Equity Finance for SMEs in SA

My first article on this blogsite was about the new Venture Capital Tax Incentive SARS was about to launch in July this year - now that the incentive is effective, here is a brief overview together with how it could benefit SME owners planning to expand their businesses.

Access to equity finance by SMEs is one of the main challenges to the growth of this sector of the SA economy – potential growth opportunities often do not easily outweigh the risks and SME owners often lack the expertise and network to reach potential investors. In addition, the typical characteristics of SME companies and entities in SA would be as follows:

· They are forced to grow organically
· Are undercapitalised – often attractive businesses in terms of product, future potential and sustainability, but unable to grow / expand (this in turn can lead to missed opportunities and cashflow pressure)
· Succession planning is not a priority – often, the owner ‘is the business’ and little value remains upon his exit (which results in making the business less attractive for buyers / investors)
· Are generally owner managed – business owners sell their business at retirement
· Do not have middle management
· Generally lack solid financial systems and controls
· Are sceptical towards relinquishing a share in their business (fear of loss of control, future direction of business, reduced profit share)
· Given the current economic climate, access to funding from financial institutions has become even more difficult

Venture Capital Tax Incentive

There was a very exciting development on the SME front earlier this year.

To assist SMEs in raising equity finance, SARS has legislated a tax incentive (Revenue Laws Amendment Act 60 of 2008) for investors in SMEs – the incentive came into effect on 1 July 2009 & will run until 30 June 2021. Very broadly, this development entails the following :

· A Venture Capital Company (VCC) fund would be established & approved by SARS (subject to certain conditions)
· Investors would invest in the VCC which would in turn invest in small businesses
· The minimum size VCC fund must be R 30m
· Investors can be individuals & listed entities & would be allowed tax deductions against their taxable income subject to certain criteria
· Individuals would be allowed a R 750 000 deduction per tax year with a life time limit of R 2.25m eg. if an individual invested say R 1.5m into a VCC, they would be allowed to deduct R 750 000 from their taxable income over 2 years
· Listed companies (& their 70% held / controlled subsidiaries) would be allowed a 100% deduction provided they do not own more than 40% of the VCC.
· The VCC must invest not less than 80% of the fund (R24m in this instance) in SMEs where the book value of the assets after the investment does not exceed R 10m
· The VCC can only invest in qualifying companies viz. SA registered & owned, privately owned (cannot be listed). Non qualifying companies include those involved in financial / professional services, property developments, casinos, liquor, tobacco or arms. Importantly, VCCs may invest in companies involved as hotel-keepers ie. hotels, bed & breakfast / guest house establishments, lodges.
· The VCC would normally invest in certain preferred industry sectors and would have strict investment criteria – these would of course vary from fund to fund.

Please note that the VCC Tax Incentive also applies to investments in junior mining companies – although the investment criteria are similar, the VCC fund sizes & target company asset requirements are different.

What would VCCs focus on ?

A recent survey conducted by the South African Venture Capital Association (SAVCA) on it’s members highlighted the following as the key considerations (in descending order) for investing in a particular business :

· Management – the entrepreneur must be honest with integrity together with a great desire for success, excellent management skills, hardworking & reliable combined with good leadership ability ie. Does the entrepreneur and his team have the capacity to grow the business to it’s full potential ?
· Product / Service – a solid market acceptance for the product / service with a competitive advantage
· Financial – the business can provide a high internal rate of return, solid potential for earnings growth and could be worth substantially more in 4-5 years time
· Market – strong market need for the product / service and potential for market growth

Investor readiness

As an SME owner with plans to expand your business over the next 2-3 years, it is vital that you are constantly ready for an approach by an investor / VCC that is looking to secure investment opportunities with solid potential. So what is required and what can you expect should such an approach be made ? – here are some thoughts & suggestions :

The process of raising venture capital can be time consuming (3-6 months) – make sure you prepare thoroughly to save time
Ensure your disclosure document is clear, balanced & up to date & covers at least the following : background, current position, products, markets, management, strategy, financials & the employment of funds received
In an uncertain world, investors like facts & figures (rather than guesses & speculation)
VCC teams back teams rather than individuals – show that you have a spread of skills
Be prepared to answer very detailed questions about your projections (sales & cost drivers)
Be prepared to devote sufficient time & effort to the process

What to look for in a VCC

By acquiring a share in your business, the VCC would of course have a vested interest in the future of the company. At the same time, it would essential that as the owner of the business, you are clear about your expectations regarding the involvement of the VCC team in your operation ie. what would they bring to the table ? A suitable VCC team should be able to offer :

· Mentoring & advice to the SME owner – together with acting as a ‘sounding board’
· Access to new networks
· Strategic & succession planning input
· Various business development services eg. business planning
· Specific expertise relating to various facets of the business

At the same time, a very important consideration would be to ascertain as soon as possible whether you could see yourself working closely with the new investor on a regular basis.

