Mugo started a new business in February importing computer speakers from South Korea and distributing to high-end retailers across East Africa.
Every speaker he sold garnished him a 60 per cent profit. Due to unexpectedly high sales demand, Mugo realised that he needed to import much larger shipment. In his bank account, Mugo only had 20 per cent of the down payment required for another shipment.
Due to the large profit margin involved in computer speaker sales, Mugo made the assumption that securing financing for the remaining 80 per cent would pose no significant hurdle.
Confident in his future success, he met with some of his old university friends one evening. Mugo’s friends cautioned him that finding funding might prove trickier than he expected.
The friends stayed talking late into the evening discussing venture capital, bank loans, angel investors, private equity placements, public bonds, and eventually listing on the Nairobi Securities Exchange.
Mugo went home later that evening perplexed over his options and the probability of his success. He woke up the next morning and drove to a family reunion in Meru.
Throughout the four-hour journey, he thought more in-depth about which source of financing to target and how to approach his different options.
Mugo finally arrived at the family home. While at the gathering, he enjoyed the memorable surroundings and interacting with cousins, aunts, uncles, and even distant relatives.
As lunch finished and family members sat around the compound talking to each other in small groups, Mugo realised that he needed to decide immediately about his source of financing for his business.
If he chose to seek family financing, then he had to start conversations before the family members left the event.
How would you advise Mugo to proceed? Should he seek bank financing, search for investors, or start with family financing?
Many entrepreneurs wrestle with ways to fund their new businesses. The single most frequently asked question at USIU from undergraduate, graduate, and executive students alike: “how may I find funding for my business”?
Further, many new entrepreneurs feel that the funding issue incorporates the most difficult aspect of starting a business.
However, financing is not the most challenging part of new business creation. Creating and implementing an appropriate business model is far more important and difficult.
Unfortunately, many new entrepreneurs think that if they generate a brilliant idea, then funders will desire to rush in and provide money.
Such a scenario almost never happens. Do not expect it, for you will be let down. Do not ask for it for you will look foolish. An idea without implementation provides no comfort for future success.
As an example, USIU tries to secure funding for our entrepreneur students’ businesses. We target angel investors — people who desire to boost new and innovative businesses at very early stages.
Even such charitable investors almost always require some sort of track record, even a brief one, or at least a prototype which could serve as a sample of what you hope to produce.
You must generate your business model, commence implementation, and then seek funding. The only funders who provide financing at an early stage with just an idea and passion might include family and friends.
Family and friends know your character and your propensity for business success. However, involving family and friend might yield very positive or highly negative results.
If your business succeeds and you repay your family and friends, then your interpersonal bond with them may grow immensely and your business may become a focal point for family pride and identity.
On the other hand, if your business fails, do you want to risk your long-term relationships with your family and friends? Families often tear apart by mixing business endeavours.
Alternatively, many entrepreneurs turn to dreams of bank financing. Banks base lending decisions on five main criteria: cashflow, collateral, character, capacity, and credit.
Unfortunately for new business startups, unless the founder has a prior history with other startups, then the firm possesses no historical basis for any of the five banking criteria.
So, a bank would only provide financing if the entrepreneur personally guarantees the loan and provides collateral or security.
Many entrepreneurs fear tying personal assets, such as family property, to cover bank loans for their startup businesses.
Next, as stated above, angel investors provide the next logical target for financing after product or prototype launch. Angel investors typically find motivation for investing from a sense of trying to do good for society and help entrepreneurs rather than the type of return they may receive.
Angel investors often expect their money back in two to four years along with a modest three per cent to eight per cent return on their investment.
Angel investors understand the risks associated with new startups and often provide advice to the entrepreneur on how to structure their businesses.
Angel investors exist in Kenya, but due to a huge demand for their funding, finding an actual match for your business may prove difficult.
Finally, many students in USIU’s entrepreneurship executive masters programme ask whether or not they should accept venture capital as a way to grow their businesses. Venture capital comes with many conditions and requirements.
Often times, venture capitalists desire to remove you from your own company once they acquire more than 50 per cent of the shares in your firm.
Venture capitalists recognise that often times people who are good at starting businesses are not the same people who are good at growing and scaling businesses.
An entrepreneur must know that venture capitalists fund businesses once the business passes out of the startup phase and has a track record.
So, look for venture capital funding much later. Then, understand that pure venture capitalists desire to come into your business, make changes, grow your business rapidly, and then sell their portion for a large profit.
If you desire long-term partners, then venture capital does not present itself as your best option.
In summary, which funding model would work best for Mugo? Clearly he must explore friends and family financing and then search for an overdraft facility at a bank before pursuing an angel investor. Venture capital still remains far away for Mugo’s business.
Prof Bellows serves as the director of the New Economy Venture Accelerator (Neva) at USIU’s Chandaria School of Business.