What every entrepreneur must know about capital raising

Business News of Tuesday, 5 March 2019

Source: John Armah

John Armah

Trend Analysis:

Both The Digest Africa Index and the Annual Venture Investments in Africa Report 2018 suggest that Startups in Africa raised $618m and $725.6m respectively. The variation in data is attributable to the metrics adopted in the deal flows and types of deals, investment size reported for the period 2018.

Digest Africa’s Annual Index tracked 448 funded and M&A deals of which 344 were disclosed generating a $1.2 billion deal value. This report by Digest Africa considered Debt financing, grants/non-equity assistance, venture capital, angel investment, crowdfunding, corporate financing and initial coin offerings (which is still yet to be a valid metric in the finance world).

The Venture Investments Report 2018 reported USD 725.6 Mn was invested across 458 deals — a 300% gigantic leap in the total funding amount and over 127% increase in the number of deals compared to what was reported in 2017. The indicative value of comparison is a 448 to 458 deals compared by both firms. A fair size for comparison to determine variance in deals.

In a comparison of Funds that were established or capital raised to seed companies, 2018 according to Digest Africa in its report suggest a total value of funds at $1.094B, with an average fund size of $68.4m, $314m maximum fund raised, $250k minimum fund raised.

These three variations increasingly show a rise in deal flow and support services to African Startups. However, Sub-Saharan Africa particularly Ghana continues to lag in attracting Capital to its Startups, significantly different from the typical KINS(Without Ghana’s) economy. Kenya, Nigeria, South Africa are the ideal spots for capital raising and startup capital.

Why are (African) Startups not raising enough capital?

1. High Net Worth Individuals and Risks- High Net Worth Individuals are either difficult to find or relatively hard for Startups to convince. When these Investors commit, the typical periods for closure drag or that calls for capital go unheeded. Interests by typical Ghanaian High Net Worth Individual’s or the growing institutional family type firms for Startup investments are for companies with proven business models, audited accounts, no liabilities, in summary an Investment thesis typical of requests by Banks. The typical risks applicable as KYC- “Know Your Customer” requirements for banks apply to Startups. In contrast, Startups vary from Idea/Seed Stage to Growth, some even matured.

Two types of businesses will continue to exist, Companies with liabilities, companies without liabilities that still need capital injection. Worthy of note, not every liability is bad business, and not all assets are good assets. The investment thesis demanded by HNI’s must be revised and examined within the context of scale, business development and corporate governance support through shared experiences. Can capital injected enhance restructuring processes to reduce liabilities of exposed, leveraged companies?

What will it take to convince HNI’s to consider Startups, perhaps a system of scalable micro equity/micro debt investments leading to equity in a typical convertible debt type deal?

2.Variation Models-

The mistakes most startups make is the inability to marry traditional business models with evolved business models, a tech enabled African spiral growth is restricting an inherent understanding of the traditional African value chains and lifestyle changes that may occur in the medium term but as factor and measure of development and cultural exchanges.

A typical e-commerce shopping app may discover that while price, convenience and mobile penetration and variables in usage present market opportunities, a market sizing on preferences of consumers to type of groceries-organic or otherwise, user experience, certification, and an understanding of the market queens and market stalls operational supply models can largely determine how innovative grocery apps perform especially from an aggregator perspective to consumer choices. To each model must be a sustainability agenda with a blended value of profit and impact to win in the African market.

The African capital market has largely been dominated by traditional financing regimes, driven by offtakes, contracts, which makes letters of credit, credit lines, invoice discounting as a part of factoring whether reverse or otherwise an ideal structured finance for most firms, some of which have demonstrable financial history in audited or management accounts, information memorandum, good corporate governance, an asset base to meet KYC requirements among others.

Private equity and venture capital in the startup market is growing, traditional VC’s have focused on very traditional sectors with some history or knowledge of the market. African startups today are unconventional, pioneering models alien to the African ecosystem and tech inspired, the rules of traditional financing may not apply.

The Myth around financing “ready businesses” will change if the myth around the two types of businesses is understood. Companies with liabilities, companies without liabilities will still demand capital injection. Worthy of note, not every liability is bad business, and not all assets are good assets. But could Africa’s HNI’s see the “sale of potential” than historical/projected performance with an appreciable return on equity, at variance to a phenomenon of African startups as a measure of an industry that is growing and attracting increased capital.

Will an African Unicorn change the narrative? Will foreign dominated African partnered firms deplete the needed capital for traditional startups yet to find their feet? Will the regulatory bottlenecks continue to stifle capital growth? Without understanding Investment Readiness and its importance to a growing startup ecosystem, many startups risk looking flashy with high operational costs funded by Directors of the business and loans than focusing on the core business of sales, organic or otherwise.

The African market and its complexities have made a “fund of funds” for deal sizes between $100,000 to $15m nearly impractical. The race to close African grown fund rounds with greater local participation will be determined by the investment thesis such funds develop, potential of pipelines, training, risk mitigation factors from a purely market oriented approach, corporate governance, sector specific funds, management and boards.

Africa’s incubators and accelerators may offer the needed support to improve the quality of ideas by startups needed to close deals, however, like the funds that are actively raising capital to invest, these hubs and accelerators need capital to fund their activities whether in providing co-working spaces or training.

Question is, will the success of the capital raise be determined by the startups incubated, offered space or accelerated or the intent to support will be enough. Either way, without a viable investment thesis and an improvement in the quality of ideas, an evolution of business models that combine traditional and western type models and greater participation by local High net worth individuals, Africa’s startups will continue to chase foreign funds, while foreign funds raise capital to fund our very own startups most of which with a foreign partner makes the capital raise easier and shorter.

About the author:

John Armah is the C.E.O of Orios Group, Board Chairman of Junior Achievement Ghana, and the Chairman of the JA Africa Board Chairs Council, a global non-profit organization committed to promoting entrepreneurship development around the world. He is a Business Development Practitioner with vast experience in the development of start-ups, MSME’s and business strategy. A consultant, Trainer and adviser in business start-ups development, business financing, business development.

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