S1E6: What Do Entrepreneurs Consider When Seeking Venture Capital?

Katlego [00:12]: Raising money is hard and it's meant to be hard. As a starting position, everyone needs to accept that.Justin [00:17]: That's Katlego Maphai, co-founder and CEO of Yoco, the South African based fintech company. Katlego and his counterparts know a thing or two about fundraising and venture - the company has raised over $23 million in funding, including a $16 million Series B one year ago. In this episode of The Flip, the first of a three-part series on venture capital in Africa, we talk to entrepreneurs about their experience fundraising. But to start, I want to address Katlego's comment - that raising money is hard and it's meant to be hard. I have no doubt that that's true, particularly on the continent. But I think, as a starting point, we should instead start by asking why are you fundraising?VO [01:09]: You're listening to The Flip, the podcast exploring more contextually relevant stories from entrepreneurs around Africa.Justin [01:19]: Welcome back to The Flip - I'm your host Justin Norman. There's a big buzz topic on the continent, or at least in South Africa, the topic of investment readiness. Candidly, I don't like this topic. Of course, it's important that entrepreneurs are investment ready and the proverbial we should help entrepreneurs get there. But I think the term investment readiness presumes that you should be raising money. That it's just something you're supposed to do as an entrepreneur; that it's a requisite part of the journey of starting a business. But as I said, I think we should start from the position of asking, should we be raising money? And the answer isn't binary - it isn't should or should we not raise money? But rather, should we raise money right now? Do we need to - and if so, for what purpose?

While VC funding is meant to serve a strategic purpose, it's important at the onset to understand the implications of taking outside investment.

Keith [02:11]: When you take on VC money, it creates a binary outcome for you as the entrepreneur.

Justin [02:16]: That's Keith Davies, ex-CFO and partner of the South African fintech company Zoona, who we heard from in episode 4.

Keith [02:23]: A lot of people think there's grey in this VC path, but unfortunately there is just isn't. You either grow or you die.

Justin [02:30]: This binary outcome is a function of the VC model, in which venture capitalists and their funders make most of their money when a fund exits an investment. And given the risk involved with early-stage investing, and the small percentage of startups who make it, it means that often the expectation of a VC is that the startups who do make it will have to make it big in order to make back the return expectations for the fund.

Keith [02:52]: So there's a huge incentive for the VCs to drive the companies to either shoot the lights out and make that really really big return that they need, or almost die quickly so that there's no longer any focus left on them. Once you understand the economics of VCs, it quickly becomes clear the binary outcome. The obvious implication here is as an entrepreneur once you understand that, are you comfortable with that?

Justin [03:19]: Grow or die. Are you OK with that? Luke Dominique Warner, founder of Intergreatme, he wasn't.

Luke [03:26]: Intergreatme is an identity management platform for your personal information. The purpose for me was, I was really frustrated with having to fill out lots of forms and having to provide documentation. So there was this view of, can't I make a master customer index for myself so I can keep everything on a dropbox and if you ask me for stuff I say bam there it is.

Justin [03:42]: Intergreatme has huge implications for financial services and telecommunications companies who are subject to Know Your Customer laws and have to keep up to date records on their customers. But Integreatme's core belief is that they're providing a better experience for customers and users, who have to fill out the same forms over and over again. It raised an interesting philosophical question for Luke and his team - how do they service corporates, who are their initial paying customers, while also ensuring that their company is positioned in a such a way that they are able to make their service available far and wide to users, like Luke, who are fed up with filling out forms? And this question had fundraising implications for the company

Luke [04:20]: We got lots of term sheets from VCs and private equity companies but they are looking for a 10x mandate and you can very easily get a 10x return by signing one large corporate, white labeling, executing for 3 years and saying there's my payout. And if those are your investors, that's what's driving your board decisions and your management decisions or you get fired.

Justin [04:37]: But Luke realized that if they want to provide Intergreatme as more than a white-labeled service to corporates, they had to be diligent with the type of money they were taking in, bearing in mind the incentives of the investors who would be involved in the strategic decisionmaking process of the company.

