eBusiness Weekly
Nokuthula G Moyo-Muparuri
In the quest to design our own home grown start-up ecosystem, last week I wrote about policy design.
This article will go into detail on how we can map the finance design. Finance design is about developing a range of financial services for start-ups and also creating an enabling environment for investors.
Investors include institutional investors such as financial institutions, venture capital firms, private equity firm and individual investors such as business angels.
This article will discuss the following; the importance of funding for start-ups, access to funding for start-ups, and then sources and types of funding for start-ups. Five design elements to be discussed are; developing a legal framework to support start-ups; enhancing government support for start-ups; establishing financial literacy courses for start-ups; setting up investor networks; and last but not least increasing synergies between institutions to ensure start-ups access funding.
Start-up funding is the money a start-up business uses to start or support a new business. There are many different types of funding. Start-ups use these funds to cover marketing, growth and operating expenses to launch the business.
Importance of funding
The most common reasons start-ups fail are running out of cash or failing to raise capital. As such, having the capital to invest in driving the business forward is imperative. The funding is used to develop the product or service. Developing the product or service requires resources such as equipment, office space and development fees.
Money is one of the biggest factors preventing people from starting a business. Bootstrapping or loans may not be attractive to start-up founders because of the risk associated and the time it may take to get the business off the ground. Therefore the ability to apply for funding gives a route to enter the market.
When starting a business, there is a high likelihood that the business will not be making a profit for a while. All the money the business gains from the funding will be used to set up the business, build product or service and pay employees. These are all costs needed to help the business survive and achieve profitability.
The revenues will be low and most likely reinvested into the business. Therefore funding gives the business the run way to develop and reach profitability.
Access to funding for start-ups
Having access to funding is an invaluable asset for start-ups and can be the difference between success and failure. When a start-up has access to funding, it is able to fund operations, grow its business and take advantage of opportunities that might otherwise be out of reach. Other advantages are; ability to pursue growth opportunities; flexibility to respond quickly to changing market conditions; improved cash flow and increase credibility and investor confidence.
Challenges that arise without access to capital are limited resources. The start-up may have a great product or service, but lack the funds to properly market it, leading to a smaller customer base and lower sales volume. Another challenge is limited growth. Without adequate funding, start-ups are unable to expand operations thus leading to stagnation and lack of progress.
Without access to funding, start-ups potential for success is limited as they may not have the resources necessary to develop new products or services that can bring in new customers or revenue streams. They may also struggle to keep up with industry trends or find themselves unable to compete with larger and more established companies.
Access to funding is essential for start-ups. It enables them to pursue ambitious projects, upgrade equipment, hire additional employees and weather economic downturns. Without access to funding start-ups may struggle to reach their full potential and experience slower growth than those with adequate funding sources.
Sources of funding for start-ups
Debt and equity are two major sources of financing. Debt financing involves borrowing funds from creditors with the stipulation of repaying the borrowed funds plus interest at a specified future time. Debt financing may be secured or unsecured.
Secured debt has collateral. Unsecured debt does not have collateral and places the lender in a less secure position relative to repayment in case of default.
Equity financing means exchanging a portion of the ownership of the business for a financing investment in the business. The ownership stake resulting from an equity investment allows the investor to share in the company’s profits.
Equity involves a permanent investment in a company and is not repaid by the company at a later date. The investment should be properly defined in a formally created business entity. An equity stake in a company can be in the form of shares.
Companies may establish different classes of shares to control voting rights among shareholders. To help with the funding process, start-ups will typically be given a valuation.
This valuation allows investors to calculate how much equity they get for the cash they put in. Equity is valuable to investors as they get ownership in a business without having to run it on a day-to-day basis.
If they have selected wisely, they may receive a return on investment when sell their equity for more than they bought it for. This capital can then be allocated to more Start-ups in the future.
Types of funding for start-ups
seed Funding
Seed funding is the funding for a start-up when it is at the seedling stage that is inception, ideation or the beginning stage. It typically represents the first official money a start-up raises. After securing seed funding, start-ups may approach Venture Capital firms to obtain additional financing.
Venture Capital
Venture capital is the funding that is invested in start-ups that are usually high risk but also have the potential for exponential growth.
The goal of a venture capital investment is a very high return for the venture capital firm, usually in the form of an acquisition of the Start-up or an Initial Public Offering (IPO). Initial Public Offering is the process by which a private company can go public. It could be a new, young, or an old company which decides to be listed on an exchange and hence goes public.
Venture capital is a great option for start-ups that are looking to scale big and quickly. Because the investments are fairly large, the start-up has to be prepared to take that money and grow. A venture capital firm is usually run by a handful of partners who have raised a large sum of money from a group to invest on their behalf.
The partners are typically large institutions. The partners have a window of 7 to 10 years with which to make investments and more importantly generate a big return.
Creating a big return in such a short span of time means that venture capital firms must invest in deals that have giant outcomes.
These big outcomes not only provide big returns to the fund, they also cover losses of the high number of failure that high risk investing attracts.
Angel investor funding
Angel investors are typically high net-worth individuals who look to put relatively small amounts of money into start-ups, typically ranging from a few thousand dollars to as much as a million dollars.
Angels are often one of the more accessible forms of early stage capital for a start-up and as such are a critical part of the equity fundraising ecosystem. The most beneficial aspect to working with an angel investor is that they can usually make an investment decision on their own.
Not having to manage a partnership or corporate hierarchy of decision making allows the angel investor to make bets that they feel comfortable with personally. Often this is what a start-up needs early in their start-up development. Angel investors also tend to have subject matter expertise in a particular area.
