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The African start-up scene has become increasingly attractive over the last five years for budding entrepreneurs and investors alike, writes Africa investment specialist Yvonne Haizel.
2015 was a year that saw significant capital being raised for the likes of Off Grid Electric, M-Kopa and BitPesa. According to start-up portal Disrupt Africa, it was a year in which African tech start-ups alone received $185.8m.
While such success stories are often highlighted across the media, raising capital remains one of the biggest challenges for African entrepreneurs, and for those that are successful in attracting investors, many fail to realise that it could come with unwanted strings attached. For that reason, it’s important to get the timing and approach right to avoid some major pitfalls.
Below are five reasons why entrepreneurs should be cautious before embarking on raising capital.
Attempting to raise capital requires a lot of time spent engaging with potential investors, accountants and lawyers which often fails to materialise. To put it into context, a mobile agribusiness I recently worked with took eight months to complete a funding round. During the eight months, dozens of meetings and on-going due diligence took place. The point is, instead of focusing on raising capital, it is important to consider whether the time could be better spent developing the business and surpassing key milestones in the early stages.
Giving up too much too soon
Raising too much capital early on could result in giving away a significant portion of the business and deter later stage investors. Although there is no hard and fast rule on what proportion to give away, 20% fully diluted in a series A round is what you could typically expect. If the founders are left without a meaningful share and no option pool, it rings alarm bells to most prospective investors. There have been many occasions where I have been surprised to come across founders that have given away substantial shares of their business, leaving them with dirty capitalisation tables; a very un-calculated move!
One of the main reasons start-ups seek funding is to scale and fast. Equally, one of the main reasons start-ups fail is due to premature scaling. This can be in the form of employing too many staff or overspending on marketing before the product has launched. From my experience, start-ups that have surpassed the adolescence phase and nailed their value proposition tend to attract smart capital and at relative ease. For less experienced investors and entrepreneurs, raising capital too early often creates the expectation to scale, and could in effect increase the cash burn rate prematurely.
Ultimately, investors seek to generate a return and will accordingly have some say over the companies’ direction, sometimes more than founders desire. Recently, a tech start-up I worked with lowered the priority of what they initially thought was their main value proposition in response to new market opportunities. Had the company already raised capital, they would have faced scrutiny for significantly changing the direction of the business. Therefore it helps to first progress the business before raising capital. This would also de-risk the investment for investors and allow founders to focus on achieving key milestones mutually agreed post investment.
The wrong investor
In the quest to raise capital, entrepreneurs are often open to various forms and sources of capital, particularly when it comes to raising seed capital. Having a ‘smart-investor’ with the industry know-how could accelerate the progress of a business. In contrast, a financial investor comes with little additional value other than the funding. Another thing to be mindful of is the potential misalignment of interest with investors that do not share the same strategic vision, which can slow progress. For that reason, founders should go so far as to consider turning away potential investors that will not add value.
An African Investment Specialist focused primarily on the tech and tech enabled sectors, Yvonne Haizel spends her time traveling throughout the African continent identifying and appraising investment opportunities, as well as supporting the deployment of capital and value up of portfolio companies.
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