often at a cost of equity or future rights.

A venture capital firm will provide capital  usually, but not always, in the form of ordinary equity. Sometimes, more innovative financial structures can be utilised which allow for entrepreneurs to preserve or reduce the reduction of their relative shareholders. But a good venture capital firm is one that, in addition to capital, brings experience into the strategic process, provides advice on key decisions, assists in the formalisation of internal processes and keeps an eye on the goals jointly set by the business and the venture capital partner.

Consequently, before choosing an incubator or a venture capital partner, a business must answer these 5 steps:

  1. Do you trust them?
  2. Can they help you now?
  3. Do you trust them?
  4. Can they help you in the future?
  5. Finally, do you trust them?

As we move along the company’s life cycle, the capital raised may take an increasingly variety of forms as more sophisticated and informed investors seek to manage the risks to which they are exposed – for example preference shares relative to ordinary shares, or voting versus non-voting – while at the same time realising as meaningful returns as possible. These structures may also seek to defer key commitment points through the use of hybrid financing. For example, convertible loans allow capital providers to defer decision as to whether they wish to be long-term participants while allowing for preferential treatment in the event of business failure.

Once the company has demonstrated further traction by way of profitability and steadily increasing cash flow, the company can start moving away from the above sources of equity and quasi-equity capital and approach traditional funders such as commercial banks to provide leverage, i.e. serviceable debt. Here companies would consider bank loans and, should they become substantial corporations, bond finance.

Throughout this funding lifecycle, it is also important for the entrepreneur to have a clear view of where the company is going and what their intended exit is, i.e. is intended to exit to a private equity house, sell to a trade buyer or even consider a listing?

Whilst these plans will probably change, it’s the job of the founders, venture capitalists and advisors to keep abreast of this goal. Understanding this will inform the funding strategy and positioning in the market, and what steps need to be taken early on to ensure long-term funding and business success while retaining the flexibility to allow the desired exit to materialise. At HAVAIC this future process is a core investment and strategy position that we look to constantly. If we don’t believe we can add value here, we would be unlikely to invest.

In any business, whether an early-stage tech company, a growing manufacturing company or a mature retail business, the primary role of any finance or capital, is that of a lubricator, i.e. the capital is used to lubricate the bearings of the company machine so that it continues to turn.

Many start-ups view venture capital providers as the equivalent of a pot of money and demonstrate little desire to leverage off the experience of their partners. This attitude is summed up as: ‘All money is the same’. However, it’s our belief that not all providers of money are created equally, and this is where choosing the right early-stage partners comes into play as it impacts on the company across the funding cycle.

The venture capitalist needs to be a lubricant and so much more. Not to seek to benefit from the insights gained out of experience, the access to possible networks and the common goals of angels, venture capital partners and / or incubators is one of the reasons why a young company may run out of cash flow notwithstanding the initial funding support.

So, pick your venture capital partner carefully and remember….

  1. Do you trust them?
  2. Can they help you now?
  3. Do you trust them?
  4. Can they help you in the future?
  5. Finally, do you trust them?

HAVAIC specialises in early-stage, high-growth African businesses with proven concepts and global prospects. Alongside that, it partners with sophisticated individual investors and international venture capital companies to fund these African businesses.  

 

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