#StartupFunding101: Capital funding and the fund raising basics

A company that is at an early stage and growing quickly may find it hard to pay back debt in the early stages of growth as cash is reinvested back into the business rather than debt holders - think of this stage like feeding a growing child.

Equity is more suited in this instance as it enables the investor to share the risk of this growth instead of prioritising cash flows too early which can hamper growth and value. Often at the early stages of growth, hybrid debt-equity instruments are used, rather than pure equity. These include SAFES and Convertible Notes.

Although debt allows for less equity dilution of a founder, the dilution in equity and control should be compensated by the value of having a strategic equity investor on board to share the risk in growing the business.

The value is in having a small slice of something big and shared (which is ultimately what a stock is) rather than a big slice of something small. Historically innovative ideas need large amounts of patient capital to reach their potential, for instance imagine if Apple hadn’t had patient enough investors to back them?

Are there any drawbacks to sourcing capital through these routes?

There will always be a tradeoff. In debt and equity, the main tradeoff is between control and growth. With debt, one does not give up equity/control but there is a requirement to pay back the capital plus interest in a certain timeframe.

With equity, the tradeoff for dilution in shareholding and control is funding and/or strategic partners for growth. This type of funding is best suited for high growth startups whereby the growth offsets the loss of dilution and control.

Where would a first-time business owner start?

A first-time business owner should first understand the needs of the business and then work out the best source of funding - not the other way around. Speak to people and mentors already in this sector. It is critical to work with capital providers you trust. This is a long-term partnership – building your business will have ups and downs, and you want a patient, supportive partner to back you when the going gets tough.

As a rule of thumb, debt will always be cheaper but not necessarily in a high growth, asset light businesses.

It is always best to start with immediate stakeholders who understand the businesses and its vision/potential - this means an easier conversation when it comes to pricing for risk.

Let potential funders get to know and trust you, people invest in what they know and trust.

Engaging customers and suppliers are often a great source of capital. Crowdfunding is also a popular source as well as bank loans, grants. Be specific and niche in terms of the capital pools identified. There are also a host of accelerators which give a route to funding and offer soft capital and support. Grant funding is also abundant especially in the impact space.

Are there any specific criteria to access capital funding?

Depending on the stage and quantum of funding, capital providers will want some level of comfort around money they invest and they are often in fiduciary positions.

Accountability, reputation and trust are key.

Each funder will have a specific mandate with subsequent criteria attached, it is important to get to know what these are. As a rule of thumb, a capital provider will want to be able to assess the risks and return so criteria which give comfort around this is key. Track record, pre or post revenue status, team dynamics, competition, traction, cash flow are all factors that will come into play.

There is a debate in venture capital circles whether one backs the jockey or horse. The reality is that businesses are all about people. People invest in people, ultimately.

What is something that someone starting a business needs to know, but doesn't?

The success rate of startups is very low. Be very clear about why you are starting a business.

Success requires 100% commitment and passion to an extent of crazy, it is not going to be easy - one needs more than a good idea to succeed.

Networks are everything, especially ones you can trust. Always be open to listen to what the person next to you, or a mentor has to say and offer - the ability to listen and pay attention are your best resources.

What happens after capital funding is secured?

If funding has been obtained correctly there should be a plan and strategy with how the funds are to be used. Making sure that the money is invested in an efficient way and communicating this to investors is key to ensuring the relationship is nurtured. Capital efficiency is absolutely critical.

Return on equity is the most important metric a founder needs to know and this is what an equity investor will most likely focus on. Communication is important, funding comes with responsibility and your stakeholders need to be managed accordingly as they will be your supporters in times of need and opportunity.

What is the best advice you can give to anyone starting a business?

Find your passion and follow that, build a network and tell people about your ideas. People want to help, if they don’t know how to, they can’t.

Be clear about what your ask is, the clearer you are the easier it is for people to help.

Develop humility quickly, being able to iterate and fail fast forward is critical, in businesses and life nothing is personal, everything is just feedback. It is important to separate a business from personal life even if the two can seem inextricably intertwined.

Work with great partners and focus on building the right team. Building a business is a marathon (even if it can feel like a sprint!), building resilience and a strong foundations are going to stand you in good stead.

Do you see any trends in the funding of startups?

There has been an increase in funding flowing to startups with accelerators and angel investors. Liquidity is finding its way to the entrepreneurial communities especially if one looks at dual focus funds of both impact and profit.

Grant funding with an ESG focus is abundant. The drawback is often that it is one off whereas most businesses need continuous support.

Funding is also starting to come from successful entrepreneurs reinvesting back into the ecosystem.

In South Africa, there has traditionally been a gap at growth stage funding rounds (Series B+), so start your fundraising journey early and work with ecosystem partners like Endeavor if you intend to dominate your market or scale globally.