Luke [04:51]: We had to do a bunch of these deals to sustain cash flow and attract investment, but it never satisfied our core requirement of having an Integreatme brand. You Uber somewhere, you Airbnb, you google something, you should Intergreatme. If somebody asks you to fill out forms, you say Intergreatme. We weren't getting the public good. You get a fancy digital process with a bank or with a telco or with an insurance company and it'd be like cool this digital process is now two minutes instead of an hour, but you weren't able to reuse it in multiple vendors.

Justin [05:23]: So Intergreatme decided to go an alternative route - crowdfunding. And while crowdfunding is a whole other conversation for another episode, their experience is an illustration of one of the main reasons why startups choose to raise money - or in Integreatme's case - not raise money from a VC. Strategic investors - whose experience and relationships can have an outsize impact on the company beyond just the financial implications of their investment. And the strategic purpose of seeking out investors, who can provide value far beyond the money they invest, has considerable implications for how startups are soliciting investment, and from whom. For many on the continent, it's an important balance between local investors with local know-how, and foreign investors with expansion and scaling experience. And attracting local business leaders and high net worth individuals to participate in early-stage investment is a key initiative for several organizations whose goal it is to grow the investment ecosystem.

Eva [06:15]: One of our key drivers as EAVCA is to promote local angels.

Justin [06:21]: That's Eva Warigia, Executive Director of the East African Private Equity and Venture Capital Association.

Eva [06:27]: In as much as we try to attract international capital at the end of the day, for startups it would help to have a person who resonates and appreciates some of the dynamics of doing business in the region to take that initial support and they can then be able to help them, mentor them in curating their business in a way that appeals to the next level of capital.

Justin [06:52]: The importance of working with local investors with local expertise and relationships, is something echoed by Ben White, the co-founder and CEO of VC4A.

Ben [07:00]: Individuals within the business community they understand the landscape, understand the dynamics, the challenges, the opportunities, they're engaging the pipeline of talent early, they're able to identify the teams that have the potential and they can do a lot in terms of helping them formalize their structures, improve their governance, develop strong management practices.

Justin [07:28]: And then, as these companies start to scale and expand, it's incumbent upon them to solicit investment from a different set of investors, with different experiences.

Eva [07:37]: Tech scaling is more advanced in western markets so if you're an investor investing in similar businesses on the continent you have operational skills we could tap into.

Justin [07:49]: And in connecting foreign investors to local startups and opportunities, this is where the work of organizations like EAVCA and VC4A shows dividends.

Ben [07:58]: And as those teams start to develop traction and they seek to expand into new markets or they seek additional capital to fuel their growth, there's a platform that allows investors from outside that market to participate.

Justin [08:27]: The local versus foreign investor consideration has been the experience of a variety of startups across the continent. Here's Onyeka Akumah with Farmcrowdy, who we heard from in episode 1.

Onyeka [08:37]: We want money and we want people who are able to create value beyond money. What my own investors do is, they will find angel investors that are local that are part of the deal that will provide local expertise, they will provide ground relevance, relevant introductions - while they do their own thing. They maybe help with the business structure, they help with funding, they help with PR.

Justin [08:58]: And investors can help with other investors, as well.

Onyeka [09:01]: For us, our first investor was a top HNI in Nigeria and he became a member of the board and so all of our investors who have come from outside of the country if they want to get feedback they talk with him directly and they're able to get their feedback from the local perspective.

Justin [09:17]: We heard just a minute ago from Ben White that startups may seek additional capital to fuel their growth, and apart from strategic investors, another reason why startups take VC money is to do exactly that - to take advantage of a specific growth or market opportunity that requires additional capital. The money is not indiscriminate, it's strategic in that it's for a defined and specific purpose.

Keith [09:37]: If a wonderful opportunity comes along your path that you need to take advantage of immediately and the best path of doing that is to raise capital, that's a great place to be.

Justin [09:46]: That's Keith Davies again.

Keith [09:48]: And that's where you want to be is to be able to take that money to take advantage of an opportunity.

Justin [09:53]: Opportunity to scale, opportunity to expand into a new market, opportunity to hire more employees to fuel growth. There are a myriad of opportunities worth capturing that require funding.

