In 2019, the failure rate of startups was around 90%. A strong recurring reason for this failure is a lack of capital at the initial stages to develop the business, and a lack of capital to enhance its continuous growth. We look at what seed capital and angel investments mean for startups.
Why do Startups need Seed Capital?
Startups usually require a large amount of capital to get itself off the ground and running. Getting capital is a critical stage for every new business, as capital is required to develop the business plan and set it in motion. Statistics show that for 33% of small business owners, the greatest challenge is lack of capital.
29% of small businesses fail because they run out of funds. Thus, once adequate capital is gotten for each stage of growing and running a startup, such a startup has a better chance of succeeding than startups with little or no capital.
Capital can be gotten from a variety of sources, such as venture capitalists, banks, lending houses, etc. However, before these sources can provide a large amount of capital required, startup owners must properly develop the business or product idea and successfully sell same to potential investors. Seed capital is needed to develop such a business idea which will, in turn, be presented to investors who will provide bigger capital to run the business.
Preliminary activities such as market research, product research and development (R & D) are critical aspects of developing a business plan. A major reason for the failure of startups is fundamental shortcomings in their business planning, and a poorly drawn-up business plan may be a result of insufficient capital which is needed to carry out thorough research.
Statistics show that 30% of startups fail from a lack of capital to grow the business for marketing, personnel acquisition, design, and development of the technology and business direction.
Its 2019 report also showed Kenya and Nigeria as the premier investment destinations on the continent for that year, attracting US$149 million and US$122 million in funding respectively.
Investors such as venture capitalists and banks usually require a well-drawn up business plan before they decide to invest in any business. It is the business plan that shows them whether such a startup has the potential to succeed and bring the envisioned return on investment. Investing in startups is considered high-risk and this is because such startup has no track record of success or any portfolio to prove to investors that their money is being invested in the right business.
A lack of seed capital may mean that a startup owner will not be able to properly develop his business idea. And this will mean that such a startup will not be able to attract venture capitalists and/or banks that have large amounts of money to invest. Seed capital may come from the owner’s personal assets, or from his family and friends, and such capital is a relatively modest sum. It has been shown that 77% of small businesses rely on personal savings for their initial funds. Family members and friends may or may not get anything in return for what they invest in the business, depending on what they agree on with the business owner. Another source of getting seed capital are angel investors.
Angel investors are persons or groups who provide initial or continuous capital for startups in return for ownership equity in the company or convertible debt. They could be family members and friends of the business owner. They could also be unknown persons to the entrepreneur, who are looking to invest and get a stake in the business or just to mentor the startup.
Apart from monetary investment, angel investors could also provide technical know-how, mentorship, financial planning or legal advice to a startup. In 2018, there was an estimated 345, 000 business angel investors in Europe. The name ‘angel’ is given to this group of investors because they are the ones who invest in a new business when no other group of investor is willing to do so.
Angel Investment (in Africa)
In recent years, there has been a rise in angel investment and other early-stage investments in Africa. According to a report from Disrupt Africa, funding for African startups jumped by 51% to $195 million in 2017, while the number of funded startups also increased by 8.9%. Its 2019 report also showed Kenya and Nigeria as the premier investment destinations on the continent for that year, attracting US$149 million and US$122 million in funding respectively. Another report by Weetracker in 2018 also showed that USD 725.6 million was invested across 458 deals in Africa, which was over 127% increase in the number of deals in 2017.
Furthermore, Future Africa, an African-based angel investment platform recently released a report showing that it had invested $1 million in 9 African startups in the third quarter of 2020. Perhaps, the reason for the exponential growth of early-stage investment in Africa is due to the untapped human and natural resources on the continent. It is estimated that the continent’s labour force is expected to reach 1.1 billion by 2040 and that she has 60% of the world’s unutilized but arable cropland, as well as the world’s largest reserves of critical minerals.
Or perhaps, it could be because of the vast opportunities available for developing emerging sectors such as fintech. Or possibly it is due to the fact that African companies grow faster and are more profitable than their global peers. Whatever the reason, one thing is certain, and it is the fact that the coming years will see greater investment infiltrate the startup space in Africa.
