Bootstrapping and your personal savings can only go so far when you’re trying to build a start-up from scratch. Sooner or later, as your business grows, you would have to go hat in hand to an outside investor for fresh capital injection.
Entrepreneurs in the Middle East and North Africa (MENA) today are, in a way, better placed than their predecessors, as the region’s start-up ecosystem has evolved, attracting a host of financiers from individual to corporate investors. There is also a growing commitment among entrepreneurs to give back to other start-ups.
An Essence of Enterprise report published by HSBC in June 2018 underscored that majority (66%) of entrepreneurs in the Middle East become angel investors, investing their time, money and expertise in other privately held, non-listed businesses.
The fundraising landscape in MENA has also been gathering momentum. Between 2008 and 2018, around USD 12 billion was raised mainly for early-stage strategies in the region, according to Preqin, an intelligence firm focusing on the alternative assets industry.
Outside investors – whether angels, private equity firms or venture capitalists – can play a critical role in your start-up’s success. But as a business owner, you might be wary about approaching investors because you don’t want to dilute your company’s equity. Whatever your reasons, it would be in your best interest to understand the advantages and disadvantages of the different start-up funding sources.
Angel investment
Angel investors are individuals or private investors who provide pre-seed and seed funding to young start-ups. Because angels invest in the early stages of a company – often before it is able to generate revenue or develop a minimum viable product – they have to deal with very high risks.
Pros
One of the advantages of angel funding is that you’re not expected to repay the investment or pay interest for the money invested into your start-up, even if your business fails. Also unlike banks, you won’t be required to produce collateral or any personal assets as guarantee. As risk-takers, angels are willing to take a chance on nascent start-ups, sometimes even in the idea stage, provided they have the potential to grow. Because many angel investors are entrepreneurs themselves, you stand to benefit from their expertise, especially if it is within the same industry as yours. Lastly, angels are able to make investment decisions more quickly than other investors.
Cons
Receiving money from angel investors, however, means giving up a portion of your business. The percentage of equity they’ll ask will usually depend on the amount of investment they put into the business. While some angels may choose to stay on the sidelines, others may want to take a hands-on approach to running the business.
Venture capital funds
Venture capitalists (VC) can be government or private firms, investment banks or financial institutions. They often provide funding to early-stage start-ups with a proven business model, rapidly expanding customer base, and revenue strategy. Corporate Finance Institute estimates the average size of VC investment at “anywhere between USD 1 million and USD 20 million”.
Pros
As your start-up prepares to spread its wings, it will benefit from the additional resources that a VC firm can provide. Aside from the financial backing, VCs can also provide support in terms of marketing, legal, human resources, and business management. VCs can offer valuable insights on how to grow the business. In addition, VC partners could open up more business opportunities as they can introduce you to their wide network.
Cons
Receiving VC funding means surrendering partial ownership of your company. How much equity you have to give up will largely depend on the amount of investment a VC has injected into the business. VCs would also want to have a say in the business’ day-to-day operation, as well as the decision-making process that will influence the direction of the business.
Private equity funds
Private equity (PE) firms are investment funds or institutional investors that invest in a company that has reached middle to later-stage development, when it has matured and exhibited stable cash flow. They invest in a high-growth start-up with the objective of eventually selling their stake – usually after a five-year period – for higher profit. By this stage, a company’s valuation is expected to be considerable, which means the size of PE investment is also significantly higher, often ranging in the tens of millions of dollars, or more.
Pros
The biggest advantage to seeking PE funding is the amount of financing involved. Because they can provide the largest investment compared with other funding sources, your company will have the ability to fund further growth-related expenses such as market expansion or new product development. PE investors are also hands-on and can be expected to scrutinize every aspect of the business in order to maximize its financial value.
Cons
To raise the massive capital needed to fund a later-stage start-up, most PE firms often borrow money from other investors. As a result, the pressure on the company to succeed is much higher. The significant amount of PE investment also means you have to give up a larger chunk of equity and, in some cases, even turn over management control of the business. Also, expect stricter due diligence as PE firms often look at a company’s cash flow, and earnings before interest, taxes, depreciation and amortization (EBITDA) before they part with their cash.
© Accelerate SME 2018
