Venture Capitalism – how and why to get in early.

Venture Capitalism is a wonderful thing, if you know how it works and how to get in safely. By the time you finish reading this, you should have just enough information to be a pocket venture capitalist right here in Accra, Ghana. This is the same information that makes so much money for Mark Cuban, Goldman Sachs, the many rich people of Wall Street, and soon, you.

The reality is that, in the good old days, the rest of us could wait for a tech company to go public before we buy and own a piece of it. Back then, companies went public relatively very early. Microsoft went public not when it was valued at a billion dollars. Oracle went public not when it was valued at a billion dollars; same for Apple, and Amazon.

If you bought those stocks back in those early days, and you held them till now, you’d be a multi-millionaire by now, maybe even a billionaire. 

The problem is that these days, there are many valuable companies that have great prospects and easily demonstrate that they are the next trillion dollar businesses in the near future. But you and I are not invited to invest when it really counts. It’s not open to the public until the big guys get the most out of it, then they say “oh hey come buy shares in this company and hope things go well”.

venture capital is a form of private equity financing that is provided by venture capital firms or funds to startups, early-stage, and emerging companies that have been deemed to have high growth potential or which have demonstrated high growth. Private equity financing means you’re giving the startup money in exchange for ownership shares.

Everybody knew very early that Uber was a game-changer. I wish I bought into Uber when it was only a few years old. Uber waited from 2009 when it was worth about $5M, till it was worth over $76 billion in 2019 before going public. Since then it’s stock has moved from just over $40 per share, to just under $60 per share. That’s not exciting at all.

THE REAL MONEY WAS MADE BY THOSE WHO BOUGHT INTO UBER WAY EARLY BEFORE THE COMPANY WENT PUBLIC. THE BIGGEST VALUE IS IN EARLY STAGES OF THE JOURNEY, NOT 10, 20, 30 YEARS AFTER.

That is why I advocate for increased venture capitalism activity in Accra. Because there really is a simple way so that you and I and the regular working guy can create or buy into private companies the way that the big boys and the big girls do, before they go public.

How do you get started?

Let’s get very basic.

HOW TO IDENTIFY A STARTUP

We toss around this this term a lot, but it’s really important to understand how a startup differs from a publicly traded company since venture capitalism targets startups to invest in. I have three main ways to rank startups: the business model, the scale, and the ownership structure.

The Business Model: Don’t think of this as the actual business model that the startup has. It’s if there is a business model that’s already been established, fairly tested and that is ready to scale, but hasn’t been scaled yet. 

A publicly traded company already has a business model that is working to some relatively high level of capacity and now in a public market. In fact that is why the company is now in the public market: to raise funds to scale the more.

Unlike a startup, a publicly traded company has already solved a bunch of their major problems and now they’re looking to take it to the next level. A startup on the other hand, hasn’t really figured that out yet. 

A startup is still looking for that repeatable and scalable business model, and so when you invest, you might be investing in the potential of a future business model that hasn’t really been proven out yet. Imagine investing in Uber before the company tested out and confirmed that the same model used in San Francisco, California can work in Ashale Botwe, around Madina.

The Scale: Scale is really the size and the amount of impact that this company is already having. Think of ‘impact’ as from the perspective of impact on the world, or financial impact. 

It is very common for a startup to make zero revenue; we call that a pre-revenue company, meaning it has yet to make any sales. Or, a startup might make a little bit of cash in a month but the size of “little bit of cash” depends on what they do. Point is, for their sector, its considered little.

On the other hand, a publicly traded company is often times doing hundreds of millions, maybe billions in revenue or profit, just per quarter. So the scale we’re talking about is several orders of magnitude difference. It means a repeatable business model has already been found, and it’s really being put to work and that’s why it’s really showing in the scale.

The Ownership Structure: Another core difference when it comes to investing is the ownership structure. So when you’re investing in a publicly traded company, the company is by definition “public”. In other words, when you invest in a publicly traded company like MTN, you are trading stocks and actually becoming a part owner. You also have the ability to transfer this ownership in a public market. 

The ownership structure in a startup is private. In other words, only the founders or a few investors have control. And you can’t easily transfer shares in a startup company on a public forum like you can in a publicly traded company.

