Startups and Investors Seek the Right Fit

Raising capital in developing markets can be difficult, but what must entrepreneurs know and do to increase deal flow and improve scalability and growth for pre- and post-revenue companies?

John Armah has experience with the subject through his experiences in raising capital for companies. The business growth strategist and entrepreneur reviewed the development and positioning of startups for financing with We Talk Biz.

Armah is chief executive officer of JA Venture Capital. He is also board chairman of Junior Achievement Ghana and chairman of the JA Africa Board Chairs Council, a global non-profit organization committed to promoting entrepreneurship development around the world. 

He is also a business development practitioner with vast experience in the development of startups, micro, small and medium enterprises, and business strategy. Armah serves as an advisor on other boards, including one of Ghana’s leading startup incubators, Kumasi Hive.

“There will always be companies that will grow organically per a minimum viable product,” he said. “Others will require investment to grow. There will also always be companies that require an investment that may have liabilities. Regardless, entrepreneurs well versed in their business must know when their startup is ripe for investment.

“However, the most important question to any of these businesses is—whether seed, early or otherwise—are you investment-ready, and what is your ‘investment thesis’?” Armah said.

He believes startup owners must answer these questions before typically considering a raise:

• Is my model viable?
• What is my market and its size—business to business, business to consumer, business to government or otherwise?
• What are my funding needs and type?
• What does governance mean to our business?
• Performance and financial management?

These determine the following:

• Is there a proof of concept?
• If not, what will the funds be applied to?
• Has the business considered the funding types and its requirements if they so choose debt or equity routes?

Know growth stages

The stage of business usually determines what type of funds apply.

“A business must first know what stage of business growth they are in,” Armah said. “There are seed—pre-seed, seed and post-seed—early stage and series cycles. More importantly, capital raised, product development and generally the business structure and cash flow cycle determine the overall business stage.”

Startups can tap into several types of financing.

“The nature of the business determines the capital applicable,” Armah said. “Is the business export-oriented? Is it a seed-stage company? Typical of our market are credit lines, convertible debt, business angels, credit guarantees, grants, private equity debt or equity. However, scenario planning for these largely determine capital raising approaches, hedging arrangements and the rest.

“Knowing the investor requirements, focus and type of model the business runs, determines what capital should be applied for,” he said. “Typically, some business models require that a grant should fund a proof of concept and will yield a minimum viable product to ensure organic growth to merit rounds of funding from seed to series.”

Entrepreneurs need to know the fiscal requirements of their potential suitors.

“Most funds have specific sectors of interests,” Armah said. “They usually will demand a pitch document, information memorandum, market summary, capitalization table, financial plan, contracts, off-takers, organizational policies, any proof of intellectual property that is key to growth, historical performance, industry research and pre-feasibility reports, details of litigation, financial statements, management biographies and team profiles, and track record, even if it’s a green field.” 

Overlooking key elements

In his view, startups miss out due to inexperience on these factors. They fail to communicate or develop projects to meet due diligence requirements of investors.

“Crowdfunding is still growing and will pick up in a few years,” Armah said. “The debate about profit and impact based on a desire to capture societal sentiments or culture of giving in Africa is predominantly still growing. There are benevolence approaches through either social responsibility or social investment models. 

“Importantly, most investors are very interested in the ‘revenue model’ of most businesses,” he said. “There are debates about whether or not subscription models work. So, fusing traditional models with innovation models based on market information, customer targeting, and socio-cultural nuances of the African economy can create firm specific defining moments for growth and traction for such sector specific firms.”

Armah believes a company may have to continually revise its business information decks, especially during pre-revenue or post-revenue stages. That’s when more insights are gained either from business angels, pitch events, pilot phases and others to improve chances of raise.

The more information business owners can provide to financiers, the better.

“An investor wants to know if the business has enough data to validate its financial projections, its product and what is offered to the investor,” Armah said. “Has the business advanced enough to merit valuation to determine what is in it for the investor?”

That involves these considerations:

• Return on investment
• Internal rate of return
• Gross profit margins
• Earnings before interest, taxes, depreciation and amortization 
• Profit before and after tax considerations
• Break-even cycles spread across capital gains in net profits
• Potential for investors to recoup
• Periods
• Controls
• Reporting

Deams alone not enough

Although entrepreneurs hear that they need innovative ideas to raise capital, investment concepts by themselves can’t provide for consistent business.

