Kenya’s start-up scene is growing, attracting venture capital from all over the world. For instance, in 2017 alone, private equity and venture capital firms injected sh43.57 billion into the country’s economy as per the latest data from the East Africa Private Equity and Venture Capital Association.
However, as excitement grows over the possibility getting millions of shillings in funding, Kenyan start-ups should approach venture capital with caution. Here are a few things to know about raising venture capital.
- How venture capitalists (VCs)make money
VCs make money by investing in companies at low valuation through multiple rounds of funding and then exiting at a higher value through an Initial Public Offering (IPO), merger into a public company, asset sale etc. However, they do not always succeed; a study by Harvard Business School researcher Shikhar Gosh found that 75 percent of start-ups failed to return their investment.
This is important to know so that with every deal made, the entrepreneur knows what the investor is aiming for in the long-term and that it is a risk for them too.
- Search for product-market fit before raising seed fund
Make a prototype for your business idea and continuously test it with the market to discover your market segment, validate that customers exist and need your product/service, additionally, you’ll secure early adopters in the process. Once you have a product-market fit then start fund raising.
- Find and close a lead investor
A lead investor is a firm that will take at least a third of your fund raising round and are very significant because at times, other investors only commit after the lead has invested. Nevertheless, make sure you have spent time with your lead investor to ascertain that they are people you could work with well.
- Hire first employees with stock options
You have successfully raised seed fund, and perhaps given 25 percent of your business to investors. Now set aside another 10 percent for your first employees in form of stock options (not shares). Stock options are rights that you give allowing people to buy common stock at a specified price within a pre-determined time.
Let’s say employee B joined the company when your start-up was valued sh1 per stock, stock options gives them the privilege of buying your company’s stock at a sh1 price within an agreed period of time even if the value of the company stock rises to sh10 per share . It is a reward to early employees for risking to work in a start-up.
- Raise additional investment
You have managed to raise a little bit of capital and hired a few employees to kick-start your business, however, opportunities are opening up and your business needs to grow to exploit them, it’s time for additional investment.
When approaching venture capitalists for a second round of fund raising, you have an option-pun intended, to sell stock or stock options to investors. The value of your company will have grown from the first round of investment and thus likely to get more investment for less shares given out.
All things considered, venture capital is useful, however, it’s not the only source of financing, there are other financing methods that don’t dilute ownership e.g. Loans, grants, bootstrapping etc. try them too.