Plugging the Start-up Funding Gap in South Africa
In my book Nuts & Bolts, I highlight that one of the things that every entrepreneur lists in their top five challenges with their start-up at one point or another, is access to funding to develop their business’ underlying concept. I go further to categorically state that South Africa does not have a lack of funding problem for start-ups and innovation in general. Rather, South Africa has a management problem in terms of how the available funding is spread out across the innovation value chain and consequently, the processes of distributing the available funding. The focus of this article is not on small business funding in general, but rather on start-ups and innovation. In borrowing from Eris Ries’ definition of what a start-up is “a human institution designed to create a new product or service under conditions of extreme uncertainty.” Based on this definition, there has to be some unchartered territory that a business is working on, for it to be called a start-up. So not every small business is a start-up. The unchartered territory invariably points to some level of innovation that the business must be working towards – solving an existing problem, removing some inefficiencies or barriers in a value chain, making it easier for customers to engage with a product or service, essentially creating value that was not there before. Accordingly, the late Harvard Business School Professor Clayton Christensen’s definition of innovation as being “a change in the process by which an organization transforms labour, capital, materials, or information into products and services of greater value,”is a fitting definition of innovation and aligns with the ‘uncertainty’ that Ries refers to when referring to a start-up.
Before elaborating on the funding management problems I have referred to, it is also important to mention that in my experience working with entrepreneurs, most start-ups fail because of a poor value proposition and inability to capture customers through their failure to validate whether or not the problem they are working on is big enough to be the basis of a viable sustainable business. Consequently this results in poor business models or unsustainable revenues. In my engagements with entrepreneurs, they often ask me how someone can validate their solution and business model in the absence of critical funding for them to develop a minimum viable product (MVP). In well-developed start-up and innovation ecosystems, entrepreneurs typically access this initial funding from family, friends, and dare I say, fools (those that buy into a dream without checking how realistic it is). But South Africa is not a normal society nor does it have such ecosystems. Entrepreneurs from well-to-do families are able to fund the MVP through family and friends, hence are in a better position to validate their solution offering to the customers. Unfortunately, such entrepreneurs are a very small percentage (not even a mere 10%) of the pool of potential entrepreneurs in South Africa.
In countries with functioning ecosystems, governments generally play an important role in providing critical financial support to entrepreneurs and start-ups, for example the Small Business Innovation Research funding in the USA which has demonstrably been critical funding for many start-ups. In South Africa, government has over the years established funding agencies such as the Industrial Development Corporation (IDC), National Empowerment Fund (NEF), Technology Innovation Agency, the Small Enterprise Finance Agency (SEFA), SPII (which used to be administered by the IDC), and the Gauteng Enterprise Propeller (GEP), but to name a few. TIA was in part modelled to be a hybrid of the SBIR, and France’ then OSEO in addition to incorporating the businesses of then agencies the Innovation Fund, CapeBio, LIFELab, PlantBio, BioPAD, AMTS, and Tshumisano Trust. I worked for TIA and the Innovation Fund, and so my comments and observations are made within the context of having been an insider of the South African innovation and start-up funding ecosystem. I also spent close to eight years as CEO of The Innovation Hub, with over 350 entrepreneurs in its incubators at the time of my departure in the middle of 2018. The Innovation Hub itself was not established nor operated as a funder. In the book, I elaborate on the need we identified in 2011 to assist entrepreneurs in the incubation programmes with some gap funding, as they were getting stuck in accessing the critical funding to validate their business concepts.
Our experience at The Innovation Hub was that entrepreneurs with innovative ideas could spend anything from 12-24 months being pushed from pillar to post by funding agencies, and most failed to access funding at the end of that tussle. The question that has always baffled me is – why do these agencies take so long to reject an application that does not meet their criteria? The sooner the entrepreneur knows that they will not be funded, the quicker they can move on to find alternative means of funding their ideas. Some may say, why they don’t do that anyway from the beginning – well, most entrepreneurs do, and get frustrated by the indecision, unexplainable delays, and most often, flimsy feedback they get from these agencies, as to why they cannot be funded. Some argue that entrepreneurs have an entitlement mentality – in my experience, such are a minority of real entrepreneurs that I have been privileged to work with. In my experience, all entrepreneurs want, is to be properly informed, timeously, of the outcomes of their funding applications – and more importantly, where they are unsuccessful, be provided with constructive feedback on how they can improve their prospects of accessing financing or other support to take their ideas forward. Bear in mind that some entrepreneurs fund their ideas from other income, where they are fortunate to have one. Owing to underdeveloped innovation and funding ecosystems, there is a paucity of deal making skills in public sector funders, thus explaining the long processing times. Often, by the time a decision to reject is made, the entrepreneur has become very disillusioned or the innovation has been superseded by more competitive solutions. This in part, explains the management problem we have in South Africa. In 2012, The Innovation Hub established the Start-up Support Programme (SSP) as a mechanism to provide entrepreneurs in its incubation programmes with much needed gap funding in the range ZAR250-1m. Eight years later, the results speak for themselves – in the roll out of the SSP we made sure to address the management problems that characterise the start-up and funding ecosystem, with a promise of decision no later than six months, ideally three months. The results as detailed in Nuts & Bolts talk attest to how well we were able to make a contribution to unlocking the potential of many entrepreneurs that may not have survived the start-up battle.
