Venture-Capital: When my capital is senior to yours

August 27, 2008
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, NAIROBI, August 19 – Richard Bell is a true venture capitalist; he is not emotional, he does not care whether you are the most beautiful or the most gifted engineer or techie, your business plan has to make sense and show projections for growth.

His main interest in any business venture is to ensure that his capital yields the highest returns; help entrepreneurs achieve their dreams and make money in the process, no emotions involved.

Venture capital is financing offered to new businesses, start-up firms and small businesses with perceived long-term growth potential and typically entails high risk for the investor, but it has the potential for above-average returns.

The technology sector has benefited from global venture capitalists.

As the managing partner of East Africa Capital Partners with a Sh6.5 billion venture capital fund, Bell has the tough task of assessing hundreds of business plans and determining which ones to fund.

His job entails looking for businesses with high risks but with prospective high returns. But one challenge is that Kenyans are lousy in writing business plans and the best project may not get a chance to be funded.

“When the businesses come to us for funding, the first thing we ask for is business plans. One of the biggest difficulties is that there are a lot of enthusiastic, young, energetic people with great ideas but they are incredibly poor at articulating those issues on paper,” says Bell.

Out of 100 business plans presented to the venture capitalists, 90 of them don’t have the right information and the screening process is too fast meaning that good projects may be overlooked.

“Failure to get the business plans has hindered many innovative ideas from getting funding; if an entrepreneur can not write a business plan, maybe they can not run a business either, and that is why we do not rewrite the plans,” argues Bell.

East Africa Capital Partners manages funds from private equity and from the Overseas Private Investment Corporation (OPIC) which is an independent US government agency dealing with investments, the US$750 million (Sh50 billion) fund was unveiled by president George W Bush on his last visit to Africa.

The money is invested in many fields among them technology, media and telecoms in East Africa but will soon include projects in Malawi and Zambia.

According to LiquidAfrica venture capitalist analysis, the private equity industry is very small but has been growing steadily in the past few years. African venture capital funds are more often than not supported by government agencies and multilateral agencies such as OPIC. Interestingly, Africa is recognized as a high return investment by many of the financiers in Africa, exceeding other emerging markets.

There is a lot of rumours and urban legend about venture capital; some think it is capital advanced at interest rates while others think venture capitalists are out to take over businesses.

“Venture capitalists are not banks; we do not advance money or accumulate debt. All that venture capital is looking for is to make money; we are equity partners, to make as much as we can. Our interests have to be the same with the entrepreneur, to grow the business and make returns, we are not a bank to provide debts,” argues Bell.

While there is no text book that spells out what venture capital does, Bell says they assess business plans and decide whether they are prepared to give you money on their terms and the entrepreneur can accept or not.

Terms are determined by the opportunity, the vision and the prospective returns; the higher the chances of returns the better the terms.

“If an entrepreneur comes with a business plan saying they are going to be Africa’s version of Google Inc. then the terms may be better than another whose idea may not be clear or those who dream of putting up a computer shop in Ngara,” he quips.

The tricky part for any entrepreneur is knowing basic finance and the risk adjustment returns, which is heavily considered by venture capitalists.

While disputing the myth that venture capitalists are out to take over people’s businesses, Bell says that he does not run businesses – the entrepreneurs do – and the returns are based on whether the business is successful.

“I invest in people who know whether the business model is successful or not. Nobody actually knows but it’s a gamble. I am gambling on the people investing in. If they are not delivering, then we will have a problem. If they grow the business, why would I want to take it?” Bell argues.

The toughest part for any investor is that the venture capitalists’ investment is superior to the entrepreneur’s capital. In case the business does not succeed and had invested in assets, the venture capitalists take off with the assets and it is assumed that the entrepreneur had invested the working capital.

“My capital is senior to your capital; if the business suffers, you suffer more than I. Take a business with a capital of Sh1 million. Say the entrepreneur invested Sh0.5 million, while the rest was injected by the venture capital, and one half is in assets and the other in working capital. If the business fails, I take the assets because I did not make the business fail,” Bell asserts.

Isn’t that unfair? If the business is risky, shouldn’t we all lose? Well, Bell suggests that the entrepreneur should read about venture capital and finance 101 before approaching East Africa Capital Partners for funding.

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