Succeed Magazine – www.succeed.co.za – March 2007
It is a bonus if your bank or a government funder lends or grants you money for your business. But more often than not, attempts to raise funding through conventional channels do not turn out positive.
As potential business owners and entrepreneurs, we need to explore all avenues for raising capital to start or grow our businesses. We cannot rely on the banks or the government only.
Take a look at these ideas. They may get your mind working on still more possibilities.
1. Offer to pay a major supplier a premium in exchange for extended credit.
This approach may work if you have a single big supplier whose credit will fund a part of the business. In the case of a magazine, for example, this may be the printer, as printing costs may account for up to 25% of total expenses. An electrical supply company may approach the manufacturer of electrical goods for extended credit. One potential downside of this approach is that high interest will usually be charged for the outstanding money. However, in many cases, the advantage of being supplied with products or services up front easily outweighs the disadvantages. You may have to offer the supplier company additional incentives in order to convince them. Be prepared to negotiate. For example, a magazine may offer to advertise the company free of charge, or the electrical company may offer to conduct a free electrical installation for the client. When using this approach, success often comes down to a matter of trust. It will also typically depend on some kind of relationship existing between yourself and the supplier. Someone who has held management positions in the field will typically be well known and will have developed a standing in the industry. A reputation for honesty, integrity and business acumen will go a long way when raising capital via this method.
2. Attract numerous small investors
Some of the greatest companies in South Africa were started by young entrepreneurs who had raised capital through many small investors, as opposed to a few large ones.
Not least of these entrepreneurs is Pick ‘n Pay founder Raymond Ackerman, who in 1967 went so far as to put in an offer for his initial three stores without the finance for it.
The asking price of the stores was R620 000 and he offered to settle the asking price as R600 000 cash, with R20 000 provided in shares. The next few days became a nail-biting race of frantic intensity. Ackerman mustered up as much as he could, including the entire R100 000 bequeathed to him by his late father. He then went on to raise stakes of R3 000 each, made up of R1 500 in capital and R1 500 as a loan, from 53 investors – 25 from Johannesburg and 28 from Cape Town. The agreement was that interest on the loan would not be paid for the first two years. This gave him breathing space while he built up the initial outlets. As only half the loans were capital, he easily retained control of the business. Ackerman’s purchase was a success, and the business has since become one of South Africa’s retail giants. Some of those original investors still hold Pick ‘n Pay shares today.
Another great businessman who accumulated his starting capital by attracting small investors is Liberty Life founder Donald Gordon. Forty-nine years ago, he drew up a document detailing his proposals for the formation of a new life insurance company, employing a radically innovative approach. It had been his dream to start a life insurance company since qualifying as an accountant in 1953. With proposals in hand, Gordon set about raising the capital for his venture. After nine months of disappointment, frustration and rejection he managed to raise R84 000 from small investors. By September 1958, Liberty Life was on the road. Back then, if you were one of the brave few to back Gordon with R1 000, it would be worth over R13.7 million today. Liberty Life is one of the leading financial services companies in South Africa, and the third largest insurance company listed on the Johannesburg Securities Exchange today. The company’s assets currently amount to more than R144 billion. Many a successful company has been formed through the accumulation of small investors. If you are that sure of your business concept, it may be the way to go.
3. Cash in your equity in long-term insurance
Surrendering your life policies to raise finance for a potential venture is an option to be considered with extreme caution. Certain life insurance policies have an investment component that accumulates over time. The objective of paying a portion of your monthly premium over the years into an investment component is that eventually it starts paying for the life cover, and you no longer need to pay premiums. The tricky part of this kind of policy is that, as your investment portion increases, so does the surrender value of the policy and this becomes a temptation if your business needs finance. The surrender value may be useful in your business, but in the long term you will almost certainly be losing. The problem is that the surrender value is a fraction of the insured amount, and when it is withdrawn, the cover amount is significantly reduced. It is usually very difficult to build your life cover to the level that it was at before, and as you get older, the cost of life cover becomes far more expensive. When starting a business it can be very tempting to surrender your life policies to raise capital and the risks need to be carefully examined. You should ask yourself, should it happen that you die and, without you, the proposed business does not take off, what life insurance pay-out will there be for your family? If this type of financing is seriously considered, your estate as a whole needs to be assessed as to whether you can afford to surrender a policy of this nature. If your business succeeds all may be good and well, but the risk you are taking is real. You could offset the risk by taking out a less expensive term life policy that does not build up equity. That can cover you with life cover. The advantage of this method is that the money is there immediately – you do not have to wait for financing. You have to make the decision whether or not it is worth the risk.