The one danger I see often is our direct comparison to markets with well-developed ecosystems where most financing is done by angel investors, venture capitalists and banks; and where government provided funding, for example in the USA, France, Spain, Canada, Brazil, etc. there are well developed and predictable financing mechanisms to support entrepreneurs and innovators to get to the point of having a validated MVP or at least understand that they will not have a business. So as a country and indeed most of Africa, we need to learn from these ecosystems and then innovate to develop our own ecosystems tailored to our contexts. Capital follows opportunity – this is the case in countries with well-developed innovation ecosystems. Entrepreneurs often require certain level of financing to complete an MVP so as to demonstrate the opportunity and value proposition to prospective customers. This absence of funding to develop ideas to proof of concept or MVP is the cause for much frustration amongst entrepreneurs.
So what solutions should we put in place to address the funding challenges? I propose the following four (4) interventions:
- All public funding institutions must have a social contract with the public in terms of clarity of funding mandates, clear timeliness to provide feedback on funding applications, and constructive feedback where the application is not successful, including referral to either another agency or incubator. Let us fix the management problems.
- Public funders should establish ‘gap funding’ in the range ZAR100,000 – ZAR1,5m as an expedited funding to enable development of MVPs for entrepreneurs meeting the clearly defined mandates / funding criteria. The funders can work with incubators and innovation hubs to ensure proper management of the gap funding and non-financial support to enhance the entrepreneurs’ chances of success. As Socrates famously said “Just imagine if these guys had a little seed money” – indeed there is an element of trust that we must develop and place on our entrepreneurs noting very well that not all of them will live up to that, but most will make it worthwhile. So we need to give our entrepreneurs some gap funding for them to edge closer to giving us new products and services that create value for society. This should also feed the pipeline for larger funding available through agencies such as the IDC and NEF. There is no need to provide a start-up with loan funding unless there have proven that their MVP has market traction and they will be able to repay the loan. So agencies such as SEFA need to relook their funding mechanisms and develop hybrid funding schemes that embed the gap funding as part of feeding the funnel.
- There must be better co-ordination amongst the funding institutions to ensure that there is sharing of information and resources, so as not to duplicate efforts that might already have been undertaken by other public funders.
- Restructuring of enterprise development (ED) initiatives with less money going towards ED enablers and more towards entrepreneurs. It is important that we move away from compliance to value addition and true partnership between start-ups and established businesses. ED should be linked to industry value and supply chain, and companies should be compelled to demonstrate how they have contributed to developing their industry value and supply chains.
Ultimately, we need to also remember that economic impact comes from supporting new businesses and not necessarily from existing businesses. Existing small businesses should be supported through ED initiatives, so that they can grow and be more sustainable. However, more emphasis needs to go into innovative new businesses, the start-ups that have strong value propositions or are addressing real problems in the market place – these have the greatest potential to catalyse new markets as well as downstream benefits in the form of jobs and stronger value chains. Ideally such businesses will be in manufacturing or agricultural value chains – and in future Fourth Industrial Revolution (4IR) industries such as artificial intelligence, robotics, augmented reality, additive manufacturing, and internet of things, and the like.
We have to get the funding and start-up ecosystems to function or we stand to exacerbate the lack of trust in public funding institutions and rob the tax payer of greater economic returns for the taxes they pay.
Let us #MakeItCount!
By McLean Sibanda, Ph.D
18th December 2020
 Eric Ries, The Lean Startup: How Today’s Entrepreneurs Use Continuous Innovation to Create Radically Successful Businesses, Crown, 2011
 Christensen, Efosa Ojomo, and Karen Dillon. The Prosperity Paradox: How Innovation Can Lift Nations Out of Poverty. New York: Harper Business, 2019