“Business sustainability and consistency are a function of the structure, product, innovation capacity, capital and scalability, and even intellectual property,” Armah said. “Without understanding these unique qualities within regional or local contexts, consistency can’t be achieved. Sales yields consistency.”

While business owners might worry about being too small for investment or financing, other factors are in play.

“Most startups forget that while you are selling potential, to any investor it is the return on investment, exit scenarios, team, product, governance, size or knowledge of the market that determines what and how much capital is made available,” Armah said.

Business models should be based on clear goals while keeping customers in mind.

“Such a model should be relative to the size of market, purchase patterns and products that consumers actually want,” Armah said. “Translated in sales and use, a consumer’s problem may change, but understanding the customer’s lifetime value and product development growth phases is critical to growth.”

Entrepreneurs also need to put on their best face for venture capitalists.

“These investors have specific sectors of focus, be sure your idea is a fit,” Armah said. “The venture capitalist may be a minority or majority investor, so do your research. Determine the ticket sizes they do, past investments and requirements.”

Address pain points

He proposes business owners should do this:

• Court the investor and show value: Let your pitch—not restricted to startups—show a clear problem and solution, benefits not features, tell a story, competitive advantage, competitor analysis, revenue model, risks, traction, performance metrics and indicators, team and what-if scenario.
• Have a capitalization table, information memo, financials and valuation including amortization schedule for debt financing, legal structure copies, contracts and demo products if you’ve built prototypes.

“Share the ask,” Armah said. “Show what you will give for it. As much as possible, there must be some owned intellectual property to make the startup definitive and unique. Tech startups and e-commerce models are primarily different. Show cause for how different you are.

“What does cost schedule operating expense and capital expense look like relative to expansion or growth?” he said. “Are your customer acquisition costs high relative to potential revenue? Who makes up your team? Have you sufficiently advanced the product? Numbers? Not just potential and results?”

Although the average startup owner might not understand business or financial jargon, ignorance is no excuse.

“It’s really important to get help as much as possible in building your business case,” Armah said. “You can’t do it alone. Understanding the business jargon is the key to entry for raising capital or courting investors. It is what investors want to hear.”

Are solutions worth the price?

Investors and financiers look for specific things in small businesses and startups.

“You may be solving a problem as a startup, but the question is how big is that problem compared to size of the market?” Armah said, “Are consumers able and willing to pay for your solution? What’s the proof? What’s your route to market? How different are you? What are your expectations on return on investment?

“What are your business growth metrics?” he said. “Who has supported you in the past with funding or advisory? What stage are you at, and what type of capital is applicable? What sort of internal controls do you have? How regional or scalable can your product be?”

Knowing those answers will sharpen presentations.

“A good pitch is when you tell an investor, ‘I have put in X, built from point A to B,” Armah said. “These are my earnings, attracted X and Y, people. This is what I offer. These are who are using it. These are my competitors. This is what we do differently, plus plans for scale and risks.

“Grants are different,” he said. “Grant applications or tender processes are routes often ignored by startups, but can be a key pole on your growth or sustainability plans. Understanding what requests for proposals, requests for quotations, technical proposals, bid assessments and criteria look like is really important.”

Look for assists

Armah offered this advice for anyone on the journey of looking for financing and investment:

• Build your capacity. Get help to build governance and internal controls. Demonstrate proof of concept. Be focused. Don’t just chase public relations and noise. Build functional products. Don’t chase every pitch competition in the world.
• Let people open doors for you. Raising capital is a patience game. You may outsource capital raising to firms. Focus on sales. Share your growth as much as possible. Have an impact model.
• Be different. Be unique. Be realistic and practical about what is possible. Don’t be idealistic. Build teams. Understand the dilution of shares. Understand the licensing requirements for your business and product.

“No one knows your business better than you,” Armah said. “While others may agree to help, you must be coachable and trainable. Learn how to agree and disagree professionally. Not all funds will work for you. Partnerships don’t always work out.”

Of course, entrepreneurs should first make sure they really need funding. Then get what they are worth.

“When people tell you owning a piece of something is better than owning 100 percent of nothing, tell them No!” Armah said. “Tell them yielding control of the business can destroy your dreams. Knowing what partnership is right and it’s value thereof is the key to making that phrase true.

“Primarily, capital raising in development markets is fast changing with the activities of development financing institutions,” he said. “African businesses must redefine growth poles, regional, geo-market dynamics and hybrid models in innovation to be ready for the next wave of the African investment renaissance.”