One of the most common challenges shared by entrepreneurs around the world is the need to raise capital to grow. In order to raise this capital, entrepreneurs must decide when they need it, how much they need, what they must give up in exchange for it, and how they can best use it to grow.
Many of these challenges are even more pronounced in frontier markets where there are fewer earlystage investors, fewer successful deal precedents, and more structural challenges.
Despite these challenges, a number of investment options exist for frontier market, early and growthstage entrepreneurs. These options are often flexible based on business needs. Some investors take full risk by investing in equity, others offer fixed returns through debt, and some offer creative "quasiequity" structures that blend the characteristics of debt and equity.
Increasingly, these investors are expanding into frontier markets looking for new opportunities. Investor networks often offer matchmaking services while industry conferences can offer great networking opportunities for small businesses. At Open Capital, we play this role as an intermediary, helping highpotential businesses in Africa reach 'investmentreadiness' with a strategic plan, strong systems and processes, and the financial knowledge needed to raise capital. Since 2010, we have successfully helped our clients raise more than $60 million through transactions averaging $1 million in East and Southern Africa.
Before a business begins networking with investors, we strongly recommend entrepreneurs first understand the type of capital that makes sense for their business and how they will invest it for growth. As each business situation varies, it is helpful to consult advisors or experienced peers for more information, keeping in mind the following points.
If you are not yet profitable, you likely offer a much more risky investment proposition to potential funders. This means your future investors will want a financial or impact return that justifies the risk they are taking and, as a result, may be more interested in equity or equitylike structures.
One of the biggest challenges at this stage is valuing your company, since most of your value is often in your future potential, not your historical results. There are mechanisms to address this. For example many early-stage entrepreneurs use a Discounted Cash Flow valuation method, or other similar investments as a comparison.
In addition, investors can also use creative structures like convertible debt to bridge gaps in valuation expectations, enabling you to obtain future compensation if your business is able to achieve future milestones.
If you are profitable or nearly profitable, debt may be more easily available, since you can demonstrate your ability to repay. In addition to your expected future growth, collateral becomes an important question for potential lenders. Depending on your trackrecord, investors may still require upside beyond traditional interest, for example through profitsharing, or "warrants," which allow investors to share in longterm dividends.
At this stage, equity remains an option. There is a large private equity industry interested in growth stage transactions. As an entrepreneur looking to raise capital, it is important to consider when equity is an attractive option. Equity can be much more expensive than debt if your business is successful, since you will be required to share long-term dividends with your investors.
Before raising capital, there are a number of elements to consider beyond the financial implications. For instance, you should research the funder you are considering. Key questions to consider include: How is the investor’s organizational culture aligned with yours? What type of contact and oversight do they expect in your business? Is one funder better placed to provide your business with industry expertise, contacts, or other non-financial resources that could accelerate your growth?
In addition to understanding the type of capital you need and the potential investor fit, it is critical to prepare a detailed, actionable growth plan. This plan will inform your capital need and when you think you will be able to repay investors or share dividends. At Open Capital, we work with more than 110 investors to help African businesses prepare for investment and find the right partners.
One of the most common requests from these investors is a clear growth plan that is linked to achievable milestones. No matter how small or big your business is, we strongly recommend you prepare a written plan with enough detail to convince an investor that you know what you’ll do once you receive funding. This will improve the efficiency of your capital raise and help you identify the best fit partner.
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Photo credit: Bobby Neptune