JOHANNESBURG – Only around one in every 100 potential deals in the venture capital market turn into an investment.
While this may be an unsettling statistic, there are ways for entrepreneurs to approach the venture capital system that can raise their chances of getting finance by following a few simple rules.
Brett Commaille, chief executive officer at AngelHub Ventures, said it is important to understand that what the entrepreneur has to offer might not be within everybody’s mandate.
He was speaking about investment selection in the venture capital market at the South African Venture Capital and Private Equity Association’s (Savca) Venture Capital Training Course. According to its website, AngelHub Ventures is an “Angel seed fund investing into lean startups with disruptive business models and technologies”. Former FNB CEO Michael Jordaan is a co-owner and investor in the business.
All venture capital funds aren’t focused on the same markets and products and entrepreneurs may find that their idea only fit into one or two mandates.
Moreover, a good product does not necessarily translate into a good business and even if it does, this does not guarantee that it is investable from a venture capital perspective, Commaille said.
He said they see a lot of great businesses where the entrepreneur may become reasonably wealthy. However this does not mean they the business would generate the kind of returns they would require from a venture capital perspective because of simple fund metrics.
Venture capital funds have to invest in businesses that would generate a high enough return to compensate for those projects that are less successful.
Where investors find opportunities
Finding the right deals is all about the “personal network”, Commaille said.
According to a 2012 Savca survey only 7% of deals concluded are the result of “cold approaches”. Ninety-three percent flow from networks where an entrepreneur was introduced to the investor through somebody he knew – the so-called “warm introduction”.
Commaille said one group of entrepreneurs who approached them took the recommendation to get a “warm introduction” quite seriously and spent several months trying to find somebody who knew them and who would be willing to make a recommendation. In the process they got several offers to invest, he said.
What investors are looking for
Commaille said they are not looking for a 90-page business plan.
Instead they want to see a quick summary that shows the entrepreneur can briefly explain what the business does.
He said he often finds that after reading through ten pages of a business plan, he still doesn’t know what the business does. This is a fundamental issue because if an entrepreneur can’t explain what the business does, they won’t be able to “sell” it.
This is why they like the “Tweet concept”. In short, what an investor looks for is an exciting venture that matches their investment mandate, he said.
What makes a potential investment exciting?
Commaille said a prospective investment is exciting when it matches their mandate and when it has a strong management team with passionate entrepreneurs.
They have been approached with a great business proposal many times, but because the team did not look capable of delivering on it they had to walk away.
“We’re the investors, we don’t want to be running the business. That’s what the entrepreneur must do.”
An exciting opportunity also has high growth potential. The business model must be scalable which means revenue must grow faster than costs. This often means there is an element of technology involved.
Commaille said they also look for unique opportunities – something that would be able to stand out in a way that the market will understand.
Since South Africa is a small market, cross-border growth prospects or export potential also creates an interest.
“We’re looking for industries that are showing growth.”
Ultimately, the investment terms have to be favourable and there should be potential for them to add value, he said.
The pitch deck
Commaille said they want to see a great team with the ability to launch a product that will address a gap in the market. The market must be big enough and the offering must be clearly differentiated. If the offering is protectable in some way it is even better, he said.
However, the plan must be executable and should have an “element of realism”.
In a pitch deck they typically look for a description of the business or concept and an explanation of the business model.
Commaille said an explanation of how the business makes money is ignored by a lot of entrepreneurs. It should also discuss the industry size and potential.
He said the customer is a major focus point. An entrepreneur should be able to demonstrate that he understands who his customers are and how they can be reached. Potential investors also want to see a competitor matrix.
“It is obviously a big problem for us if they don’t understand who else is in the market.”
The differentiation, the management team credentials and the traction of the business is also important.
Commaille said the part that most entrepreneurs leave to the end or exclude entirely, is the numbers. Yet this is extremely important for investors. They want to know what the funding requirements are and how the entrepreneur plans to use the money.
When pitching a business idea or product, he advises entrepreneurs to tell a story and to get the funders to identify. Explain why the idea makes good business sense and only then raise the issue of funding, he said.
Ultimately funders like passion, integrity and coachability, Commaille said.
It is important that the entrepreneur knows more about their business than the prospective funder does.
They also like a business that has traction. It is the one thing that tends to make all other things somewhat less important, he said.