Raising capital to finance the startup’s operations is undoubtedly one of the most challenging tasks of any founder. The challenge gets even bigger for African founders. According to The Better Africa: tracing success and failure of African startups report by the GreenTech Africa Foundation, more than 50% of African startups that shut down have never received any external funding. Furthermore, the majority of startups cannot scale their markets because of the scarcity of funding opportunities. In this article, we will explore the various instruments you could use to secure the required funding for your startup.
1. Get a debt funding and payback later
Conventionally, banks and commercial lenders are considered the mainstream debt funders for business owners – although lenders could be other non-bank entities if they follow properly the rules and regulations and have the licenses to work in Rwanda. Traditionally, bank requirements and strings attached to the loans such as interest rates, grace & payback periods, usually hamper the ability of startups and innovative market-oriented projects to secure the funding. Banks require extensive documents & assets before they approve the loan; they often need the business plan, funding collateral, maintenance of a good relationship and managerial of competence and a good credit score. However, such requirements are usually not becoming to the startups since extensive business planning is increasingly becoming obsolete as more projects go agile today. Moreover, the managerial experience of startup funders is nascent and the ability to provide collateral is often non-existent. With these facts taken into consideration, it is obvious that traditional lenders are risk-averse. For any startup to get this debt funding, you need to:
1. Enough Traction
Ensure the project has enough traction to be able to pay back the loan. Highly risky innovative projects are not suitable for traditional bank loans.
2. Prepare a business plan for your startup.
This does not have to be exceptionally long and complex; but a simple formal document picturing your current and future target market & customers, finances, and tactics to use. At the Digital Transformation Center, projects such as Make-IT in Africa, support you with capacity development to build a bankable business project.
3. Assess risks
Ensure that your startup has enough traction in terms of cash flow, revenues and profit to pay back the loan at the maturity date
Debt funding is the mainstream instruments used not just by SMEs but also corporates and startups. For early-stage ventures, this could respond to the capital needs more efficiently and consistently. Nevertheless, it is important to be extremely careful before to ensure you have positive returns in terms of both the liquidity and profitability of your business.
2. Attract more owners through equity financing
Equity investment aims to attract external funders to inject capital in your startup in exchange for a part of the company’s shares. For investors, equity is, usually, the riskiest form of investment since the investor will lose the entirety of the capital injected, should the startup fail. Nevertheless, for startups with high risk innovations, this is a great funding instrument, since, unlike debt funding, it does not put pressure on the startup to generate revenues & profit as soon as possible. For any startup to secure this, investors conduct a due diligence process in which they investigate the potential of the startup to grow its profit and revenues.
3. Get risk-free funding by securing grants
4. Explore hybrid methods such as mezzanine funding and SAFEs
Unlike convertible notes that offer debt at the beginning, SAFE only targets the future shares to be offered by the startup. SAFE stands for the Simple Agreement for Future Equity – a term coined by YCombinator to simplify the process of raising capital for early-stage companies. Due to their simplicity, SAFEs are typically riskier than convertible notes for experienced investors but are effective in raising capital through a trusted network of investors such friends and family members.
5. Share your revenues with the funders via loyalty-based financing
This is also known as revenue-based financing; this is neither a debt nor an equity investment. The investor receives a certain percentage of the startup’s ongoing revenues in exchange for the funds invested. In a revenue-based financing the startup will offer the investor some shares until the total agreed capital has been repaid – usually 2-3 times the initial investment. It is risky for investors since repayments are only directly proportional to the startup financial performance but also it gives investors an excellent opportunity to secure a lucrative deal, should the startup sales skyrocket in the future.
How to select the best investment instrument for you
You can bootstrap your startup as much as you can. However, sometimes your startup needs external funding to stabilize or scale its operations in Rwanda. You wonder which of the five investment instruments is the best for your venture. The truth is, any of any them could be a great fit if put into the right context. Securing funding is not just about the instrument used, it’s about the network of people and organizations you approach and how you articulate the need, it’s also about the internal readiness of your startup (e.g., having your books in order), another factor is the investment scene at the ecosystem level, opportunities, threats, laws & regulations, etc. To understand comprehensively how this systemically contribute to getting your startup funded, check Make-IT in Africa’s publication – The Entrepreneurs’ Guide to Investment in Rwanda. Don’t just read this, try, try and try again; as Henry Ford said,
” Whether you think you can, or think you can’t — you’re right.”