Luke [10:03]: For 100,000 bucks this is what I was able to do. For 5 million bucks this is what I was able to do. You need to be able to show that you're not just giving me this money and I'm going to experiment.

Justin [10:12]: That's Luke with Intergreatme again.

Luke [10:14]: I'm not just taking the money from the crowd and saying I'm gonna go play, there's a proper plan, there's a proper financial model, there's proper traction, there's proper contracts.

Justin [10:21]: Whether raising money through crowdfunding, angel investing or through commercial VCs, they're raising money with intent and purpose.

If money is raised for strategic purposes, it means then that the process of fundraising and soliciting investment should be equally strategic. And while there's money available, as we've argued, it's not merely about money, but often about who can provide strategic value beyond money. And the list of investors who can provide that strategic value in these markets, and similarly, who are interested in investing in these markets and this asset class in the first place, that list of investors is narrow.

Salami [10:58]: That process of finding and working with investors has to be extremely delicate.

Justin [11:03]: That's Abolore Salami, the CEO of Riby, who we also heard from in episode 4.

Salami [11:08]: It's not a shotgun approach, it's a silver bullet approach where you need to carefully sort out the kind of investors that are interested in what you're doing.

Justin [11:17]: For Riby, their targeted focus was on investors who are also interested in solving similar problems in the fintech space.

Salami [11:23]: They all had a direct understanding or a direct connection with the problem we are trying to solve.

Justin [11:30]: But others target investors, who more broadly, are focused on emerging markets.

Keith [11:35]: A question we would come to quite quickly would be - do you invest in emerging markets, and specifically Africa?

Justin [11:41]: That's Keith once again. Zoona had interest from your typical Silicon Valley investor, but they found ultimately that a lack of understanding of the market from an investor standpoint was a step too far out of the comfort zone for these investors.

Keith [11:53]: From an investor's perspective, if they don't understand something, it introduces a lot of risk into the process. There was certainly an education process and for some funds that was just a step too far. We did go and pitch to a variety of established market investors, SIiicon Valley-type investors, who I think were very excited by the underlying economics of what we were doing, and also the kind of customers that we were dealing with. But just getting them to invest and actually put their money in was a step too far.

Justin [12:20]: Just as entrepreneurs are looking for strategic investors, investors are looking for investments in which they can also add value -

Keith [12:26]: It was so far removed from what they were used to, their ability to, first of all, understand the risks involved in the deal was difficult, but second of all I think their ability to help the company. I think for a lot of those funds they didn't feel like they'd be able to add a lot of value in this environment because it was so foreign them.

Justin [12:48]: At the end of the day, these selection criteria have a few aims. One is making sure you're getting in bed with people who share a similar vision and strategy as the business, as Luke discussed earlier. But equally, focusing narrowly is an exercise in deliberateness, in an effort to not waste any time. And this has implications on raising locally vs. abroad. In Keith's experience, pitching the wrong foreign investors can slow down the process.

Keith [13:12]: There were a lot of funds we approached where we did feel like there was a lot of education in the process, which pushes our timelines.

Justin [13:19]: And in Onyeka's experience, pitching the wrong local investors can slow down the process too.

Onyeka [13:24]: I struggled with finding deep-pocket investors in Africa that were ready to take the risk on a new venture like ours.

Justin [13:31]: And their risk tolerance is presumably a function of smaller fund sizes when compared to foreign funds.

Onyeka [13:36]: Two was, I struggled to find local investors that were impact-driven that had the kind of ticket size that made sense for us to bring them on board. Today now we're looking at scaling, and I'm not talking to any local investors at the moment - because I also don't want to waste time.

Justin [13:53]: Focusing on the right investor may reduce the time spent fundraising, as does focusing on the experienced investor.

Onyeka [14:00]: The ecosystem in Africa is still very new. The entrepreneur in Africa is not as experienced and exposed as you have in the US, that also affects the investor in Africa is not as experienced and exposed as what you have in the US and Europe.

Justin [14:13]: This is something echoed by Yoco's Marcello Schermer, who we heard from in episode 3.

Marcello [14:18]: What we often don't acknowledge is that in this African startup ecosystem, essentially everyone is doing everything for the first time - first time founders, first time investors, corporates working with startups for the first time.