WHY YOU SHOULD INVEST IN STARTUP COMPANIES

To support the vision of company: Again, using Uber as an example, as an early investor some 10 years ago, you would have had the bragging rights as being one of the few to have spotted the great vision and contributed with your hard earned cedis, or dollars. You can’t really say that now if you buy Uber stocks.

When you invest early, you really support the vision of the company when they need that support the most. As an early stage investor, you have the ability to get connected with the founding team to bring the entrepreneurs’ vision to life by helping through other ways like mentoring and other capacity building activities.

Diversify your portfolio: You might also see this as a great way to diversify your portfolio. People naturally want to invest in things that make their portfolio interesting. 

It’s nice to say you have shares in this company and that company but the most interesting thing an investor looks for in his or her portfolio is the profits. Diversifying your portfolio reduces your chances of making an overall loss.

Insane Profit Opportunity: You have to think about the insanely huge amount of money you can make from a financial perspective if you diversify by buying into just a few promising startups. To many people, this is the number one reason as to why they would want to invest in a startup. It’s important obviously to want to have a financial return on your investment. 

When you invest in a startup company, you have the opportunity to make some really insane amount of money. Through venture capitalism, you could invest just $50,000 in what could be the next Facebook or Google and that $50,000 can easily turn into a $1 BILLION return on investment.

These figures get absolutely insane but it makes sense when you see how Uber’s company valuation was less than $2 million in 2009, and $76 billion in 2019. Imagine how much you’d be worth if you invested $50,000 into Uber in 2010. It’s crazy numbers, but it checks out. You’d be worth over $2,000,000,000 today! 

These types of returns are really not possible in any other investment class. Investing in startups through venture capitalism is truly an alternative investment route and should be been treated as such. Nonetheless, making money through this route isn’t rocket science as I am currently trying to demonstrate.

HOW YOU MAKE MONEY AND HOW LONG IT WILL TAKE

This part is really important to understand before you get interested in investing in startups. You have to understand how this all works and make it work in your favour. I’ll talk about a few ways you can make a return on your investment when you invest in a startup.

When the company goes public: When a company goes public, there is an initial public offering (called an IPO). When this happens, the private company you invested in converts into a publicly traded company. 

At this point, there is a public value on these shares that you own in the public market and you can trade this stock and transfer ownership very easily in exchange for cash. You have this liquidity through an initial public offering but that is extremely unlikely because very few startups make it to the point of an IPO. 

BUT, it could happen. It takes about 10years judging from recent IPO’s.

A merger acquisition: A merger is basically when a big company eats (or acquires) the startup company. You might have a public traded company buying the small startup you invested in or you could have another private company buying your startup.

A good example of this is Facebook buying Instagram. 

It is actually more possible for you to make a return through this way than through an IPO. The likelihood of a merger acquisition type of event is much higher. But it’s a much more common scenario. As the investor, you will get liquidity through this acquisition.

Through dividends or revenue share: This really depends on the structure of the startup and its rules concerning investments. You could get paid like a publicly traded company pays through dividends, or through a revenue share agreement.

This is also not a very common way of earning from startups. Startups are small and looking to grow. Most of their focus is certainly not on giving back the money you invested in anytime soon. They want to grow through their gains.

Through secondary markets: Actually this is the way that most of the very smart venture capitalists see liquidity as an early stage investor. This is how it works.

You make an investment in one of the first funding rounds of the company and then in about 18 to 24 months later, there usually is another round of financing taking place. This will present an opportunity for you to sell some or all of your ownership shares in the startup because a new investor will buy out the early investors.

This buying out usually happens when the company is valued higher than at the previous funding round. Which means your ownership shares will now fetch you more money than you paid for them.

WHAT IS THE WORST-CASE SCENARIO?

Venture capitalism is a beautiful thing when you hit the jackpot. There’s a method to doing it properly. But to be completely honest with you, if you invest in a startup company, you could lose 100 percent of the investment.

