Guide to Venture Capital Funding in South Africa

If you are looking for money to start a business or money to grow your existing business, there are a number of different types of lenders who provide finance to entrepreneurs, these include angel investors, banks, debt financiers, niche lenders, personal lenders and venture capital (VC) funding.

While venture capital funding in South Africa is a little-known financing option, it is an essential source of funding that gives entrepreneurs access to capital markets.

South Africa still has a small formal start-up scene and an emerging VC industry. The majority of start-ups are self-funded with only a small minority of entrepreneurs having been funded by angel investors or development finance institutions (DFIs).

According to an FM Magazine article, some of the reasons for the low uptake of VC funding among entrepreneurs are “fear of losing ownership of the business, relatively high regulatory costs, and inexperience with capital markets”.

The industry is, however, showing growth with an influx of capital coming from local and international investors. South Africa has an estimated 202 venture capital funds.  Some of the notable ones are Naspers, an early and growth-stage venture capital investment firm that invests globally; Cape Town-based Knife Capital which focuses on technology-enabled ventures; and 4Di Capital, a seed and early-stage focused venture capital firm.

In 2021, South African start-ups attracted more than $800-million. The majority of local investments are still mainly in the Gauteng and Western Cape region.

From a sector perspective, fintechs continue to attract the lion’s share of venture capitalist funding in South Africa. The most notable deals made last year were all in the sub-sector. Digital bank TymeBank secured US$180 million Series B round and Africa’s largest digital payments network, MFS Africa, secured US$100 million Series C, led by AfricInvest.

Also in the top three is Yoco, the payments and software start-up, which had one of the biggest deals of the year. They raised US$83 million in a Series C round. This is the single largest investment to have been raised by a South Africa-based payments company. Investors in the round include Dragoneer Investment Group, Breyer Capital, HOF Capital, The Raba Partnership, 4DX Ventures, and TO Ventures. In 2017, Yoco raised an undisclosed sum from US-based Quona Capital and Velocity Capital of the Netherlands. To date, they have raised a total of $107 million.

Venture Capital (VC) is financing that investors provide to businesses in the start-up and early growth phases, that they believe have high growth potential. VCs invest money, and technical, or managerial expertise in exchange for minority equity ownership.

The investment can be used for product development, beta testing, hiring the right talent or getting their product to the market as soon as possible. It can also be used to expand into a new market or to accelerate user acquisition.

Investors in a VC fund earn a return (or profit) when a portfolio company exits (converts investment in the company into cash), either through an IPO, merger, or acquisition.

This investment model is not for every business, cautions Keet van Zyl from Knife Capital, an VC firm, in the article, “Playbook For Raising Venture Capital Funding In South Africa”.

“Venture Capital should not be the go-to funding choice for everyone starting a business. A start-up is a high-growth potential company in search of a repeatable and scalable business model.

“Once it gets product/market fit and some traction through the scale-up phase it turns into a so-called ‘Gazelle’ — an extremely fast-growing company [not measured off a low base], which maintains consistent expansion of revenue, employment and/or profit metrics over a prolonged period of time.

“If your business model does not fit within the spectrum of these definitions it is not VC backable and other funding mechanisms may be more appropriate.”

VC deals typically start with an introduction to an investor and a pitch explaining the company’s purpose and why your business is worth investing in.

There are a number of ways that entrepreneurs connect with VCs, mainly through start-up and VC events or other industry events. Most VC deals, however, originate from leads from within the VCs wider trusted networks.

It is the entrepreneur’s job before meeting with investors to research the VC firm to determine if their business is in line with the types of businesses/sectors the venture capitalists invest in. This means looking at their portfolio of companies and their investment mandates.

Allon Raiz, founder of Raizcorp, gives the following advice. “Investors usually have preferences which relate to their own expertise and experience in a particular industry. For example, there are investors who specialise in technology, agricultural processing or financial services, and they will only engage with and fund businesses that fall within their focus area”.

Entrepreneurs will also be asked to share their pitch deck. This is a presentation (typically in PowerPoint or PDF) used to explain a start-up idea to potential venture capital investors. The pitch deck provides a brief but informative overview of your business and goes into detail about your monetisation model, how you will scale, as well as provide a viable exit strategy.

If your pitch is successful VCs will start discussing investment terms with the founder. A thorough due diligence will also be conducted on you and your business.