The advantages & disadvantages of equity finance

1) Advantages

· Funding is committed to a business when you dispose of a portion of the shareholding – the investor will only realise his investment if the business does well
· Right investor can bring skills, expertise & experience
· An adequately capitalised business improves it’s ability to borrow (the banks are placing increased emphasis on the strength of a company’s balance sheet)


2) Disadvantages

· Raising equity finance can be demanding, expensive & time consuming – however, even if you are not successful in raising equity finance, it could be a worthwhile exercise
· You will lose total control of your business – however, a reduced share may be worth a lot more in time
· Business owners would have to invest additional management time in providing information to investors
· There would be various legal & regulatory issues to comply with

Going forward

The advent of the global recession late last year impacted heavily on potential investors appetite for risk. Although a recovery is expected to be slow, there will no doubt be opportunities for investors to take advantage of the growth in certain SMEs - as such, one could possibly see the formation of various VCCs during the course of 2010 across SA.

Capital can make the difference between an average company & a great company – there are many solid SMEs that lack the capital to grow / expand. Although they can be high risk, they have the potential to generate high returns provided they receive the right support / input from the incoming investors.

SA needs a strong, healthy & vibrant SME sector – they are substantial contributors to GDP & have the ability to reduce unemployment.

Rules for Buying a Business

I came across an article recently written by Richard Parker of the Trump University Entrepreneurship Faculty entitled 'The 10 Golden Rules of Buying a Business' - it made a lot of sense so thought I would share it with you :

Rule 1 - make sure the business is right for you ie. your strongest skills must align with the driving factor of sales & profits (in other words, focus on your strengths & don't pretend you are something you're not)

Rule 2 - Never buy a business without Seller financing (ever)

Rule 3 - this is a Buying process, not a Looking process ie. if you are serious about buying a business, set yourself a timeframe in which to secure one

Rule 4 - Every business has secrets ie. make sure you do your homework, prepare properly & do a thorough due diligence


Rule 5 - There's no such thing as a 'perfect ' business (it does not exist) ie. determine whether existing issues are incidents or catastrophes; adopt an open-ended, but not reckless, attitude

Rule 6 - It's OK to overpay for the right business (& the wrong business is never cheap enough)

Rule 7 - There are more bad owners than bad businesses ie. there are many good businesses being run by the wrong people - these businesses can prove to be gems if you know how to uncover the drivers of revenue, how to improve & grow it

Rule 8 - Fall in love with the business AFTER you own it - remain objective at all times so that you can formulate an opinion based on factual data & logical thinking

Rule 9 - No one cares about your money or future like you do - validate absolutely everything the seller or agent tells you. It is always better to err on the side of conservatism when your money & future is at stake

Rule 10 - Buying a business is one thing; then you must run it ie. ask yourself the question ' am I going to enjoy running this business everyday ?' You must derive tremendous satisfaction from the business itself if you are planning to build it into something great.

Good luck & enjoy the ride !

Do your homework

I have discussed how important doing the right amount of research is, particularly today, in an earlier blog - I believe it is worth emphasising again.
Whether one is starting a new business, growing or expanding an existent one or even 'keeping one's head above water', one needs to manage and make use of the available information. The current economic crisis has taught us that things can change very quickly and dramatically without too much warning - the ripple effect from the credit crunch / sub-prime fiasco was felt throughout the world within a very short space of time - 18 months ago, not too many people had an inkling of what was to come.
Hopefully (& it is very unlikely) we will not experience a similar crisis for some time to come - but it should serve to constantly remind us that we cannot be complacent, should not assume anything and always consider the worst case scenario.
When doing your planning & research for any undertaking, try and get as much independent input as possible from people you trust & whose contribution you would value.

Thinking ahead

We are all in the midst of the 'great recession' which hit us hard late last year and looks set to continue for some time to come. Although a very tough time for most businesses, it can also be a good time to focus one's attention on the key drivers within a business to ensure sustainability - although business owners have different goals for their businesses, most of them will probably agree that increasing the value of the operation over time is vital.

Some areas of the business to consider could be :



1) Revisit your business model - what are you offering your clients, how are you connecting with your clients, what are the revenue streams & associated costs etc ?

2) Is your business plan current or if you do not have one, set aside the time to put one together - it is a worthwhile exercise to focus on each aspect of the business.

3) How certain are you about where future business is going to come from - look closely at your existing clients, talk to them & try and establish what their plans are for the next 6-12 months. At the same time, how will you secure new clients ?

