Want R25 million?

founded in the late 1980s, EDH is a small company that has its roots in the defence sector. Its expertise is the design and development of 3D tracking radar systems that track projectiles in flight, and which were initially used for testing weapons and ammunition. But it soon became evident that the technology could be adapted to sports, to track and measure the likes of cricket bowling speed and other ball sports.

Want R25 million?

By 2005, the company was chugging along nicely, with an office in Stellenbosch and a handful of employees and markets.

All this changed in 2006, when the company came to the attention of Mark Shuttleworth's venture capital fund, Here Be Dragons Venture Capital (HBD). After a series of investments by HBD, EDH's revenue has grown by more than 33%, sport is now its primary focus, it has customers in 37 countries, its Stellenbosch office has become the manufacturing hub, and it now has an international marketing arm based just outside of Orlando, Florida, in the US, and representation in the UK, the rest of Europe, Canada and Asia. And, says Tom Johnson, director: business development & operations at EDH, it may "shake out" the defence side of its business.

Not only was the capital injection from HBD the catalyst for EDH to aggressively step up the international marketing and sales of its products and services, but it's been better able to protect its intellectual property. And, remarks Johnson, its investment even enabled EDH to buy employees golf shirts with the company logo: something directors generally don't have money for when they were funding company growth from a second mortgage on their homes.

DISCOVER YOU INNER ENTREPRENEUR

Budding entrepreneurs dreaming of the similar success stories can take heart: late last month, HBD announced that it was looking to make at least one more investment, but possibly two, of between R10 million and R25 million in a local, early stage business this year, with the focus on companies with innovative ideas with the potential to expand internationally.

Julia Fourie

HBD is a Cape Town-based venture capital firm founded and wholly funded by SA entrepreneur Mark Shuttleworth. His aim, when starting the fund in 2000, was to reinvest a portion of the funds he received from the high-profile sale of Thawte, his company specialising in digital certificates and cryptography, to US giant VeriSign, into South Africa companies.

HBD's first fund ran from 2000 to 2006 and offered seed capital to a range of start-up companies. Nine investments were made from this R70 million fund. One of the successful sales were Red Five Labs, which achieved an 84% internal rate of return.

The new investments will form part of HBD's second fund, launched in 2006 and closing at the end of 2009, and will be the last investments for this particular fund.

This fund has a commitment of R150 million. HBD has made six investments from Fund 2 thus far: into EDH, Fundamo, Clicks2Customers, orderTalk, SACab and Moyo.

HBD is one of only a handful of true VC funds in South Africa, says JP Fourie, executive officer of the South African Venture Capital & Private Equity Association (Savca).  e maintains there are only between 15 and 20 funds in the space, providing seed capital, and middle and later stage funding, with some R2.5 billion in funds under management in the country.

"Yes, there could be more capital available to the market, but South Africa is not bursting at the seams with high-quality innovative ideas. Besides, funding is only a part of the success equation: you need a high-quality product, and a high-quality business plan and risk assessment, among other things," maintains Savca's Fourie.

HOW HBD FUNDING WORKS

"The nature of venture capital is to invest in early stage businesses, in exchange for part ownership in the company, assisting them to grow and become more profitable, with a view to selling the investment to another partner within a three to five-year period," says Julia Fourie, CEO of HBD. She explains that part of HBD's investment criteria is that these investment companies have no less than six months sales history and illustrate a sound global growth strategy that will ultimately allow HBD to profitably sell its shares in the business within five years.

Although HBD is not specific about the sectors in which it will invest, there are a few sectors which it excludes, including armaments, financial services, project-based works such as 2010 initiatives, real estate, tobacco and other morally objectionable industries, as well as very risky industries, such as agriculture which is weather dependent.

"Applicants will undergo rigorous screening and must meet some strict criteria before meeting HBD," says HBD's Fourie.

"Most importantly, investments will only be made in local businesses with tried and tested ideas. "The company must have been generating revenue for the past six months, and show potential to expand exponentially," she adds.

HBD's Fourie says that HBD already receives about 10 applications a week, "but not all of them meet our initial mandate, that is being a revenue-generating company based in South Africa".

From their experience, there are always a large number of technology (software particularly) related proposals, mining, banking (such as mobile payments), fishing, RFID, solar type products and more.

But she does anticipate that the current economic downturn will result in an increase in applications in the coming year.  "Tough times normally result in new ideas coming out as companies are required to become more efficient, people are retrenched and some of them go out and start a business that they have been wanting to for ages," notes Julia Fourie.

FEAR IS THE STUMBLING BLOCK

Alas, says HBD's Fourie, recent research shows that although South Africans have flair in trying out new ideas and a positive orientation to entrepreneurship, only 20% of start-up businesses in this country make it.

Despite a positive orientation to entrepreneurship there is a resistance or fear towards starting one's own business, she adds. The recent Global Entrepreneurship Monitor South Africa Research Report - conducted in association with the Graduate School of Business - shows that around 40% of South Africans between the ages of 18 and 64 believe they have the required skills to start a new business, but fewer than 10% are involved in businesses of their own.

"Fear is one of the biggest stumbling blocks, with many South Africans being afraid to start a new business. The factors that might contribute towards fear are complex, and include costs of adhering to procedures, difficulty of obtaining finance, the risk of operating in unknown market conditions, lack of resources, and a culture and history which has not been geared towards entrepreneurship.

"I think ultimately culture is an important part of this: if you grow up being exposed to entrepreneurs, schools teach you about the concept and even have 'entrepreneurial days', all this leads to a different view on entrepreneurship. I certainly see that, for instance, schools and universities have started building an entrepreneurial culture over the last few years."

Moreover, government has come to the party. "There has certainly been an improvement [from their side] since we started in 2000. The latest being the announcement Trevor Manuel made in last year's budget speech around tax incentives for investors in VC funds, although this hasn't been rolled out yet," observes HBD's Fourie.

Savca's Fourie indicates that these tax incentive are due for implementation in July.

Venture capital defined

Wikipedia defines venture capital as capital provided by outside investors for the financing of new, growing or struggling businesses. Venture capital investments are generally high-risk investments, but offer the potential for above-average returns.

HBD's Fourie is part of the investment team of four key members that makes an initial assessment of all applications, which generally takes no more than a month. Thereafter, those that fit the mandate and show good growth potential will be more closely scrutinised. "This involves outside consultants and a full due diligence process, as it requires a detailed review of financial, human capital, legal, market and product components of the business, which can take anywhere between one and three months."

Ultimately the investment committee makes the final decision with regards to making an investment. This investment's value is not only in terms of a cash injection, but also in terms of providing strategic input, ensuring good governance and investment analyses to assist companies to operate optimally.

HBD's Fourie has been with Mark Shuttleworth's ventures since Thawte days, and with HBD since its launch. What drives her, she says, is being exposed to so many different types of ideas, industries, people and cultures. "In our position, we have a bird's eye view of a number of companies operating simultaneously - this allows us to pick up on interesting trends, similarities, opportunities, and risks."

As for what's next on the cards for HBD, Fourie remarks: "I wish I had a crystal ball. Our first goal is to fully invest this fund [Fund 2] and then we would like to manage and grow the investments until we are able to sell, which generally takes five years, so we will be around with these current investments for a while still. During this period, probably starting from next year, we will look to assess the South African industry again to see what the 'funding gap', so to speak, is and where would we like to pursue a possible fund. If we do identify something, the next step would be to decide things like composition of the fund, how much money is required, and whether we will look for outside investors into the fund, as we get many requests for this, or not," she concludes.