What do local VCs really want?
There is a misconception that it is near impossible to raise early stage venture capital locally largely because ‘investors’ are all talk AND their information requirements/terms are unreasonable.
Whilst this may be true in many cases, the few that do not fit this pattern attract the right founding teams.
Let us face it, there is a fundamental difference between venture capital and say angels, family & friends or not-for-profit/family office funds. You should understand the objectives of each source of capital before any approach. Suffice to say that globally, venture capital is for businesses with the capacity to scale and return a profit in a 5–8-year time frame. This often assumes that the business models of the companies have been tested and all that is required now is the ‘jet fuel’ to go into orbit.
With this premise, it is important to point out what local VC’s want from prospective investee companies to part with their cash? Having looked at several deals with CcHUB Growth Capital in the past year, walk with me as I show you.
1. What problem are you solving? As an asset class, VCs are optimizing for the medium to long term hence the problem has to be BIG enough to generate attractive returns over that period. In our clime, the opportunities are immense to build platforms that can grow large enough to be monopolies/command a large market share. We are starting from a very low base so technology enabled businesses have the potential to win (that’s not to say exponential technologies shouldn’t be explored)
2. Is your business investment ready? If your team has not validated the market & received important feedback from users/customers on how they will use your product, perhaps you are not ready. What do I mean? What experiments did you carry out and what did you find? Your ability to communicate this in a clear and concise way that shows market potential, team capability and perfect timing is key to getting the cheque. In essence, have a Minimum Viable Product & prove that you have figured out the business model from your Proof of Concept. Still trying to figure out what your users want? Perhaps not the time for VC money
3. What Investment Structure should i accept? As a VC, whilst our job is to optimize for a strong upside, it is important to protect against potential risks or downsides. Over optimization for downsides probably means the deal is not worth doing in the first place. But common terms like Preference shares, liquidation, redemption, minority investor rights are not uncommon. Rather than flatly reject such terms, seek to understand the position of the VC and then negotiate accordingly. In any case, use a lawyer familiar with such deals to get the best possible scenario. Yes, we are seeing more structures like Convertible debt, S.A.F.Es etc. but these are not the only ways to enter into a deal.
4. What is your business worth? Now the ELEPHANT in the room. I have witnessed a lot of back and forth & failed deals on account of inability to reconcile the risk profile of the business in form of valuation. As a founding team, your job is the reduce the risk associated with the business i.e. market, customer, product, revenue as much as possible in order to command a higher valuation.
Without this, there will continue to be wild ranges of value and it will leave lots of deals undone to the detriment of both sides. The other issue is the perception that founders at an early stage want to play a valuation game, forgetting that funding rounds are tied to milestones. Once milestones are not met, it often forces a down round to the detriment of mostly the founder(s). Higher valuations from a founder’s perspective are not always a good thing.
5. How will the VC make money from an investment? In the end, the investment is with a future expectation of strong returns (to return to our Limited Partners — LPs). So, any decision to invest is hinged on a strong upside from the company over the life of the investment based on due diligence and market potential. If you cannot help the VC see how an investment will help them smile to the bank, perhaps you do not need their money.
6. How will your business be governed going forward? A critical part of the business that MOST founders do not pay attention to. The perception is still about the company being theirs with absolute control post VC money. In that case why seek external funding? A local VC is looking for signs of a team keen to implement strong corporate governance principles for their business. It’s an important part of the negotiation process. We are constantly trying to determine the founding team’s propensity to apply strong governance process into the business. Board of Directors composition with Independent members (with core expertise & not investors), accountability (monthly and quarterly financial records), the budget process (including approvals for thresholds above the approved budget) etc. Once a team balks at such terms, it most definitely scares a local VC away.
7. How have you kept your books? A local VC is looking to see how the company has been run from a financial standpoint. Have records been properly kept? Is the company conscious of its financial position? Are the financial books kept and in order? Any conversation around valuation usually stems from this so it’s critical that the right things have been done from Day 0, which includes any previous monies raised or expended on the business.
In my opinion, the ideal founding team for a local VC at seed stage is one that has proven that the product meets the need of its target audience — proven traction i.e. revenue, users and has a strong view on how unit economics will be achieved. Whilst still trying to gain traction or understand user needs, other types of funding can suffice. This may prevent a clash of objectives and the perception that VCs force companies to scale too quickly if/when product market fit has not been attained.
Where does all this leave founding teams still in their very early stages? Well, this requires a more active angel investing community e.g. African Business Angel Network which would be better aligned to meeting their cash and risk profiles.
Is your team ready for a local VC? We’d be happy to talk with you at Growth Capital. See more here: www.gc.fund/apply