4) Should something unforeseen happen to you tomorrow, could the business survive without you ? Without getting to bogged down with paper, make sure you have the necessary systems, controls & processes in place so that your staff know how everything is interconnected. Do not assume that they know what 's going on in other areas of the business.

5) Following on from the above point, make sure that you have financial systems in place to produce management accounts very soon after the previous month end - make sure that you get the right information relating to the income statement, balance sheet & cashflow to monitor performance

6) Take time to think about what a buyer of your business would focus on & make sure you these are assessed regularly.


We spend so much time and effort on our businesses - it will pay dividends
to critically evaluate all the key aspects of your business on a regular basis so that we it comes to selling, you can derive the maximum return.

Put your best foot forward

We have had enquiries from four totally different businesses over the past 1-2 weeks regarding access to potential investors - unfortunately, all four gave the impression they had left things to the last minute ie. the potential for expansion was there but they were running out of cash.



Finding a suitable investor today is a lengthy process & given the current global recession, expect higher returns for taking on risk. Investors are of course inundated with approaches by business owners to invest in their businesses - to really attract their attention right upfront, you have to put 'your best foot forward'. By this I mean taking the time to put together a professional business proposal in which you tell a compelling story as to why they should put money in your business. They will look for the following :



1) A business that is unique in some way - does not have to be the latest, most advanced product on the market, it could mean having expertise that very few other businesses have

2) Management - who is running the business, how experienced are they & can they achieve the future targets they have set ?

3) Financial projections & return on investment - are the figures realistic & are they backed up with sound assumptions ?
4) An exit in 3-4 years time - an investor will look to 'cash in' their original investment some time in the future. This could be a sale back to the other shareholders or to an outside party.

There is definitely no substitute to a well prepared & professional business proposal - if necessary, get help from someone who has experience in this area to ensure you 'put your best foot forward'.

Working on your business

Determining a value for a business is not an easy exercise and is commonly described as the most inexact science around ! When it comes to valuing a small private business, the task can become even more difficult - why is this the case ? To a large extent, it is a subjective exercise where the opinion of the valuer regarding the future of the business is expressed.

There are various methods used today to value a privately owned business - from earnings multiples, discounted cash flows, net asset value, return on investment etc. Without getting into the technicalities of this exercise, thought I would mention a few aspects of a business that could affect it's value either positively or negatively (again, they are subjective) viz.

1) The industry in which it operates - is it growing or mature, what recent or current developments could have an impact ?
2) Up to date, reliable & verifiable financial information - outdated and disorganised financial records create doubt in a potential buyer's mind
3) Is past profitability sustainable - it is always difficult to justify future projections if past trading has been below par (unless of course you have secured tangible new contracts)
4) Reliance on the owner of the business - how did he create his success and are his existing client relationships very dependent on him?. Creating a management structure with clear roles & responsibilities covering key aspects of the business becomes critical as the business grows. He may also have certain key skills that no one else in the business has - once he goes, a lot of value could go with him.
5) What is the extent & diversibility of the client base - having one or two big clients is a major risk should you lose one together with having a large exposure to one industry sector
6) What are the barriers to entering the industry in which the business operates ? - if they are low, it makes it very easy for a competitor to enter the industry
7) How many competitors are they - a large number of competitors can place pressure on your margins
8) How unique is the business in terms of the products or services it provides ? If they are easy to replicate, you could lose any competitive edge you may have.

There is a great saying that applies to all business owners - ' Are you working in you business or on your business ?' As business owners, we should be continually working on our businesses to ensure that we improve
the way we do things & how we present ourselves to the market - our goal must be to ensure the long term sustainability of a business so that ultimately, it is very attractive to investors or buyers.

Plan the sale of a business well in advance

Building a successful business takes a lot of time, energy & money - so when one decides to sell, ideally it should be planned well in advance to ensure you are rewarded accordingly.


Over the past few years, we have dealt with various business owners who have decided to sell but unfortunately have not planned well in advance of their expected exit - they normally fit one of these profiles :

1) They are owner managed - the owner 'is' the business and once he has left, a substantial portion of the business's value goes with him. With a clear organisational structure and succession planning in place, this can be overcome. Ideally, the incoming buyer wants to know that the business can function without him.
2) Unreliable and outdated financial information - buyers expect up to date information to substantiate the purchase price. If a business operates as a close corporation, it is worth considering audited financial statements for the most recent year end - it adds credibility to the figures
3) Lack of management systems - particularly operating manuals for the key areas of the business. If everyone in the business knows exactly what they have to do (roles & responsibilities), the business becomes far easier to manage
4) Lack of a medium term vision for the business - where is the business going & how is it going to get there ?
5) A hesitancy to provide detailed information on every aspect of the business - there is no substitute for having the right information when making a decision. Buyers expect a professionally prepared disclosure document right upfront so it is worth spending the time in preparing one.