Some examples of red flags investors will look for as part of the due diligence process are:

• A checkered credit record.
• Inconsistency in information provided.
• Inaccurate or outdated annual financial statements and management accounts provided.
• The inability of applicants to provide substantiating information.
• Lack of technical skills and/or business acumen by the entrepreneur.
• Unreasonable or unsubstantiated projections or budgets.

If all is in order, you will receive the funds in the bank.

Unlike other more traditional forms of funding, VCs bring a lot more to the table than just money. Experienced VC fund managers often play an active role in supporting and nurturing those start-ups to ensure a mutually favourable exit.

Some of the post-investment services that VCs can provide are: “strategic guidance, connections to other investors, connections to customers, operational guidance, help hiring board members, and help hiring employees”.

Once investors have put money in the company you will be required to share information about your company with them and delegate some decision-making.

The shareholders’ agreement covers the rights and duties of your investment fund managers, eg: Some of the rights and duties of investment managers, according to nibusinessinfo.co.uk, are:

• receiving regular company performance reports
• consultation on important decisions, eg business acquisitions and disposals
• control of the exit process

There are 5 stages of start-up funding.

• The Seed Stage – Funding for this round is typically used for research and development to get an idea from concept to prototype or production. The money may also be used for market research and to grow the team. The investment is usually small.
• The Start-up Stage – With the initial product finalised, the focus of this stage is advertising and marketing the product/service to new customers.
• The First Stage – The start-up will at this stage have a commercially viable product. Funding will go towards manufacturing and production facilities, as well as sales and marketing.
• The Expansion Stage – Funding at this stage is meant to accelerate the growth of the start-up, which is at this stage generating significant revenue. With the investment, the start-up can expand to other markets or on new product development.
• The Bridge Stage – At this stage the company has reached maturity and may be going public. The financing required will be used to support acquisitions, mergers, and IPOs.

VC firms get their money from large institutions such as pension funds, financial firms and insurance companies. In South Africa, the public sector remains a major investor. The firm then invests these funds on behalf of its investors into fast-growing businesses.

Compared to other parts of the world, South Africa does not have as many investors investing in the industry, says SAVCA’s Tanya van Lill.

“There is therefore an opportunity in South Africa for more institutional investors such as pension funds and Development Finance Institutions, to start investing in the industry.

“As the industry matures and develops a track record, we are hoping more investors will invest into VC’s which in turn would mean more investment opportunities for entrepreneurs.”

VC funding in South Africa is traditionally channeled to businesses that already have some clients/revenue, with massive potential to grow even further.

Investors will also take a lot at other factors, including the entrepreneur driving the business. It begins with you, the entrepreneur, says Jeremy Lang, Regional General Manager of Business Partners.

“Funders want to see: Committed business owners, both financially and through their level of involvement in the business, business owners who understand their business from a technical perspective and have good levels of business acumen, business owners who run their business with integrity and transparency, business owners who clearly illustrate a passion for the business and industry and a business owner who understands their customer and market segment well.”

• Read the full article: Why You Have Been Rejected For Funding

Darlene Menzies shares other factors investors will look at before investing in your start-up:

• If there is a big market: They want to assess if the business is addressing a burning need for a large market i.e. are there a lot of people who will want to buy what the business is selling?
• Product differentiation: How is what this business is doing/going to do differently from what is already being done?
• Competitor information: They want to ensure the entrepreneur has done their homework on who and what is already available in the market.
• What is the business model: They want to know how the business is going to make money e.g. is it going to receive monthly recurring business for providing a service etc.?
• What is the ‘go-to-market’ plan: How will the business be marketed and what sales channels will be used to acquire customers?
• Team: Who are the key employees in the business? Who are the owners and are there any other investors?
• Traction is vital: They want to know if any sales have been made yet i.e. has the product been tried in the market and are there people willing to pay money to use it?
• Financial forecast: They need a summary of the next 3 to 5 years’ projected income and expenses in the businesses, with a lot of detail provided on the next/first 12 months. Once a VC has done an initial assessment of the opportunity and they are interested in possibly investing, they will then do a more detailed investigation, called a ‘due diligence’.

They will ask for further information and also go through the business’s financial statements and their history to date.

Read the full article: SA Funders and Finance Seekers – Where Is The Gap?