How to finance your business ideaBy Isabelle Coetzee
A life-changing business idea can induce excitement, and have you jotting down the first draft of your business plan. But this can quickly turn into concern once you start considering the costs of your start-up, and how you will be able to fund it.
“Most entrepreneurs only know about banks when it comes to raising finance – this is the last place to start to find start-up capital,” says Darlene Menzies, who has created several successful technology businesses, including Finfind for which she is the CEO.
“Banks only fund 2 – 3% of the start-up finance raised in South Africa. In reality more than 90% of the funding to start a company comes from self-funding, family and friends,” she adds.
It’s nonetheless important to know where else you can source funding. Menzies outlines the following three funding categories:
1. Crowdfunding – this is the practice of funding a project or venture by raising many small amounts of money from a large number of people, typically via the Internet.
2. Government funding – various government agencies offer a range of funding options including grants (ranging from 35% to 100%), incentives, loans (usually at a lower interest rates and better terms than private sector lenders and the lending criteria is less onerous), as well as equity finance
“When you think of places where you can access finance, your first thought might be to consider the private sector. But, in fact, a very good option is to look at the government funding available,” says Menzies.
For an easy guide to understand how government funding works you can go to Finfind, a one-stop access to finance solution which is available free to South African entrepreneurs.
3. Equity finance (from Angels, Venture Capital Companies and Government Agencies) – this refers to the sale of a percentage of ownership in your business in order to raise finance to fund your business idea.
According to Menzies, equity financing can differ tremendously in scale and scope from a few thousand Rand to a couple of million Rand.
“The investors provide finance to the business in return for being issued with shares in the company; the investors aim is to later be able to sell their shares for much far more than they bought them. Generally equity investors will exit (sell their shares) within 3 to 7 years of the initial purchase,” she explains.
Simon Stockley, who is the managing director of Catalis Holdings and has a background in debt and equity funding, points out another way would-be entrepreneurs can fund their upcoming business ventures.
“Bootstrapping refers to a situation where an entrepreneur starts a company with little or no capital and then funds its growth from personal finances or the operating revenue of the new company,” says Stockley.
“It contrasts to using Venture Capital to fund the enterprise and helps the entrepreneur maintain control over the early decisions relating to the company. However, the downside is greater and sole responsibility for the financial success of the company and the potential to stifle growth due to an inability to raise external funding,” he explains.
He highlights that regardless of the type of funding used to finance the business, it is critical that entrepreneurs have a well thought-out and written business plan.
“This will be demanded by potential investors or lenders, but more importantly it will provide a roadmap against which the entrepreneur can track and measure the business over time,” says Stockley.
According to Wayne Berger, who currently has four successful start-up companies and is the chairman of Instant Property, regardless of these options, it’s difficult to find funding unless you have a business track record in the specific industry.
He points out that, “On an international level, it is already difficult to raise funding for your start-up. One in 400 companies receive funding from Venture Capital, and Angel investors look at 40 companies before making a single investment.”
“On a local level, one of the biggest challenges South African entrepreneurs face is that the South African Venture Capital industry is in its infant stage and many aspiring Angel and Venture Capital (VC) investors are not aware of how to build VC risk into their investment models. This makes it difficult for start-up entrepreneurs to successfully raise from these communities of funders,” he says.
Berger explains that often an entrepreneur with an idea will find that investors want to see an early stage version of their product, known as a Minimum Viable Product (MVP).
“This may be the reason you require initial funding, but from my experience MVP's are important as investors will want to see some application on your side, and MVP's reduce the time to market and the ability to acquire critical feedback on your early stage idea,” he adds.
Berger suggests searching for start-up meet ups or pitch nights in your home town. Initiatives like Venture Network South Africa and Silicon Cape are committed to growing the South African start up eco-system and these evenings (often free) are a great resource of ecosystem information and networking opportunities.
Considering the difficulty in finding funding, Menzies offers the following tips:
- Make sure you do your homework, prepare well, and research the various finance options (e.g. ensure you understand the difference between a grant, a loan and equity finance), understand the different types of lenders and get to know the basic finance terms when it comes to lending.
- Ensure you can demonstrate that your business idea has a sound business model i.e. you need to show how it makes money (to achieve this, produce a basic business plan).
- Be clear who your target market is, who your competitors are, how you are differentiated from your competitors, and be able to explain how you will get your product/service to market.
- If you have a bad credit record, don’t ignore it. Understand where the problem lies and communicate with the organisation concerned to sort out a repayment plan. To check your credit record, click here.
- If an entrepreneur believes they have a bankable idea but they don’t have the know-how or the money to properly package their funding request to present to lenders, they should approach an accountant or small business advisor. Once the accountant or advisor has reviewed the idea, and if they believe it’s viable, the entrepreneur should consider asking them to package the funding request (including generating the financial model) at their risk and to approach the lenders on the entrepreneur’s behalf. The accountant or advisor can be paid for their work via commission on the funding they raise.
- The truth is, the easiest way or place to raise start-up finance is by approaching people you know who have the financial means to invest in your idea – i.e. family and friends in business who know you, who believe in you, and would be willing to invest and/or open doors for you. While it’s probably the last place an entrepreneur wants to go for funding, when you don’t have collateral, have never run your own business, and don’t have a trading history (being a start-up) it’s the most viable place to start. Humble yourself and just do it – don’t ask for a large amount first. Ask for a small amount and be clear what you are going to achieve with it, once you’ve delivered on this you can ask for more.
In regards to improving your business plan, Gideon Potgieter, the group senior manager of business development at Resolution Circle, offers the following advice:
- Demonstrate Product and Market fit (i.e. is the business idea really addressing a need in the market)
- Demonstrate that market research has been done, early adopters (potential customers) have been approached with a clear letter of intent (LOI)
- Demonstrate the team’s capability. Who is the product developer (Inventor)? Who looks after developing the business? Who looks after the finances?
- Develop the business model into something that both the entrepreneurs understand and can pitch and that will attract the interest of an investor.
- Develop the financial model into something that both the entrepreneurs understand and can pitch and that will attract the interest of an investor.
Tafadzwa Madavo, chief operating officer at Riversands Incubation Hub, believes that aspirant entrepreneurs may believe a lack of funding stands in the way of their success.
“Yes, it’s a hurdle, but start something regardless. It could be a side hustle to begin with, or it could be gaining some work experience in the sector that you want to work in. Just keep moving,” Madavo encouraged.
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