This helps start-ups in that they already know the space and they may be well connected in particular industries, so they can also bring valuable resources.
Crowd funding
Crowd funding is a method of raising capital through the collective effort of friends, family, customers and individual investors. This approach taps into the collective efforts of a large pool of individuals, primarily online via social media and crowd funding platforms and leverages their networks for grater reach and exposure.
Crowd funding platforms offer the start-up a platform to build, showcase and share their pitch resources. It is much easier for the start-up to get their opportunity in front of more interested parties and give them more ways to help grow the business.
Series funding
Series funding is when a Start-up raises rounds of funds each one higher than the next and each one increasing the value of the business. Its described alphabetically: Series A,B,C,D and E. Once a Start-up makes it through the seed stage and have some kind of traction, for example number of users, revenues or any other key performance indicator, they are ready to raise a Series A round.
A start-up that reaches the point where they are ready to raise Series B round has already found their product/market fit and need help expanding. The big question here is; Can the start-up go from 100 users to 1 000? Companies that make it to the series C stage of funding are doing very well and are ready to expand to new markets, acquire other businesses or develop new products.
Grant funding
Start-up grants are non-repayable funds provided to entrepreneurs and early stage businesses to support their growth and development. Unlike loans, grants do not need to be paid back, making them an attractive source of funding for start-ups. These grants can come from various sources including government, private organisations, foundations and civil society organisations.
Incubator/accelerator funding
Incubators are organisations that work with start-ups before they are launched. They offer widespread resources for Start-ups in the early stages ranging from physical office space to consulting services.
Accelerators are similar to incubators. They offer similar support and mentorship opportunities for new start-ups.
A key difference is that accelerators are usually paid through equity and work with the Start-up for a predetermined period. Business Incubators/accelerators generally focus on high tech sectors such as biotechnology, information technology, multimedia or industrial technology, by providing support for new businesses in various stages of development.
The incubator will invite start-ups to share their premises, as well as their administrative, logistical and technical resources, for example they may share the use of its laboratories so that the start-up can develop and test its product.
The incubation phase can last up to two years. Once the product is ready, the business usually leaves the incubator premises to enter it industrial production phase and is on its own. Start-ups that are supported by incubators have a better success rate than those without support.
Developing a legal framework to support start-ups
There is need to develop a Start-up Seed Fund Act which will facilitate the establishment of a Start-up Investment Seed Fund offering a variety of funding options.
The Start-up Seed Fund Act can also play another role by encouraging investment in the start-up ecosystem by providing certain incentives to individuals, institutional investors and angel investors to invest. Incentives such as tax credits, repatriation of capital can be offered to investors. Incentives can also be given to registered accelerators and incubators.
Enhancing Government support for start-ups
The Government must enhance the way it provides assistance to Start-ups. The support must include financial assistance, tax incentives, and access to resources such as mentorship, training and networking opportunities. The goal is to help Start-ups overcome some of the many challenges they face in the early stages of development and to foster a supportive environment for innovation and growth.
Financial support can be in the form of grants, loans or tax incentives. Tax breaks or credits can lessen the financial burden on Start-ups freeing up more of their capital for growth related activities.
Regulatory support can be in the form of stream lining the process of starting and operating a business by reducing red tape, making it easier to obtain necessary licenses and permits, providing guidance on compliance with various organisations.
Establishing financial literacy courses for start-ups
Financial literacy refers to the ability to understand and manage various aspects of financial matters effectively. For Start-ups, this skill goes beyond mere budgeting. It extends to comprehensive understanding of financial statements, investment strategies and risk management. A start-up can get funds from an investor, but afterwards may lack the skills necessary to manage and sustain the funds.
With access to financial literacy courses, the same start-up has a chance to make better decisions based on their education. To keep their business going, a start-up needs to know how to manage the money related to it. Topics like budgeting, investing, managing debt, loans and credit are important.
Being financially literate empowers start-ups to make informed decisions, mitigate risk and seize opportunities that contribute to both personal and business growth. It is not just about crunching numbers, it is about mastering the language of finance and leveraging it to drive success. So there is need to develop financial literacy course for Start-ups.
Setting up investor networks
An investor network is a group of investors who pool their money and resources to invest in start-up companies. The network provides the start-ups with capital they need to get off the ground and in return the investors receive a share of the profits if the start-up is successful.
By investing together, the members of the network can share costs of due diligence and other expenses related to investing in start-ups. There is need to encourage the establishment of investor networks especially focusing on supporting start-ups.
Increasing synergies among institutions to ensure start-ups access funding
Early this year the African Development Bank put a request for expression of interest, calling on Higher Education Institutions to develop a Fellowship Programme on Private Equity and Venture Capital. In providing the context of the intervention, they explained that there is a need to increase knowledge in the Private Equity and Venture Capital Market in Africa, to also grow the knowledge base of the industry in the continent and to improve the skills of people working in the industry.
In the same vein, our education institutions can collaborate with financial institutions to develop and implement such a programme so as to increase access to finance for Start-ups in Zimbabwe and the African Continent.
G Moyo-Muparuri is a lecturer at the Midlands State University in the Faculty of Business Sciences. She is also the Founder of the Institute of Applied Entrepreneurship. The mission of the Institute is Business Skills Development and Start-up Ecosystem Development. The Institute provides Bespoke or Custom Designed Courses tailor made to capacitate Business Skills required by organisations. In terms of Start-up Ecosystem Development, the Institute engages the network participants to collaborate in developing a vibrant and dynamic Start-up ecosystem. Nokuthula G Moyo-Muparuri has also authored 3 books and co-authored two books in the area of Business Law. You can contact her on +263718747621.