Let’s say you invest GH¢50,000 in a startup. 18 months down the road, the team falls apart not seeing good traction and they decide not to raise additional financing and the company just shuts down. In this case, it’s unlikely that you will see any kind of a return on your investment. If you’re lucky you might get partial return.

WHAT IS THE BEST-CASE SCENARIO?

Also being 100% honest, if you invest in a startup company that’s hot and you invest in one of their earliest stages of raising funds, the rewards might set you and family up for generations ahead. 

Imagine being one of the early investors in Amazon or Microsoft. Or Facebook or Google. Imagine if you had the foresight to hold on to that investment and not get diluted so much and so you maintain that your position over the course of 10 or 20 years.

Any sizeable investment would in this case be worth nine figures, in dollars. You would be worth maybe a hundred million dollars now. It’s just that the chances of investing in a company under a ten million dollar valuation and then seeing that company expand to a trillion dollar market cap company, over say 10, 20 or 30years, is extremely unlikely. 

Because of that you don’t want to make your bet on the assumption that you will win 100% of the time and never lose. That’s really not how it works. If anything, you’re more likely to have your money turn to zero on any single investment. But there’s a “but”…

BUT, if you invest in enough number of startups, and you have good diversity, then you can actually increase your upside of potential gains.

WHEN YOU SHOULD INVEST.

Should you start investing your money now? This is a really important question because you don’t really want to get into this until you’re ready. I have a few suggestions on when to start investing as a venture capitalist.

After you pay off your debts: If you have debt, you should not be investing in any kind of a startup whatsoever. Now this is different from say debt in a real estate portfolio. This is referring to debt as in loans. Do not take out short-term loans to invest in startups; the venture capitalism model makes this a bad idea. 

If you have massive debt also, you should really not be investing in startups. You should pay that off right away. Put your capital instead into your own financial situation to be in a better spot. 

After building a rainy day fund: You should also only invest after building an emergency fund because when you invest in a start-up, it’s illiquid, meaning you can’t pull your money out as quickly as you’d want to. Unless there’s a funding round, secondary markets aren’t just waiting on you to sell your investment. This isn’t like a publicly traded stock 

So you have to have an emergency fund. I’m thinking you should have a reasonable flow of income with your living expenses taken care for the medium term future. After that, if you’ve got some extra money that you’re looking to invest, then of course first invest in less risky asset classes like treasury bills and other government bonds. 

Do all of that… and then you consider investing in startups. 

IT’S HAPPENING RIGHT UNDER YOUR NOSE.

The pandemic, though generally dreadful, has been very favourable to the tech industry.       For instance, the Video Conferencing tool ‘Zoom’ has become the go-to app for interacting with colleagues and families.

Every sector of industry has had to seriously and innovatively address working remotely, even in agriculture. Tech stocks in particular have done extremely well during lockdowns and the new work-from-home norms. 

Tech Innovation & Integration are now crucial to supporting mission-critical business systems. Now, we need to enable customers to continue to successfully conduct business, anywhere and anytime.

In the 21st Century, companies that thrive will have one thing in common: a strong tech and digital culture. In Africa, there have been many investors that are already cashing in on this opportunity.

Africans are missing out on the gains to be earned on investing in this new tech wave. Most of the Africa’s tech companies are being invested in by companies from the West, outside of Africa. It’s time for Africans to get involved!

Foreign venture capital and private equity firms are dominating Africa. Funding into Africa is good. Nonetheless, more Africans need to get involved to reap some of the value that’s created during the process.

Global heavyweights such as Goldman Sachs, Stanford University, Chan Zuckerberg Initiative, and Andreessen Horowitz have all invested more frequently in African start-ups than African firms. Why? Because they see a way to generate and maintain above-market returns. So, GET INVOLVED!

One more thing… I am merely expressing my personal opinion. You should not construe any such information you have read here or what I have written or any other material as legal, tax, investment, financial, or other advice. Nothing contained in this written piece constitutes a solicitation, recommendation, endorsement, or offer by me or any third party service provider to buy or sell any securities or other financial instruments in this or in any other jurisdiction in which such solicitation or offer would be unlawful under the securities laws of such jurisdiction.

Individuals and entities that have read this article are encouraged to consult their own financial and legal counsel.