Getting funded: Part II- Types of investors for early-stage startups

A few weeks ago, we published the first part of this series, where we summarised some of the options founders in Africa have when it comes to talking to investors for funding.

Part 1 was more focused on organisations like accelerators, incubators or high net worth angels; in this post we will dig into the world of institutional investors.

But first, what is an institutional investor? Put simply, an institutional investor is a company, organisation or group that invests money on behalf of other people.

Institutional investors include mutual funds, pensions and hedge funds. But within the context of investment into start-ups and companies, we are often referring to Private Equity investors.

Private Equity typically refers to capital investment made into companies that are not publicly traded. A private equity investment will generally be made by a private equity fund, impact investor, a venture capital firm or even an angel investor as discussed in previous articles. Each of these categories of investors has its own set of goals, preferences and investment strategies or asset classes (i.e. equity or debt). However, all provide working capital to help a target company to grow, develop new products, or restructure the company’s operations, management, or ownership.

So, if you are looking for funding, what do these terms mean and when should you seek out institutional investment?

Venture Capital (VC):

VC is a type of financing that is provided by firms or funds to small, early-stage, emerging firms that are deemed to have high growth potential, or which have demonstrated high growth (in terms of number of employees, annual revenue, or both). Some notable VCs in Africa are TLcom Capital, EchoVC, Enza Capital, or Novastar Ventures.

Our view: Getting an investment from a VC is a great milestone for a company, as it is typically the first institutional investors providing finance in a start-up lifecycle. However, it is important to understand how each VC is able to help, and whether they are the right fit.

• What type of financing do they typically provide.
• What are their terms.
• What areas of strength or expertise they offer.
• What their current portfolio looks like.
• Have they had any recent successful exits.

It is also worth understanding if the amount of funding required is within their typical investment range. Before engaging with a VC, make sure to check all information publicly available. If you feel like a particular VC is able to help, then it might be worth trying to get an introduction by talking to other founders that are currently in their portfolio.

Private Equity (PE):

PE is very similar to VC financing but generally is accessed by more mature companies. Though these companies are more mature, some may be struggling, some doing very well, the investment they may receive will depend on the investment thesis /risk appetite of the PE firm. Some notable PEs in Africa are Adenia, Africinvest, or Helios Investment Partners.

Private Equity firms or funds invest in more mature companies than VCs. Their investment thesis varies but will often look for business that are already profitable and looking to substantially grow. They typically invest in exchange for an equity ownership stake, but some also invest using debt instruments.

Our view: When seeking PE investment, then our recommendations which apply to VC investment are still valid. Any start-up or company interacting with a PE fund should understand the investment thesis including any soft and hard requirements. It is worth mentioning that PE tends to have a much lower appetite for risk, and much stronger requirements from their investors. Therefore, there is likely to a greater focus on governance from the company management team.

Impact Investors:

Impact investing refers to investments “made into companies, organisations, and funds with the intention of generating a measurable, beneficial social or environmental impact alongside a financial return.” Investors are typically private funds, but can also be multinationals, foundations, or non-profits. Notable impact investors in Africa include Investisseurs & Partenaires, and Bamboo Capital Partners. A list of impact investors can be found here at GIIN.

Impact Investors typically invest across asset classes from equity, debt, and other fixed incomes products. It is worth noting impact investments can be made in either emerging or developed markets.

Our view: Similarly to VCs, before engaging with impact investors it is important to understand what kind of financing they provide, what are their terms, what areas of strength or domain expertise they can offer. Impact investors are interested in reporting from both a financial and impact basis so founders need to consider that before interacting with them. Questions to ask yourself are: is my start-up providing an impact or contributing to a goal that falls into the investor’s criteria? It is also worth asking yourself if the financing on offer is the right fit — is the investor offering equity, debt or a blend of both?

Family Offices:

Banks are financial institutions that typically provide debt financing and loans to individuals and businesses.

Though most banks will typically invest with debt products, i.e. loans; some can also invest via direct equity and become shareholders of the company.

Our view: Banks will typically ask for collateral in exchange for any loan offered. This can be very difficult for start-ups (particularly in the tech space) to provide a security. Be very careful and consider other options before looking into banks to fund your start-up; as you could still be committed to repayments even if the start-up fails.

Initial Public Offering (IPO):

IPO or stock market launch is a type of public offering in which shares of a company are sold to institutional investors and usually also retail (individual) investors. An IPO is underwritten by one or more investment banks, who also arrange for the shares to be listed on one or more stock exchanges. Through this process known as floating, or going public, a privately held company is transformed into a public company. Initial public offerings can be used to raise new equity capital for companies, to monetise the investments of private shareholders such as company founders or private equity investors, and to enable easy trading of existing holdings or future capital raising by becoming publicly traded. The transition from a private to a public company can be an important time for private investors to fully realise gains from their investment as it typically includes share premiums for current private investors. Meanwhile, it also allows public investors to participate in the offering.

Our View: When a start-up reaches this stage of funding need, they estimate that they may now need not just private capital but also public funding. Essentially allowing anyone to invest in their company. This stage of funding comes with much more regulations, management and governance requirements.

In conclusion:

Choosing the right investor and type of investment is important. The bottom line is you should always do research. Understanding what type of investors you would like to engage with means matching the stage of your company, the sector, the traction, and even geography with a potential growth partner. By asking yourself the following questions: what is the investors typical stage of investment, what’s their favourite sector, and equally important what is their track record with previous investments, you are going to better understand if an investor is going to be a good fit.

At The Baobab Network, we invest early and support start-ups in Africa with funding and capacity growth. If you’re an African founder operating a tech or tech enabled start-up in Africa, reach out to us, perhaps we can be your growth partner.

By Arthur Chupeau

Head of Ventures at The Baobab Network