Five Things Funders Consider when Funding a Start-up

In the last Blog article “Plugging the Start-up Funding Gap in South Africa, and in my recently published book Nuts & Bolts, I highlight that Eric Ries defines a start-up as a very risky venture operating under conditions of extreme uncertainty to validate a business model. As such, funders are generally aware of the risk and the high failure rate of most start-ups. Accordingly, funders set their own evaluation criteria dependent on their risk appetite and ability to help the start-up navigate the runway during the funding round. It is important to also mention that although some aspects of what is discussed in this article may be applicable to small medium enterprises (SMEs), there are differences mainly arising from the fact that not every SME is a start-up, a matter I delved into in the last article and Vusi Thembekwayo has written an excellent article in this regard.

So what in essence do funders look at or at least should look at when considering whether or not to fund a start-up? This article is based on my experience as part of funding teams based on having spent over eight years at the Innovation Fund, PlantBio and Technology Innovation Agency (TIA) reviewing funding applications of nascent ideas from start-ups and consortia (academic and research organisations and private sector, incl. SMEs). I was a board member at PlantBio and as the board, we regularly had to review certain funding applications based on funding amounts at issue. On the other hand, I was part of the executive management team at the Innovation Fund and TIA, where I was intimately involved with the review of and due diligence on new applications, recommending to the investment committee, and also decisions on whether or not to continue milestone payments based on progress made and also changing market environment. I have seen the same criteria being used in many innovation and entrepreneurship competitions that I have been part of as a judge. Although this article touches on five things, you will realise that in some cases there could be sub-categories within each one of these. In practice, this would vary from one funder to the next – but in general, the following five things form the core aspects of what most funders I have also interacted with look at. So, let us have a look …

1.       The Idea – The funding application or the pitch must be clear on the problem statement and the technical feasibility of the proposed solution (in other words, the innovation being punted, considering that it is only an innovation once it is in the market addressing a problem or unlocking an opportunity). More particularly, the funders will probe whether or not the science makes sense. By the way perpetual motion inventions are something that funders do not even proceed beyond this part of the pitch – because they defy the laws of science. On the technical feasibility, they will look for evidence of the extent to which this has been demonstrated (typically a Minimum Viable Product (MVP) or field tests / pilots). Where there is an MVP or field tests / pilots undertaken, the application must be clear regarding what the next step of the Idea is – in essence what will the funding being applied for be used for to progress the idea. Typically, this may include scaling – there are challenges typically of scaling up and in some cases, the science or reproducibility of the results becomes challenging. Funders will also assess the cost of the customer switching to the proposed solution. The cost does not have to be monetary – it may simply be that the customer needs to do other additional things to use the proposed solution and this may be a deterrent to the customer switching – so what is the pain the customer will have to endure to unlock the benefits of the idea?

2.       The Market – The application must be clear on who the customer is or different types of customers (customer segments), and in particular the size of the market. It is of no use to say that the market is the entire population of Africa. You have to be specific in relation to the problem that you are addressing, other players already in the market or the way that the customers are currently addressing the problem, and what you can possibly do or achieve perhaps over a period of five years. Funders will look at the scalability outside local environment into other countries, for example. Other things to be considered are the barriers to entry, including regulatory and intellectual property (freedom to operate) hurdles. Based on assessment of the market, the investors determine their ability to get a return on their investment (ROI). In most cases, there is an ROI that the proposal must meet. In respect of customers, customer validation in the form of sales or commitments to orders does play an important role in decision making – and hence the importance of an MVP to get customer feedback. It is important to get to the market as quickly as possible to get customer feedback as perfecting the idea hoping that the customer will embrace it often leads to disaster. Under market considerations or separately, funders look at the financials and whether the punted revenues, costs, margins and costs will be sustained long enough for them to get their ROI and for them to have a good exit. It is important therefore that all assumptions are substantiated. In some engagements, it was normal to hear my colleagues argue that the projected revenues and/or profit figures in the financial section of the application should be divided by a factor of π (3.14159) for more realistic numbers.

3.       The Competition – Funders want to know who else is solving this problem, what are the current options and solutions available to the customer, and more particularly why the customer will switch to the proposed idea. In the event that the customer embraces the proposed idea, what is the likely response of the competition? This may be a price war which a well-established customer with good distribution channels and a strong brand may possibly sustain long enough for the star-up to fail. In other cases, the customer may poach key personnel from the start-up or try acquire the start-up. One thing that entrepreneurs should not say when talking to funders is that there is no competition – because there is always a way that a customer is meeting their needs or addressing the problem albeit in efficient or costly – that is competition. So it is important that an entrepreneur thinks carefully regarding who the competition is and more clearly distinguishes their offering to that of the competition.

