African startup funding cycle, different stages of startup funding

Different phases of a startup ask for different types of financing. In this post we look at the startup funding cycle as it applies to ventures listed on VC4Africa, and ask the community to share from their own experiences!

Most startups go through a similar funding cycle: you start off with finance from your own savings or from small and informal loans from friends and family. If things go well, you might be able to pick up some seed stage funding by participating in a startup event or by winning a business plan competition. With some early traction, it is possible to apply for an accelerator or get backing from an early stage seed fund. Once the concept for the venture starts to mature, and the infrastructure comes together with tangible traction, the next step can be equity financing.

In this graph we propose an “African Startup Funding Cycle,” adapted from the Startup Funding Cycle already known.

It is important to understand where your venture is in this cycle and your best sources/types of funding: Seed, Start-up, 1st round (Series A), 2nd round (Working cap), 3rd round and 4th round (Bridge and Mezzanine), and beyond. Different types of financing have specific pros and cons. We make some comments on each.

Seed Stage – In the seed stage your best bet is informal loans from friends, family and ‘fools’ (3Fs). Other relevant funding types includes Grants, winnings from a competition, or a Micro Finance loan.

1) Small and informal loans – For many entrepreneurs, friends and family are the first source of finance. They are approachable and generally willing to help you at seed stage. The question goes, if your own family and friends don’t believe in you, who will?

Points to consider: While small financing from these sources can be a good start, these funds are often not sufficient as your company grows. It can get the ball rolling, but you will quickly need to look for solutions that will take your venture into the next stage. Also, be careful what kind of agreements you make to ensure you don’t risk these relationships down the road. Did you accidentally promise equity to everyone?

2) Competitions and Challenges – These can be a good way to get exposure, feedback, and in some cases money. Some are run by companies, others by governments and/or non profit organisations.

Points to consider: The application process for competitions and business plan challenges can be very time consuming. The time spent on applying can also be spent on building your business. If you participate in a competition, know what you want to gain out of the program and make it count. If the time invested doesn’t move your bottom line, ask why you are doing it?

3) Grants –There are a growing number of organizations, universities and governments that look to support venture creation via grant making programs. These programs can be a great resource when your venture is still at an early stage of development. When it comes to grants you might wonder: what can be the downside to ‘free money’? But just as with other types of financing there are always pros and cons.

Points to consider: Small grants may be an option as a seed investment, but for making your company grow most grants will not be sufficient. Also important to consider is that when receiving grants you and your company will have to comply to certain rules and will be expected to report accordingly. Grants can end when a program ends, etc. Another thing to worry about is that applying for a grant usually asks something else than drafting a validated business plan. Commercial funding requires a thought out business model and this actually has the benefit that you are forced to think through thoroughly how to reach an economically successful business.

Startup Early Stage and Later Stage – When you reach next stages in the Startup Funding Cycle and bigger amounts become needed for the financing of your company, one could turn to investors providing Equity or Loans.

1) Incubators / Accelerators – Many programs have sprung up in recent years, especially in technology related sectors. They can provide networks, coaching, exposure, and sometimes facilitate small levels of funding.

Points to consider: Make sure the program fits your business. Is it the right environment, with a good network, and the right mentors? Also good to note is that if business is not technology related, you might have to look harder for these types of programs. If they don’t exist in your market you will be forced to find an alternative. In some cases, you might have to simply start your own networking group.

2) Equity – When your company is too big for small loans, and too small for big ones, equity is the designated option. This is the primary type of finance Venture Capital for Africa facilitates in. Equity means transferring part of the ownership of your company to an investor.

Points to consider: This has, like every type of financing, advantages and dis-advantages. Equity comes from venture capital investors or angel investors, who often bring expertise, network – often times more valuable when compared to the money. As they put their money in your company and very much want you to succeed, they will be keen to help you in any way they can. Also, the investor will want to have a say in your (major) business decisions. Equity means working together.

3) Institutional loans – This includes banks and other SME lenders.

Points to consider: The most important requirement for a loan is usually collateral. If your venture proves unsuccessful, and you cannot repay the loan, the lender has the right to sell your collateral to get (a part of) their investment back. This makes getting a loan difficult for new ventures, often they have no collateral/assets to offer. A promising business plan could make an institutional loan an option, but this is quite exceptional. But when revenue flows start to grow, this can become a good option for funding a venture in growth stage.

**Exits – It is important to realize that most investors want to get out of the business eventually and expect a satisfactory return on their investment when they leave. An IPO (initial public offering) is the dream of many startups, but a merger or sale is more common. In some cases, if you have an outstanding team, you might find this is your biggest asset.

VC4Africa experiences

The Venture Capital for Africa community supports entrepreneurs starting with an idea and supports the entrepreneur throughout this startup cycle. To learn more, check out the five steps to fundraising on VC4Africa. In the VC4Africa community there are thousands of entrepreneurs who have experiences with everything mentioned above, and more. What are your experiences with loans, equity, grants and/or other financing types from different sources? What are your suggestions to smoothly sliding through the African Startup Funding Cycle? Please share your experiences below!