In part two of an exclusive three part guest post series written for Disrupt Africa reflecting on a year of reviewing innovation pitches, David B. McGinty, Team Leader of the Human Development Innovation Fund (HDIF) in Tanzania, looks at four aspects of enterprise development required to scale innovations.
In the past year at HDIF we have invested in 24 new ventures, including SimGas, Ubongo Kids, and Shule Direct. From the first meeting with the leaders Mirik Castro, Nisha Ligon, and Faraja Nyalandu, we knew they were our kind of partner. The teams are passionate, dynamic, collaborative, lean, responsible, open to change, and speak the HDIF language. They also know how to generate a profit and want to have a tangible positive impact. And, they want an investor relationship that matches what HDIF has to offer: funding plus collaboration, networking, and technical assistance.
However, funding is often the primary focus of entrepreneurs, overlooking the total value within an investor-entrepreneur relationship.
In partnership with investors, four pipelines should be understood by entrepreneurs and developed to support strategic growth: ideas, people, resources, and organizations.
Each pipeline requires a different level and type of support at distinct times. And, a good investor match depends on the stage of a business in each pipeline syncing with the investor’s profile.
Diffusion is one aspect of the innovation life cycle: essentially, the story after basic prototyping when the innovation begins to be adopted. Many models describe the life cycle of innovation, including E.M. Roger’s Diffusion of Innovation. Check out Crafting Organizational Innovation Processes, which presents five basic stages of innovation: idea generation and mobilization, advocacy and screening, experimentation, commercialization, and, finally, diffusion and implementation. Some investors are willing to take risks on earlier stage, more theoretic or conceptual ideas. However, most formal investors require tangible evidence of the idea—at least a basic prototype and consumer feedback. If an idea has not left the laboratory, get ready for a tough Q&A session.
During my Deloitte days, the service mantra was having the right team and skills at the right time. The same is true in investing. Assessing the team around an innovation (whether by due diligence, discussions, engaging customers, or otherwise) is a critical aspect of investment decision-making and management. Certain investor preferences are nearly universal—for example, a dislike of liars and risk aversion. However, entrepreneurs span the spectrum of development from inspired but inexperienced to experts in technical fields and scaling profitable businesses. The team must be able to rationally defend their experience and capacity in light of the level of support an investor will require, especially if the entrepreneur does not want offer equity.
Investors may compliment funding with a proportional mix of mentoring, reporting, governance, and management. Before a pitch or application, an entrepreneur can save time by first exploring a potential investor’s preferred target profile and style for support.
On the funding front, entrepreneurs need to be clear in three critical areas before pitching: size, stage, and type.
Funding size is the amount of cash needed at this stage of idea, people, and organizational development. For an investor, the funding size request can illuminate the team’s understanding of the potential market, valuation, investor landscape, and their own capacity.
Funding stages span from R&D (for prototyping and testing) to seed capital (for leaving the laboratory) to start up capital (for early market testing) to growth capital (for diffusion).
Funding types are, generally, debt, equity, convertible debt, repayment grants, responsible grants, and cash awards. Specifically in pitches this past year, I witnessed growing confusion about the value of donor grants. Grant funding can buy down risk of other investors by supporting applied research, early stage prototyping, developing an evidence base for the impact of a commercial solution, or testing a market that isn’t known enough to attract capital investors. However, grantee responsibilities can distract and consume time, turning off potential future investors. Grants have reporting programme requirements, financial reporting, possible tricky contractual terms such as unilateral cancellation and intellectual property rights sharing, tendencies to over manage risks, and intensive relationship management with large donors and NGOs.
Although grant funders like Canadian Grand Challenges and HDIF have adjusted practices to better align with startups, an entrepreneur should make an informed decision to pursue grant funding with healthy skepticism before applying or pitching. Partnerships with experience grant managers are highly encouraged for businesses new to grant funding.
Finally, entrepreneurs often overlook the organizational capacity to handle specific investments. The discussion above on grant funding is a good example: does the company have the financial and other systems to satisfy donor reporting? Certain investors are willing to invest pre-start up but investors on the other end of the spectrum will require robust systems to be in place to secure the investment. The key is having an organizational structure that possessing the right capacity to facilitate the idea, people, and funding at the present stage of growth.
Too often one or more of these pipelines is ignored, not considered, or simply found too daunting to approach. Entrepreneurs should assess where they are in each of these pipelines and find investors who are looking for a similar profile.
Part three of this series will appear next week and explore how investors find investible businesses in difficult markets.