4. Trade equity for expertise or services
You may choose to give up shares in the business in exchange for the services or expertise you need. This approach can result in a massive capital injection for your business. Depending on how much financing you require, the stake you offer may be as low as 5% or as high as 50%. You can offer a large percentage of shares to one supplier or expert, or small amounts of shares to several. Whatever you decide, make sure that you offer an attractive package. Somebody starting a business selling bottled water might look for a small supplier who would be able to provide the company with the finished product at very low or no cost. Alternatively, the supplier can provide business contacts or financial expertise that the business starter lacks and sorely needs. In return, the supplier company could become a partner in the business. While at first glance it may appear that the supplier or expert would be going into competition with himself, if many competitors already exist in the marketplace, this method might provide him or her with an additional point of access to the market. These types of deals might appear risky and success will often depend on your reputation in the marketplace. The person you approach is therefore only likely to agree to the concept if he trusts that you will make a success of the business and will honour your commitments. And that he will get more than his money back. Bringing in an outside partner has its own issues. The partner will most likely want to take part in the decision-making process. He or she may want to go one way while you want to go another. If the partner’s vision is different to yours, this can lead to conflict.
5. Find a short or long-term strategic partner with the resources that offset the need for investment
A great idea for a concept, product, service or a business that requires specific expertise is often held back by the lack of it, or enough money to hire someone with such expertise. However, there are ways to get around these obstacles. Scott, a young Johannesburg entrepreneur, investigated suppliers of a high-precision grinding machine, used for the highly specialised grinding down of high-tolerance material. During his search, he found an owner who was a partly retired engineer and who was not using his grinding machine. Scott and an associate entered into an agreement that gave them one year to generate revenue with the machine. If successful, they would buy the machine by paying an agreed monthly amount. They launched their business this way. Without this deal, they could never have raised the money to buy the machine in their first year of operations. Another option would have been to give the owner of the grinder a share of the business. Then Scott could have avoided paying for the machine entirely. The advantage to this approach is that you may be able to go to market much faster than you would if you were waiting until you were able to raise the capital to build your product or open your business. In the case of the grinder, Scott gained valuable equipment, but you can also gain expertise that is needed – not just hired expertise, but expertise with a stake in the business. A strategic partner who has suitable expertise may be exactly what you need, provided you are able to work with this person. At the onset, negotiate a reasonable buy-out option, so that eventually you can be the full owner of your business or concept. It does not mean that you are compelled to buy your partner out – it just gives you the option. Your investor may be more valuable to you as a long-term business partner. You could also negotiate a ceiling amount – the partner is automatically bought out once this amount is paid out. This figure would have to take into account a mutually determined base value of the investment in services, support, overheads and expertise. You may need a third party to help with this. Be sure not to give away too much in the beginning. Expertise is not the only resource you may need. Under certain circumstances, it could be in your interest to open a small business via a large company that allows you to use unused machines. In turn, they could either receive revenue, a percentage of the business or both. Resources cost money. You can trade either shared revenue or equity for the resources. However, remember that equity, once traded, may be gone forever.
6. Build your concept or product for a client at a reduced price and retain the ownership
The idea here is to negotiate with client on a service, product or concept the client company needs. You agree to build it for them at just above cost, with only a small profit margin. In turn, you retain the copyright or patent right, and can take it elsewhere to market and sell it. The client can only use it internally and cannot market it. You may have to agree not to sell to certain competitors – for a specific time only, if possible. The advantage is that the client provides the necessary financing, while you have a new offering of a revenue-generating product or service. You will need to find a client that has a need, with a solution that you can provide at a lower price than anyone else will provide. Your offer needs to be so excellent that the client cannot say no. Once you have developed the new concept, you can sell it to other clients and start showing a profit. This idea will appeal to software people and the designers of training courses, but there may be plenty of other possibilities for this kind of agreement with a large company. Another possibility is that a client may come to you with a specific need. The idea might not be yours, but the expertise to provide the solution is, and you can see the roll-out possibilities. In this case, you might set a low price, while maintaining the right to take it elsewhere. Central to this idea is always that the client does not have any ownership, only the right to internal use. Make sure that the exclusivity time period is clear or agreed upon, otherwise the client company might feel you have taken advantage of them, or that a confidentiality agreement has been broken. This could ruin the relationship or even cause a legal dispute. But be careful. Underestimating your development time and costs could put you out of business or prevent completion of the project, creating all kinds of legal and reputation challenges. Be sure there is a market for your new concept, product or service. This is the only reason for the initial client to receive a discounted service. This method is often used with prototypes, where a client agrees to prove viability and work out potential problems before the product goes to market. The client becomes the test market and receives an excellent discount. Again, it is a win/win arrangement.