For most business owners, selling a business normally only happens once - creating the right first impression in the mind of a buyer is critical. It starts the process off on the right foot & should reduce the time and effort in concluding a sale.

Would be great to hear from business owners on their thoughts / experiences regarding this critical aspect of owning a business.

Think Win / Win when buying or selling a business

Last week we finalised the sale of a small chemical manufacturing business - the buying and selling of a business can be a complex exercise that can take months to conclude. With this business though, it was a real pleasure dealing with the seller and buyer and the deal was signed (from start to finish) within 3 months of commencing discussions.

I firmly believe that the main reasons for finalising this deal in a relatively short period of time were :

• The seller was serious about selling and had a good reason to sell
• The buyer was clear about the type of business he wanted to own and was prepared to invest his own money in the business ie. he was not totally reliant on raising debt for the business purchase
• Both parties were accommodating
• The seller was prepared to provide any information about the business to the buyer during the initial discussions
• The asking price was fair
• The seller was prepared to make himself available to the buyer for a period of at least 6 months after the effective date to provide any input / advice

Thinking win / win as a seller or buyer of a business goes a long way in ensuring that an acceptable deal is concluded within a relatively short period of time.

Ensure viability first

I met with the members of a newly formed CC last week - their plan is to start a business that manufactures toilet paper, detergents & soaps. They had completed a business plan but unfortunately it had very little research information on the market environment (particularly competition) and the production process.

My suggestion to them was to undertake a thorough viability exercise on their proposed business & if it still made sense, proceed with putting together a comprehensive business plan - they had estimated they would need to raise +/- R 1.2m to get the business going. With this sort of commitment, rather spend some money upfront to satisfy yourself it is a viable undertaking.

One can always approach a SEDA (Small Enterprise Development Agency) in your area who may assist with subsidising the cost of a viability study and business plan should your application be approved.

One of the most enjoyable aspects of what I do, is having the opportunity to meet with potential new business owners from all walks of life to discuss their new business venture - it is really encouraging to see more and more people entering the SME market to follow their dream to create something special.The type and size of the new business opportunities that one sees are diverse, spanning a wide range of industry sectors.

The reason I meet with them is because most of them need to raise finance or possibly to secure an investor but are not sure how to go about it. I thought that this blogsite would be the right forum to share my experiences with prospective SME owners (no names mentioned of course) & how we tried to assist them in this regard.

Every week I will post an experience I have had in the previous week - what the proposed new venture entailed, what they had done so far, what they still needed etc. In addition, I will include any success stories & learning experiences that the SME owner has encountered.

Having spent many years in the corporate environment, it is exciting to be involved in the SME world (the 'real' world many would say) assisting business owners achieve their goals & dreams. There are of course various challenges facing the SME owner today, not least of which are raising finance, securing additional capital & increasing the net worth of their business.

Ideally, the purpose of this blog is to create a forum for small business owners to discuss these & other challenges but at the same time, finding possible solutions to their needs & wants.

There was an exciting development on the SME front earlier this year - an Act was promulgated in January 2009 (Revenue Laws Amendment Act) incentivising individuals & listed companies to invest in small businesses. Investment funds from both of these will be pooled into vehicles known as Venture Capital Companies (VCC) - parties investing into a VCC will be eligible for a 100% tax deduction subject to certain conditions & criteria. In turn, in order to qualify for this deductible investment status, the VCC must invest in a portfolio of small businesses. The minimum VCC size must be R 30m with the bulk (80%) of the investments directed at companies with a book value not exceeding R10m after the investment. The tax deduction comes into effect on the 1 July 2009.

It will be interesting to see what response there is in the market from existing & new venture capital players - capital is of course scarce at the moment & investors are extra cautious. However, the tax break high net worth individuals would receive (albeit a tax delay until the investment is realised) should prove very attractive. The benefits to SME owners would be significant ie. :

• Capital can make a difference between an average & great company - there are many solid businesses that lack the capital to grow & expand
• A well capitalised business has a greater ability to borrow & invest in capital equipment - how often have you heard of your bank mention that your business is undercapitalised & your company's borrowing limit has been reached ?
• The introduction of the right investor could provide much needed support both operationally & strategically

There has been a delay in the release of the application form required to register a VCC & is now expected towards the end of June 2009 - as a result, one could expect approaches by new VCCs to targeted small businesses late this year.

This of course leads to the question - as a small business owner, are you prepared for an approach by a VCC who could be interested in buying a share in your business ?