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Insights into private equity and venture capital
November 13, 2009
By J-P Fourie
I‘ve got a great idea! Now where can I get the money?
Well firstly, a great idea is simply not good enough to get money! In order to get money you need to unpack way more than your idea to a provider of capital.
One of the greatest challenges facing South Africa is the rejuvenation of its business environment.
The greatest hurdle in this rejuvenation process may be the inability of entrepreneurs to access and secure financing for their initiatives.
There is a perilous misconception amongst entrepreneurs in South Africa that there is simply no financing available- a misconception that contributes to insufficient business development and an intolerably high level of entrepreneurial burnout.
Contrary to popular belief, there are many agencies in South Africa dedicated to funding small and medium businesses, however the difficulty and confusion appears to be around accessing these agencies.
It is essential for today’s entrepreneur to go beyond the traditional ‘blue chip’ methods of securing financing via commercial banks.
Private Equity and Venture Capital are terms which were coined in the early 1950s but only gained significant momentum since the IT boom in the late 1990s.
As of 2008 approximately R100 billion is under the control of private equity fund managers in South Africa and of the R100 billion, over 75 % is under management of funds that are either black influenced, black empowered or black controlled (Source: KPMG and SAVCA Venture Capital and Private Equity Industry Performance Survey of South Africa – 2009).
Granted most of these funds are earmarked for investment into later stage businesses to fund their expansion and development, but there are funds that invest into high growth, technology and innovation rich businesses.
This places private equity/venture capital in a unique position of being able to significantly assist with the funding, growth and sustainability of small and medium businesses and providing weight behind government’s commitment to black economic empowerment.
It is essential for entrepreneurs to understand what private equity and venture capital is and what financiers consider key elements when making investment decisions.
Entrepreneurs need to understand that investors are largely risk managers, ensuring the risks of their investments are commensurate with the returns they can expect. It is important to identify and communicate the risks correctly and have concrete proposals to minimize them.
The risks investors need to consider are not just the failure or success but also risks around the management team, the product, the market, the competition, the customers and of course the financial risks.
Besides these “key” elements, how do we unpack these concepts of "private equity" and "venture capital"?
The term "private equity" refers to shareholder capital invested in private companies, as distinguished from publicly listed companies.
Private equity funds are generally investment vehicles that invest in enterprises that are not listed on a public stock exchange. Private equity may be broadly classified into three categories, depending on the stage of development of the business being invested in.
The three categories are: seed or early stage capital for start-up business, development capital for growth businesses and buy-out funding or replacement capital for businesses ready for buy-out.
Usually fund managers will specialize in a particular target market and it becomes the role of the advisor or the entrepreneur to determine the matching of the entrepreneur to the appropriate fund manager.
Most entrepreneurs are pre-occupied with the final outcome to securing funding but fail to realize that more so than not, expensive funding contributes to the failure of many small and medium enterprises, and more importantly, that there are other vital aspects of their business to develop and value such as; the business model, the risks and mitigations, the skills that will be needed to develop the business, what role the provider of capital to the business should play to help develop the business, how the business will secure clients and what the sustainable competitive advantage is of their business model.
Whilst some argue that private equity is just as costly if not more so than commercial banks it is important that the capital seeker and capital provider structure the transaction with each parties needs in mind.
Parting with a portion of your business is never easy but with private equity funding often comes expertise, skills and structuring that most small businesses are incapable of securing on their own.
The entrepreneur has a choice of raising capital through two primary methods, namely debt or equity.
DEBT CAPITAL
Debt capital is a loan that is repaid over a period of time, with the entrepreneur providing collateral to secure the loan and paying an interest rate on the repayments of the loan.
The providers of the loan require the collateral as security for non-repayment and make a return on the capital provided by asking for an interest payment over and above the repayment of the initial capital provided.
EQUITY CAPITAL
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Equity capital on the other hand, is capital that is provided to an entrepreneur as consideration for purchasing a portion of the entrepreneur’s business.
Private equity investments as capital have considerable impacts in terms of productivity, skills development and job creation, as it includes the transfer and exchange of know-how over and beyond the mere flow of capital.
Private equity and venture capital fund managers play an active role in managing their investments in companies as they derive a return from the increased valuation of their investments (not just debt repayment and an associated interest rate) and hence they focus on business development for the companies they invest in and strategically contribute to their growth.
The ultimate aim of this short article is to draw the reader’s attention to the world of private equity funding and the opportunities available to South Africa in this arena.
It could be argued that the support of government in this industry and the popularisation of this industry to the average entrepreneur could lead to sustainable business growth and development in South Africa.
J-P Fourie (Executive Officer: SAVCA, Southern African Venture Capital and Private Equity Association)
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