7. Have somebody sign for you with a major supplier
Getting a friend or relative to sign surety for you with a major supplier is another way of raising finance. Take Succeed. The first edition of the magazine was printed 11 years ago, after a friend signed for Miriam and Wessel Ebersohn, guaranteeing the printing house that they would be paid. The friend, Martin Dannheiser, then owner of the Springs Advertiser, had previous dealings with the Ebersohns. The couple had sold a previous business that owed Dannheiser money at the time of sale. When the new owner tried to avoid paying back the debt, the Ebersohns honoured it, even though they were no longer legally obliged to. “Having somebody to sign for you is a question of trust,” says Wessel Ebersohn. “That act built trust – he felt he was not running an undue risk.” A close existing relationship with the person or company you are going to ask to sign for you is obviously necessary. Less than that will simply not work. In instances such as these, success will typically depend on your reputation in the industry. People want to be sure that they will get their money back. If you are experienced in the field, and have perhaps held management positions at one or two other organisations, your years of expertise and reputation for honest and ethical behaviour will all count strongly in your favour.
8. Get a company to invest in a product or project
Instead of giving away equity to raise money, you could have someone invest in one of your products or services. They then own a percentage of the product or service, not the company, and gain revenue from just those sales. When starting a business, do this with your main product or service. Initially most of your effort and overheads will go into this, generating most of your income – enough to launch your business. In time, you will almost certainly want to expand or create additional revenue through new offerings. Usually, your product that was originally most important to you will not remain your number one.
A BEE procurement advisory business may start, assisting companies with their BEE rating scores, as the main source of income. Later, the business can have someone invest and own a percentage of a second service that helps corporations source and identify those BEE companies that can do the job properly and deliver on time, through a categorising system that rates companies on ability to deliver. New staff, paid for by the investor’s money, can be hired to run this division. After commissions, fees, operating overheads and loan payback (if applicable) have been deducted, the investor shares in revenue. The stake in the product or service does not necessarily equal the percentage revenue the investor gets – hard costs have to be deducted first. You could have more than one investor or partner. Focus on people who can open doors, offer expert services, have channels of distribution and generate sales. You can do this with two or three products or services at the same time, especially if the offerings complement each other and can be sold to the same market. Try not to split your focus, making investors wary. The advantages of this method are that you do not give away part of your business, and it is the product, service or opportunity that is at risk, not the business. Pick people you know you can work with and who does not need the money back immediately. If they invest R200 000 in money and you invest R100 000 in sweat equity or intellectual capital investment, negotiate that you get your R100 000 when they get their R200 000 back in loan payments. Negotiate a reasonable buy-out agreement from the start. You may not want them as partners forever.
9. Be part of another successful company for the first two years
You are ready to launch your business. You have worked in the magazine industry for several years, establishing an extensive contact base and gaining experience across many areas of business. You have also done your research. You have pinpointed an untapped niche target market, and have broached the concept to several colleagues who have all responded enthusiastically. You know you are ready to go it alone. You have the experience and expertise, but starting up your own operation is expensive. Rent, salaries, advertising and printing costs add up fast. The lump sum in your bank account may not be enough – an additional cash injection would give your business just the extra boost needed to get it off the ground. Approaching an established company that operates in a similar line of business is one way to get the extra funding. Several publishing houses operate multiple publications under one roof. You could start your business as a part of one of these successful organisations. The company would provide you with office space and equipment, financial controls, suppliers, expertise – and branding. Indirectly, this approach could help you raise several hundred thousand rand. However, you will need to draw up detailed legal documents, listing the rights and responsibilities of each party. Make sure the agreement is clear and that it includes a buy-out option. If your long-term plans involve operating independently of the company, one potential downside to look out for is the fact that you will inevitably be required to buy the company out – and at this point the organisation will almost always ask for more money than it originally put in.
