No funding for tech start-ups

Johannesburg, 10 Dec 2008

Technology start-ups will have to find alternative sources of funding as venture capital (VC) firms reduce spending.

Jeff Fletcher, founder of IS Labs, says the prevailing mindset is costing start-ups. “Companies in SA want to reduce risk, they don't want to invest directly into start-ups. A cultural mind shift needs to happen - similar to that of Silicon Valley in the States. But a gap does exist in that we don't have the same amount of funds.”

However, Hasso Platner Ventures Africa director Andrea Bohmert says the reluctance to fund start-ups has nothing to do with the amount of funding available.

“There is lots of money available, but this money is struggling to find the right investment. In the past 10 months we have made two investments. The first one was valued at R8 million and the other at R4 million. In 2009, we're looking to invest close to R100 million and our first investment of the year is valued at about R35 million.”

But Bohmert notes this money won't be going to start-ups. “If you're a start-up, you have two options - invention and the IDC [Industrial Development Corporation],” she says.

Venture capital firms tend to focus their money on equity investments in hi-tech companies with expected high-growth in an 18-month period, says JP Fourie, executive officer at the South African Venture Capital and Private Equity Association. As start-ups applying for funding usually don't understand the aim of venture capital, they are often overlooked as they have unrealistic expectations of funding, he explains.

“VC companies do not look to repayments to make their money,” explains Fourie. “They need to increase the valuation of the company so that when they need to exit it, or sell it off, they make their money back.”

Risky business

The likelihood of failure, coupled with investment mandates to VC companies by investors and growing negative sentiments in global markets, makes technology start-ups a risky area VC companies are not willing to venture into.

Both Fletcher and Fourie note that out of 10 companies in a VC manager's portfolio, only one will perform spectacularly. They note that probably seven funded companies will fail in two to three years, while two will yield average returns and only one will be such a success that it will allow the VC company to keep the underperforming businesses. This is a trend that has led to the further shrinking of funds and has led to money not being allocated.

Bohmert explains that a company only has nine years to secure returns on its investments. “With start-ups it will take two years to get the company ready, another two years to enter the market, and another two to three years for the company to grow - that just takes too long. We are investing in commercialisation, so many things can go wrong - finding the right market, assessment of time it takes to grow and enter a market. All these things need to be considered when we make an investment.”

Going it alone

Companies now need to consider alternative funding, says Fletcher. “It doesn't just have to be big companies making investments. Start-ups now need to look at getting angel funding - which is funding from friends and a people network.”

Bohmert believes companies that have been active, even on a really small scale, will be able to secure funding. “We are investing in the market - that is what our investors are looking at.”

Pipeline development is possible and can be sustainable, says Fourie. The government increasingly talks about building a knowledge-based economy and developments, such as the Technology Innovation Agency, are indications it is concerned about innovation funding, says Fourie. But, he says, the industry needs more innovation-rich businesses, with quick-scaling opportunities to increase VC trust in technology start-ups.