There is a big difference between a small business & a start-up. Over the years building MyGrowthFund Venture Partners, I can’t tell you how many entrepreneurs I have come across that don’t understand this
… and you must understand this difference if you are looking for growth funding that is patient.
Africa’s obsession with small businesses as a solution to chronic levels of unemployment has created this mindset of “starting a business”. The idea os that if you start a business you can provide an income and a livelihood for yourself. The mindset itself is good.
But the question is this, “start a business for what reason”?
Most people that start a business just want to survive & put food on the table. So, their businesses are built to provide an income to the founder & their families.
This is not bad. But this is not a start-up. It is a small business.
The idea that the business must provide a source of income for the founder & create jobs as a primary reason for existing means that the business must be profitable.
This is the 1st major difference between start-ups & SMEs. SMEs must be profitable.
So, the founder of the SME usually uses personal savings (savings, 2nd mortgage, pension, etc.) to fund their business. But because they must pay back that debt, the business must generate sufficient cash flows to meet the interest charge of the debt.
So, the founder must make a profit. How else can they sustainably meet the debt obligations?
This is a trap. But to understand why I must illustrate:
A small business will never outprice a large business. Its Economics 101. Remember those lectures at uni or college? Yeah? You should not have bunked them.
Speaking of Economics 101, I was a student of Prof. Karungu at Wits University for the first year. Is Prof still teaching at Wits? Who can forget the tag-line, “Wits gives to the edge”.
Who can forget the fast-talking, joke spitting, shade-throwing Prof.
Back to the thread:
The basic reason big businesses become big is bargaining power. They get better prices at better terms from their suppliers.
The bigger they get, the better their free cash flow (if they manage the working capital cycles efficiently).
Remember the furor around the South Africa pharmaceutical group Clicks SA?
I have seen hundreds of social media posts and comments asking the question of why Clicks does not diversify their supplier base & create more shelf space for small black businesses. This is the classic small business thinking trap.
“Dear big business, please give me a chance”.
This is the Clicks share price movement over the past 5years. No doubt alpha returns when juxtaposed with the index funds that track the pharma stocks.
Impressive Yes?!
A big part of the gain in the share price for Clicks has been how efficiently they have managed their working capital.
Without going through the details of the Clicks Balance Sheet, here is the high-level picture:
The black is the Total Assets.
Part of the growth in their Total Assets is growth in inventory (which is financed by their suppliers because of their trade terms) & cash (the holy grail).
Here is a summary of their financial performance over the past year.
Source: Analysts Report, Clicks Group.
Now have a look at the Balance Sheet. If you are a non-financial person, do not panic.
Cast your eye on the line-items “inventory” as well as “cash & cash equivalents”. Big jump in cash, right?
How does a growth company that is investing more cash into CAPEX and new products, also see such strong growth in cash.
The answer is simple: They are using somebody else’s balance sheet to finance their growth. In this instance, they are leveraging the relationships with their suppliers to sell goods that they have even paid for yet.
Its called OPM: Other People’s Money.
How can they do this? Why would their suppliers allow it?
Simple. Click has large companies as its suppliers that can carry the load of supplying them on credit (what retailers call “terms”) for an extended period.
So, when Joe Soap with a small business wants shelf-space at Clicks, you simply can’t meet the terms.
Remember, yours is a small business. It must generate positive cash flows to pay for your operating costs & a profit to keep you a going concern.
So, the small business owner can’t play financiers to a retailer for the sake of revenue growth.
I have perhaps over-simplified what is a very complex issue. But this is an online article, not an academic thesis.
You get the point.
The small business needs profits to stay a going concern & positive cash flows to meet its current liabilities.
The start-up is VEEEEEEEEEEEERY different.
Let’s take the now overused example of Amazon. Classic start-up story. Look at their Revenue to Profit Margin ratio. Notice the spike over the past few years. Why?
Amazon is built to accumulate market-share (even if you make losses).
This is what we in venture investing call “Scale”. They will enter a new market (new product, new customer, or new geography) & run losses, as long they gain more customers.
Once they have sufficient scale (and they have successfully forced out their competitors) Amazon then normalizes prices and reap the profits from the position of a market-leading incumbent. There is a lot of case law as well as cases pending to establish whether this is anti-competitive behavior. What the Americans call “anti-trust”. But that notwithstanding, the strategy has been hugely successful for Amazon. They have replicated it across product categories, market adjacencies & even new territories.
In this classic start-up tale: profits are bad! (at least while you scale)
So, to summarize:
Small businesses require profits to stay sustainable. A start-up needs an accelerated growth rate, an increase in market share & long-only equity investors.
The founders of the start-up and the backers of that founder see loss-making as a strategy to scale. And it’s not just about scale. It’s about scaling fast. So, they raise early-stage equity funding to finance their losses & support that hypothesis with market share growth.
Why is this important?
Simple. Africa is obsessed with small & medium-sized businesses. The research shows though that start-ups and scale-ups are the most effective ways to address the challenges of a developing market.
1. Find a problem.
2. Build a value proposition around.
3. Formalize that value proposition into a business.
4. Scale that business, quickly!
If you want mass scale in job opportunities, build more start-ups, not SMEs.
Whose got this right?
Israel.
Mauritius, which has just created an RSL to fast-track innovation & streamline the funding of IDEs (Innovation Driven Enterprises).
Morocco, which at the beginning of 2020 surpassed South Africa for the competitiveness of its traditional capital markets.
Rwanda, which is often referred to as the innovation village of Sub-Saharan Africa.
… and did I mention Israel? They have nailed this formula over the past couple of years. If the start-up fails, no lengthy liquidation process. Close it. Tie it up legally. Quickly. And start another.
@EmilyKatePope wrote a great article on this a few weeks ago. Check it out here: fundera.com/blog/startup-vs-…
We @MyGrowthFund have just announced our partnership with
to build their next generation of pan-African start-ups.
I cannot get into the details yet. But check out
shares & page. We are very excited to bring this collaboration to the market. African founders & investors have been working silos for far too long. We are intent on bringing a sense of coordination, standardization, and collaboration to the sandbox.
So, do not forget: an SME is not necessarily a start-up. If you want to scale FAST, have a mass impact, & exponential growth, choose the start-up model.
Back to your regular scheduled program.
Asante Sana.
Vusi Thembekwayo
Global Speaker | Venture Investor | Leader