How we look at venture caital investing at the Industrial Development Corporation of South Africa.

1. Venture capital investing at the IDC
In this article we’ll try to answer the question of whether your business is the kind of business that
we are looking to fund at the Venture Capital unit of the Industrial Development Corporation (IDC),
taking into account the mandate within which we must operate.
Keep this thought in mind and then let’s work backwards from here: We’re looking for a business
where globally unique technology creates a long term sustainable competitive advantage that allows
cash to be generated and returned to the investor in excess of 30% of the amount invested, each
year, for the life of the investment, in other words a real after tax internal rate of return of at least
30%, or ca 4x the initial investment returned to the investor in 4 years!
Well that sounds simple enough, but in reality it’s not. Let’s assume you can tick the box that says
you have proprietary technology. You’re half way there! Wrong. You’ve got proprietary technology,
but is that technology driving a long term and sustainable competitive advantage, or could your
competitor replicate or slightly improve on your offering thereby negating your advantage? Now I
hear you saying that technology is not the only means of creating and protecting a competitive
advantage. You’re right, but for the time being our mandate is restrictive in this sense, and for good
reasons.
What about the stage of growth that the technology or business is going through? In a nutshell, we
don’t invest in an idea. We need the team to have progressed to the point of a working prototype.
This way, when we invest, there is some value on the entrepreneur’s side to balance against our
cash contribution. If we invested merely in an idea, then we could only ascribe a tiny fraction of
value to the entrepreneur’s contribution, and accordingly we’d end up with control of the company,
which we not only don’t want, but aren’t mandated to do.
We invest up to R15m in the first round, for an equity position of between 25% plus one share and
50% less one share. We’re then able to invest up to R25m in follow-on equity capital in subsequent
rounds. We’d prefer your business not to be incorporated when you come to us, but if it is, that’s
also fine. We’re an open fund, in the sense that our money is a balance sheet allocation and does
not have a specific time period attached to it, meaning that if your business will only make economic
sense after a number of years, and you’re not the star investment, we have the capacity to carry on
funding you with the purpose of creating sustainable businesses. Closed funds may not have this
luxury and your investment could be sidelined to free capacity to invest in the fund’s stars.

2. OK, so you’ve ticked the mandate boxes and you’re getting pretty excited. We now turn our
attention to the financials, which although being discussed now, are not a starting point, but rather
the end point. Your income statement and balance sheet are prepared showing monthly figures for
the first couple of years, and thereafter quarterly. You’ve run the numbers through a discounted
cash flow analysis, assumed a weighted average cost of capital of ca 35%, played with the equity to
the investor and calculated the real after tax IRR, and it’s in excess of 30%. Well done! Now we’re
interested, but not convinced. This is where your face to face discussion with us, as well as the
supporting business plan becomes important. Essentially you need to support your financial claims
with sound business logic and defendable assumptions. There are 3 main categories of assumptions
that you need to focus on. I’ll tackle them each separately.
Team: The cash that an investment returns is really a function of revenue and expenses. Can you
convince us that the team standing before us is intelligent, driven, committed and ultimately capable
of managing the start-up business and driving meaningful revenue from sales? This may sound
simple enough, but dig a little deeper into the less obvious management issues that support success
in these two areas, and you’ll unearth a multitude of other questions that we would like answered.
For example: Is the CEO the right person for the job? What is the depth of his/her network? Has s/he
convinced top quality peers to join in the venture? Has s/he convinced quality advisors to associate
their name and experience to the company? Has s/he amongst other attributes the qualities to
inspire, lead, motivate, manage, sell, relate, and empathise? Is the management team trustworthy?
Have they identified their weaknesses and put a plan in place to address them? Will the
technologists, the brains behind the proprietary intellectual property and associated unfair
competitive advantage be involved in the business on a full time basis and remain exclusively
committed to the success of the business? Who’s the go-to person on technical matters? Who’s
going to be held accountable for sales? Does this person have real and meaningful sales experience?
Have they sold a new product into the market before, from the relatively weak position of a start-
up? Who can we call on with regard to monthly management reports and monthly financial
statements? What experience does the CFO bring to the table and do we feel comfortable that the
CFO will be managing the cash appropriately? Are salary expectations for the management team
reasonable and justifiable? At the IDC we don’t ask for any personal surety from the entrepreneurs,
so commitment is shown to some degree by salary expectations, as well as previous cash
contributions from the entrepreneurs to get the company to the point where we can look to invest.
Finally is the management team adequately incentivised with equity or profit sharing? These
questions, when answered in a face to face sitting with the entrepreneur, should give us a gut feel as
to whether this is a team that can make our money work. If however we see notable gaps that
haven’t been addressed by the entrepreneur, it doesn’t mean that we won’t look further. On the
contrary, we’ll try to assist the entrepreneur in addressing these shortcomings.
Technical: Here we look at two aspects of commercialising the business, namely what is the
underlying technology and how much capital is required to take the product to the point where the
business no longer needs cash injections from us? On the technology side we need to understand if
its uniqueness is defendable and whether, if applicable, it can scale. On the cost side, along with