How to Attract Angel Investment
Since angel investment is often the primary and one of the easiest sources of funding for many startups, and since they fund more startups than all other venture sources combined (over $25 billion annually), it is important for a startup to know how to attract them.
The first is to get the basics right, such as having a viable business product or idea. To attract angel investment, a startup owner must ensure that the business idea he wants to pitch is viable and has growth opportunities. This is a fundamental factor considered by angel investors or other early-stage investors. One way to check for this is to consider whether the market has a need for such a business product or service. Statistics show that the most common reason small businesses fail is that the market does not need their product or service. No angel investor will invest in a company whose business idea is not viable enough or even needed in the market, angel investors look for companies with growth and export potential.
Another basic to get right is assembling a strong team for the business. Angel investors want to see that the team that is to run the business is functional and competent enough to drive for profit. It has been shown that 23% of businesses fail because they don’t assemble a good enough team. Angel investors look to avoid such businesses. And although many business owners choose to run solo, that is another shown cause of small business failure.
In 2019, the failure rate of startups was around 90%. A strong recurring reason for this failure is a lack of capital at the initial stages to develop the business, and a lack of capital to enhance its continuous growth.
The next step to take in attracting angel investment is to look for angel investors that are specific to the industry of the business in question. There are angel investors who focus on a particular sector of industry and are usually experts in those areas. Such investors look not only to invest money but also to provide mentorship and guidance to startups. It is easier to get angel investment this way.
Another factor that startup owners should consider is identifying angel investors that are geographically close to them. The reason being that the peculiar nature of angel investment is that the investors look to add value to the startup, either by serving as an advisory team or by having a stake in the decision-making process. It is thus important to know beforehand the value proposition being offered by the particular angel investor. “An angel wants to be nearby so they can drive over to talk to the principals,” says Jim Orgill, managing director of advanced technologies for the Business Development Bank of Canada.
Having a viable exit strategy is also a key factor that some angel investors consider before investing in a startup. It is therefore important for a startup owner to draw up an exit plan which will include how the investor can get back their money if the business fails. Some common exit strategies investors lookout for include having rights to sell the shares or gaining money from mergers.
Finally, joining business and trade organisations, as well as other community organisations, is an effective way to network and meet people who may provide insights into getting financing or other assistance for a business. It is also a way of getting one’s startup in the face of as many people as possible. Angel investors may also be found on online sites that connect entrepreneurs with angel investors and other early-stage investors.
Conclusion
There are 305 million total startups annually and 100 million startups are opening each year. However, 21.5% of startups fail in the first year with the percentage increasing in the second, fifth and tenth years. In 2019, the failure rate of startups was around 90%. A strong recurring reason for this failure is a lack of capital at the initial stages to develop the business, and a lack of capital to enhance its continuous growth.
Obtaining seed capital to develop the business idea and set it in motion is a critical stage for every startup. Attracting bigger amounts of capital from sources such as venture capitalists, banks or lending houses will only be possible if the startup owner is able to properly develop his business plan and tighten up the strings in the area of product development, market research, pricing, building a strong team, and having success with the product or service in its initial stages of operation.
Capital gotten from the owner’s personal assets or from his friends and family may not be sufficient in some instances to develop the business idea and set it in motion. Therefore, angel investments have become a trusted source of obtaining seed capital for the initial stages of the business. In addition to providing money, angel investors are also available to provide guidance and mentorship to a startup to help it avoid some common mistakes made in running a new business.
Although the number of startups that fail each year is on the high side, having the right information to run a business and obtaining a strong source of funding will help startups ‘start-up’ better in the year ahead.
Author
Emaediong Lawrence | Research Assistant, Start-Ups, Business, Jobs | e.l@borg.re
The opinions expressed are the sole responsibility of the authors and do not necessarily represent the official position of borg.
The ideas expressed qualifies as copyright and is protected under the Berne Convention.
Reproduction and translation for non-commercial purposes are authorised, provided the source is acknowledged and the publisher is notified.
©2021 borg. Legal & Policy Research