4.       Intellectual Property and Competitiveness – A question that funders will invariably ask is what makes this idea unique compared to everything else, in particular the competition. We have already spoken about the response of the competition to the market entry – and therefore critical is an assessment of how the start-up will ward off competition. Where the idea is a subject of intellectual property (IP) protection, particularly in the form of patents, designs, trade secret, and copyright, the funders will assess the quality of the IP protection. Typically they will look at whether there are granted patents or not, patent search and examination reports of any applications being processed, countries where patents are granted or applied for and whether there is an alignment with the anticipated markets or manufacturing nodes. (Remember to patent or not is a business decision and one must have a patent strategy aligned to the business strategy. We will return to this in a separate article later this year). They will also look at whether there are any third party patents that may prevent market exploitation in the chosen countries – this is what is often referred to as “freedom to operate” investigations. Where there is IP protection, other considerations are ownership and validity of the rights (granted and in force). Of course not every idea can be patented. Patents in some cases are seen as security that can be monetised or used with another team in case the funders end up owning majority of the business and lose faith in the funded management team. In the case of trade secrets, they will investigate the extent to which the key information has been kept confidential and the ease of reverse engineering – the easier it is to reverse engineer, the weaker the trade secret protection and ideally patent protection would be best. In the case of design registrations – these only protect aesthetic features of an article and hence the protection is limited – unless of course the real selling point are the aesthetic features. Trademark protection is of very limited value in most cases bearing in mind that it is only relevant when the start-up and/or the idea has market acceptance or traction given that trademarks are about branding and distinguishing goods and /or services of one party from those of another in the ordinary course of business.

5.       The Team – Perhaps this is the most important of all criteria, as I have seen funders walk away from a brilliant idea because of a questionable team. In most cases the question is whether the team has all the requisite skills to take the idea to the market and successfully pivot should the need arise. In the case of a very technical or scientific idea, funders want certainty that they will be investing in an appropriately qualified, skilled and experienced team that understands the science and also the business aspects related to commercialisation of the idea. It does help when the team is able to demonstrate that some of the founders have done this before, i.e. launched an entrepreneurial venture or been part of a start-up, even if they have been unsuccessful with other ideas in the past. Funders often will assess what might have gone wrong with past failed ventures and whether the founders learnt any lessons. Unfortunately my experience is that in some cases past failures may work against the start-up, owing to some funders not having enough experience working with start-ups – it does require a high degree of discernment to make a call on past failures. There is an adage in funding circles that – “I would rather fund a bad idea backed by a strong team than a good idea with a weak team.” So the main assessment is the capacity of the team to make something meaningful with the idea and where the start-up needs to be at the end of the funding round applied for; and their ability to pivot should the need arise. It is important that the team demonstrate its ability to work with funders and to take advice from investors. Can we trust this team? How much skin in the game does the team have? Funders consider how much sweat equity and real financial investment the founders have put in to developing their idea to the point at which they are approaching the funder. It doesn’t mean that the founders have to sell their car or house – but there must be demonstrable financial commitment. Another consideration is whether or not the founders and the team are full time in the business or still one foot in business and other in corporate / job. One of the questions that founders should ask themselves is – “Would you fund you?” Belief in one’s own idea(s) is generally demonstrated by one’s commitment and investment of their own resources albeit limited, in the development of the idea. In the quest to get the idea to market, has the team behaved like a chicken or a pig?

As I was finishing writing this, it dawned on me that perhaps the best starting point for any start-up in preparing a funding application or pitch would be to do a comprehensive Business Model Canvas (BMC). This can be done on a one-page and refined a few times and in my experience, helps with clarity of the business model and clear articulation of the value proposition – why this idea is worth looking at. Through the nine components of the BMC, one is able to at least start the thinking process around the five key considerations I have dealt with above as follows, for example:

Things Funders Look At BMC Components

·         The Idea

·         Intellectual Property Protection and Competitiveness

Value Proposition


·         The Customer

·         Market

·         Competition

Customer Segments

Customer Relations and Channels

Revenue Streams, Cost Structure

·         The Team


Key ActivitiesKey ResourcesKey Partners

If you are founder and looking for funding, I hope this article is of use in framing your engagements with investors. Most importantly, do check their funding and assessment criteria before submitting that application or making a pitch. There is nothing that puts off a funder more than someone applying for funding and has not taken time to acquaint themselves with their funding criteria and conditions. Here is to more successful funding applications and pitches.

Let us #MakeItCount!