Justin [14:33]: And when doing things for the first time...

Marcello [14:35]: If you look at how long it takes companies here to raise money it's much longer. One of course because the DD process is different, but also because everybody is doing it for the first time. Documents, legal agreements are not written up because nobody has done them before.

Justin [14:48]: The final implication is this -

Keith [14:50]: Make no mistake, raising capital takes up a lot of time and will distract your business for that time. You're going to have very important people within your business looking completely elsewhere for a period of anywhere from 12 to 24 months raising capital.

Justin [15:12]: So the question becomes - what do you need? If your business needs money, go out and get it - but be explicit about why you're fundraising and from whom you're fundraising. Finding that blend of investors, both local and foreign, to serve specific purposes is critically important - and that's what my b-mic Sayo and I spoke about, especially in his experience raising money for his startup, the South African home services marketplace Kandua.

Sayo [15:36]: I learned some stuff.

Justin [15:37]: What did you learn?

Sayo [15:39]: I think the stuff about international investors was interesting - that's probably where I have the least experience.

Justin [15:45]: Well you were talking very much about your focus is local because they provide a strategic purpose from a strategic connections perspective.

Sayo [15:55]: The biggest challenge for my business would be acquisition - customer acquisition - and I felt that local and strategic investors were the best ways to plug or help on that side of things. But for some people the biggest challenge is you might be in a more competitive environment, customer acquisition might be easier and it's just a matter of putting the numbers behind what you do and building your widget. In which case you need lots of money. You might have an expensive distribution channel. You might have a very high cost per acquisition strategy to get to scale - like your model might be super dependent on getting to a level of scale that then starts to pay you back and you need to put a lot of money upfront. That's maybe where you may be looking for international investors because you need to raise a lot of money and you need to get a decent valuation.

Justin [16:46]: I think a key caveat - so Katlego at Yoco was like, know your stage, know the stage of your business and know the stage of your ecosystem and that informs your decisions. And so for you - it's know the stage of your business, which guides your decision to raise locally versus internationally - I think really what we're trying to say is every business is different, every businesses needs are different, and there's a variety of options and I hope that we can position this conversation to say depending on the business, depending on your needs, you can set it up in a variety of different ways to fit those needs.

Sayo [17:21]: So you said you wanted to make people aware of the implications of raising VC money - so one of those implications was grow or die, which I think is kind of fair. And the second one was it takes a long time - and it's like a whole job role. It's extremely distracting. And I think that's something in my experience I didn't quite realize how distracting it was.

Justin [17:44]: You said that you spend the most time fundraising.

Sayo [17:47]: Yeah, and things around fundraising.

Justin [17:50]: Yeah.

Sayo [17:51]: And what did you think of the idea of needing VC. I thought that was interesting - you took a stand on that.

Justin [17:58]: Yeah I think Keith's whole thing - he is a big believer in grant-funded models and he's actually bootstrapping his new business right now. I think it's interesting because I really do like this conversation around investor readiness - this idea that investor readiness purports that seeking investment is just a thing that you do in the process. So it's a nice thing to say like - it's not a thing that you have to do, just because everyone else is doing it and just because we've lionized people who raise money. If you don't need to do it, don't do it. And it's important because I don't know that that many people - it really does feel like the amount that we talk, in the media especially, just says such and such company raised this amount of money. It's just purporting that this is the thing that you do. And it's important to get alternative viewpoints because you're never going to see an article that said this company bootstrapped their business.

Sayo [18:49]: It's fascinating right - there's a whole press release thing about raising money.

Justin [18:55]: Maybe we should write a press release that says - we bootstrapped this podcast.

Sayo [18:58]: Yeah, that's cool I think that'd be a fun thing to do as well in terms of promo.

Justin [19:03]: No one's going to pick that up though.

Sayo [19:05]: Maybe, who knows?

VO [19:11]: Thanks listening to this episode of The Flip. You can subscribe on your favorite podcast app and follow us on social media @theflipafrica. You can also join our newsletter by going on our website theflip.africa. Tweet us, DM us, email us. We'd love to hear your feedback on the show. We'll see you next time.