What Venture Capital investors look for in investment opportunities

With banks increasingly risk averse especially when it comes to financing the business plans of entrepreneurs and small firms, both individuals and businesses alike are turning to business angels and venture capital firms to provide the business finance for their new or growing businesses. But of course these funding options with all its benefits of both finance and experience being pumped into the business may not always be easy to find and you need to be sure that you are an attractive option for them to consider.

In a recent article on his blog on , Brett Commaille analysed why Venture capitalists and entrepreneurs often don’t see eye-to-eye, and in South Africa in particular, there seems to be a very real gap in meeting the needs and expectations of both parties.

While we know the path of the entrepreneur can be a frightfully fun but rocky one, at some stage venture capital becomes a real option to consider, and when you get to that stage, make sure you know exactly what we are looking for.

As funders, we really look for four basic things and your pitch must answer the following:

1. What is the burning need you are taking away? Is it a widespread problem and thus a big market?

2. What is your solution or product? What are the competing solutions, your differentiators and the barriers to entry for a new competitor?

3. How does it make money? You need to know this upfront, what is your realistic plan to monetise?

While you present these 3 points, we are evaluating the 4th aspect which ties all 3 together and is the key to the success or failure of the proposed business:

4. The entrepreneur. Do you have a realistic actionable plan, and who is the team that will assist you to implement it?

What you need to do to greatly improve your chances of success:

Get an introduction – a recommendation from a businessman the funder knows gets the needed attention and improves your chances of making it through the first round of discussions.

Check the funder’s criteria (usually on their website) – make sure your are pitching something that the funder is looking for.

Make sure your demo works - getting this wrong wastes time and puts you on the back foot.

Talk of your past successes – especially how you made money for your previous shareholders.

Keep to a few slides - there will be questions and interruptions; you need to get your concept across in minimal slides.

Have an actionable business plan.

Be real – be honest and straightforward.

Identify the risks – don’t ignore or brush aside the risks; clearly identify each major risk and how you plan to deal with them.

Know your industry metrics.

Focus – don’t try to sell a hundred solutions, what is your core solution/product?

Avoid these common pitfalls

“These projections are conservative”.

This statement is meaningless – projections are always estimates. Rather give specific steps of how you wish to achieve specific targets.

“A ‘Famous Expert/Big Consultancy’ says the market will be worth $50bn in 2 years”.

Also a meaningless statement.

“All we have to do is get 2% of the market”. 

Rather show specific steps to reach specific target customers.

“No one else is doing what we are doing”. 

This is a problem if it is true (there may be no market) and a problem if it isn’t (you are demonstrating naivety with regard to defining competition)

“The giant is too big or slow to be a threat”.

Never write-off the existing dominant player.

“It will take them years to copy”. 

Once you’ve proved it can be done, copying it is far easier than you think.

“Several VC firms are interested”.

Markets are too small to try this ploy. Negotiate honestly.

Never take advice without testing it.

Never argue – it’s pointless.

Avoid jargon – you risk losing your audience.

Finally, remember the following:

While a strong business model is essential

The key element is you

Be passionate and enthusiastic, and make us believe you can deliver on your plan

South African VC Numbers Increasing

From an entrepreneurial perspective, few things are more refreshing than to hear of the increasing amount of venture capital deals investing in business plans in South Africa in recent months. With a large amount of business investors already being active in the country entrepreneurs looking to fund their business plans will take heart from the fact that despite the slow down in bank lending VC's are filling the gap.

Following a a recent article in http://www.fm.co.za The global recession is probably the best thing that could have happened to the local venture capital sector. Under pressure to rebuild their portfolios, global funders and wealthy locals are now redirecting money towards the sector as an alternative investment that promises higher yields.

The global recession wiped out millions from individual portfolios and the number of dollar millionaires fell by more than 11%, according to the 2010 Knight Frank Wealth Report. With trading conditions in global markets still uneasy, overseas funders are now willing to take on more risk for bigger rewards and are investing in businesses that can demonstrate growth.

PoweredbyVC, a fund manager that manage s Internet billionaire Mark Shuttleworth’s HBD Venture Capital, is in negotiations with several foreign funders to provide venture capital for business start- ups. Its executive director, Keet van Zyl, declines to name them.

Venture capital is seen as risky because investors don’t know who they’re taking a gamble on, and they have to wait at least five years to get returns. The yields, however, are generally better than those gleaned on the general market, which has been patchy since the financial crisis. Investors can expect a minimum annual return of 20% from a venture capital fund. By comparison the R157 bond had a yield of 14,6% for the year, in a favourable bond market.