10. Raise money through a stokvel
While retaining their communal nature, some stokvels have sophisticated micro-lending schemes in place. Evolving out of the need to create a trustworthy environment for saving, stokvels were first used by labourers in the early 19th century as an alternative to formal banking. Members contribute a fixed amount to a common pool on a weekly, fortnightly or monthly basis. Money is accessed either when a particular occasion or need arises, or in rotation. The stokvel concept has expanded to include a range of offerings that cover a broad spectrum of life needs. Christmas stokvels allow for savings for a generous Christmas shopping spree, while a stokvel hybrid, the burial society, provides both financial and social support to grieving families. Money realised from stokvels can be put to good use in either starting or growing a business. Although, to make a serious difference, it may be necessary to join one in which contributions are high. Apart from the direct savings benefit, a stokvel can be used in many ways if the members are enterprising enough. An interesting example of how stokvels are used to raise finance is provided by the Community Theatre Stokvel Initiative. Established by the Victory Sonqoba Theatre Company, the stokvel is generating income on several levels. Established as a membership organisation, it charges each group of performers that join a fee of R2 000. This money is then deposited into a trust account. A compulsory monthly fee is charged, and when one member group performs, all the groups each pay R1 000. R500 of this amount is transferred into the trust account, while the remaining funds may be used at the discretion of the host group. In addition, each member group is responsible for selling 20 tickets each, which in effect guarantees the performing group an audience. The stokvel also provides the host with media and marketing services. It has established relationships with two radio stations, Jozi FM and Alex FM, and both stations broadcast interviews with the groups before their events. The stokvel has also developed partnerships with tourism companies that provide tours of townships. Operators charge tourists to watch a group’s performance and enjoy an African style buffet, with ticket sales then deposited into the trust account. More than 9 000 stokvels, burial societies and savings clubs have spread across South Africa in the last 50 years. It is estimated that the close to 50% of black South Africans who belong to these informal organisations contribute savings of around R12 billion annually. One has even been reported in Johannesburg’s northern suburbs.
11. Borrow from friends and relatives
The biggest advantage of this approach is flexibility. Because you are borrowing money from someone you have a personal relationship with, changing the conditions of a loan, making occasional late payments and reacting to changing life circumstances are much easier.
Another advantage is that when all other options have dried up, your family and friends are always there. That being said, borrowing from loved ones should be a last resort, not a first. While other options put your possessions or money at risk, this puts your relationships in jeopardy. If you fail to pay, your personal life could turn sour. Difficulties also arise in payment times. Borrowing from a friend or family member is different to a straight business relationship. A banker can send you a nasty letter, if you are not meeting a loan agreement, and it will not be personal. If a relative gets similarly anxious, the tensions that arise will be much closer to home. For this reason it is advisable to make the loan as formal as possible. Show your potential lender a comprehensive business plan to receive and repay loans – much as you would with a formal lender. Let them know exactly what to expect. Making an agreement in writing is an imperative. This should set out the first and last repayment dates, other repayment dates, repayment amounts, interest rates and, most importantly, what will happen if the loan is not paid back. Regarding the last point, make sure you avoid extreme guarantees. Pledges of handing over your house in the event of failing to pay could put your loved ones at risk. Such a guarantee, essentially, says that your friend or relative will be putting you on the street if you do not pay them back. You have to ask yourself if you really want to put them in that position.
In brief
Sometimes we expect too much from banks, the government and venture capitalists. What if you raised a fair amount of money indirectly with several of these methods, and then went to a bank? The bank would see the effort you put in, and the financial equity and contribution you made through being creative without its financial assistance. This would sit well with the bank, and increase your chances of borrowing from it as well.
Bill Gibson has spoken to over one million people around the world and is the chairperson of and a partner in Knowledge Brokers International SA (Pty) Ltd (KBI), along with Marius Liebenberg. Bill Gibson is the author/developer of the 25-module sales system titled The complete sales action system and the eight-module Managing complex business relationships system. For more information about Bill Gibson as a speaker and the KBI products, contact 011 784 1720 or bill@kbitraining.com