3. comfort around the accuracy of the budgets, we need to be convinced that potential technical risks
and mitigations have been identified. I suggest keeping your budgets as granular as possible, with a
separate line item for every expense, and monthly for 36 months, or at least until 12 months after
cash flow break even. It’s also a good idea to overlay the technical milestones with the technical
budget and to articulate funding milestones against which cash can be injected. It simply shows us
that you understand and endeavour to minimise our investment risk.
Sales & Marketing: This is where most start-up businesses struggle. It is very seldom that the
business fails to develop the product to the market’s specification. It is far more likely that the
business has no idea how to transition from product development to sales. Accordingly, an
inordinate amount of effort needs to be put towards planning this phase of growth and painting a
believable picture of the market and how you intend to address it. The end answer to this analysis is
the revenue line and marketing expense section of the income statement, but once again it’s the
believability of these lines that is under our scrutiny. Begin by explaining the need being addressed.
Where is the pain? It is this key thought that drives everything! Is what you are producing of any
benefit to anyone? If the answer to this is no, then stop. If it’s yes, then what is the benefit, to whom
and how much will they pay for it? If you struggle to articulate this on paper in a business plan or in a
room with focused investors, then how are you going to convince your customers in the short space
of time they afford you? Next study the existing value chain, its key contributors and their
incentives, then assess the market size, identify your competitors and the competitive forces at play,
segment the market and identify your target, set your price, identify possible seasonality, identify
your distribution channels and the economics thereof, elaborate on how you intend to promote your
product, and lastly anticipate your competitors’ response. Then work from first principles to build up
your sales budget. Determine where you anticipate your first sale to come from, then your next sale
and so on. It’s easy to think big once you’ve sold your millionth unit, but you need to convince us
that you can sell your first unit, and we’ll then take it from there. Finally, ensure that you are
allocating enough resources to support the enablement of your marketing strategy.
Now you’re sitting with financials that are established from first principles, and the assumptions
driving your financials are believable and documented in your business plan. You’re ready to look for
funding!
In the case of the IDC, give us a call or email through your business plan. Your executive summary
should show us that you’ve read our mandate and that your investment proposal meets our
conditions. We’ll follow up on your request and assuming there are no mandate issues, we’ll meet
face to face or discuss the application over the phone. We’ll then undertake and initial assessment
of the proposal and if the team agrees that it fits our mandate we’ll propose a due diligence. It’s at
this stage that we really dig deeply into the assumptions driving your financials. A believable
business plan will shorten this process.

4. We hope this article serves as a starting point for further discussion on start-up equity investment in
South Africa. We’d like to conclude with a disclaimer that this is a high level overview of how we do
it in the VC business unit at the IDC. It is certainly not the only approach taken by equity investors in
South Africa.
About the Author
Peter van der Zee is a venture capitalist at the Industrial Development Corporation (IDC) where the
venture capital team make significant early stage equity investments into promising technology
companies with global aspirations. Peter holds a B.Bus.Sci (Information Systems) from UCT as well as
an MBA (cum laude) from GIBS. To talk to us about your investment opportunity, please contact the
IDC Venture Capital unit on +27 11 269 3730.