SA Venture Capital & Private Equity Association (Savca) executive head JP Fourie says a move into riskier investments in uncertain times is not unusual. As the economy contracts, investors start looking for alternative investments because traditional portfolios are underperforming. A soft economy also plays some role in driving innovation. “Investment patterns regarding venture capital appears to be contra cyclical,” Fourie says — when the market is down, you buy and when the market is up, you sell.

With funders lining up — for example, an individual who wants to invest up to R20m in start-ups — the venture capital industry should add to the momentum it has steadily been building since the 2001 dot-com crash.

There are now 10 venture capital funds — up from five a few years ago — which have invested R2,6bn over the past 10 years. A Savca report, to be released at month-end, has found that the 33 funds surveyed had completed 251 venture capital transactions between 2000 and July 2010, of which about a third were concluded in 2008 . Some of the funds surveyed don’t exist anymore, and some are run by large corporations that are not members of Savca.

Ploughing money into venture capital funds requires bravery and patience, however. Such a fund puts together a portfolio of about 10 start-up businesses, which might fail or plod along over five to 10 years. The one or two companies that do perform exceptionally are either sold or listed. This is when the investor gets a return.

The local venture capital industry’s return on investment has yet to be established, because investors have not exited their investments. But that could change soon . PoweredbyVC is looking to exit two . Its portfolio includes the highly rated mobile payment provider Fundamo and Internet marketing group Clicks2Customers. Fundamo CEO Hannes van Rensburg declines to comment on whether his company is for sale.

Wealthy individuals are not being scared away by the long periods it takes for a fund to exit an investment. Over the past year PoweredbyVC has been approached by at least 30 people willing to invest R1m and more in new ventures.

These investors also take a hands-on approach . Many are retired executives and business owners with some free time who come in as consultants to the new ventures .

Demand by these wealthy people has been so huge, PoweredbyVC will be launching an “angel” investment fund to support businesses in the early stage of development.

But those with funding proposals should not think the new wave of local funders will be sugar daddies who can easily be tapped for cash. “It’s not an angel lottery. They are quite savvy,” says Van Zyl. He says that in addition to the growth in funders, there has also been a spurt in funding proposals.

But the increase in proposals does not necessarily mean more ideas will be taken up, because there is often a lack of experience when it comes to turning the concepts into products. Van Zyl cites the example of a 26-year-old “who had a fantastic [concept] but no idea how to commercialise it”.

Cape Town and Stellenbosch, in particular, have become home to many of these new funds. Hasso Plattner Ventures Africa was established two years ago, 4Di Capital was set up with funding from Johann Rupert a year ago and Invenfin was spun out of Remgro, also a Rupert group. The Savca survey found that Cape Town received more venture capital money than Johannesburg or Pretoria. Other funds, like HBD and Bioventures, have been going for even longer.

The Cape does not have a monopoly on venture capital funds, though. The Industrial Development Corp has set up its own fund, and it and Triumph Venture Capital are based in Johannesburg.

The optimism in the sector is palpable. “If I were a highly qualified person in banking and finance, I would be here [in venture capital],” says 4Di Capital CEO Justin Stanford.

The sector might be back in vogue, but it has been criticised for not embracing riskier ventures because the people managing these funds came from a banking or an accounting background and do not fully grasp what it takes to start a business. Van Zyl admits there is some truth to this. “You can see that by the lack of failure. Investments are doing fairly well, or just surviving.” By comparison, about half of all venture capital projects in the US fail.

But having a background in banking or accounting does not necessarily make a fund manager overcautious. “I left banking because I got tired of saying no to good deals,” says Invenfin CEO Brett Commaille.

Though the sector is blossoming, the old bugbear of exchange controls hangs over it . Shuttleworth has long crusaded for exchange controls to be relaxed, and recently asked for a judicial review on the constitutionality of their mechanisms . Shuttleworth, who made US$575m selling his company Thawte to US firm VeriSign, argues that the controls burden entrepreneurs who want to expand abroad because there seems to be a “random process” at the Reserve Bank for allowing money out of the country. Shuttleworth emigrated to the UK in 2001, and says living there gives him the flexibility to move small amounts of money around the world.

Fourie also says exchange controls are a problem, as they prohibit the existence of a “loop structure”, preventing South Africans from having holdings in a foreign entity that in turn has a holding in SA. This makes it difficult for small companies that are rapidly expanding globally to transfer cash. Some local business owners have sold their holdings prematurely as a result.