KAMPALA – One of the impediments that we have in the developing world, especially in countries like Uganda, is that those with ideas to make money don’t have the money to invest and those with money don’t necessarily know where to invest.
Consequently, we force those that have money to invest to become entrepreneurs whereas sometimes they are not and then force the real entrepreneurs to look for jobs because no one will fund their dreams.
However if we can correct this anomaly, we can create a substantial amount of wealth in our communities. This requires some investor education on how to invest, where to invest, how private companies work and educating people on the rights of investors /minority shareholders.
Ideas: There are people with great ideas that don’t want to share them with anyone because they wrongly believe that their ideas are worth a lot of money. Ideas are worthless until they are executed upon or rather simply implemented.
So the person that generates ideas must also have the ability to execute on them and/or find a team that is capable of executing on the idea. Ideas need champions to take them forward. That is how entrepreneurs create wealth essentially by spotting problems; organising and aligning resources to solve them.
The person must first and foremost determine what resources they need to execute on the idea. Let’s call this Capital required. Then they have to incorporate a limited liability company as a vehicle to execute on their dream.
We will use the example of Tom the entrepreneur setting up a business (a tomato sauce processing factory) we shall call Tommy Sauce Limited throughout this article.
Tom got the idea that there is a potentially huge market for Tomato Sauce in Uganda and that a company that could deliver quality and affordable Ketchup, could make a killing. Tom also knew about selling fast moving consumer goods (FMCGs) since he had worked with Unilever for a number of years. To set up the factory and run it for the first 1 year Tom estimated that he would need UGX 100M but he had no money of his own. The factory could also make 3 times that much in 3 years.
Therefore he valued his idea at UGX 500M. Note: The valuation Tom is using has some basis but it’s straight out of his head.
Tom then approached Vicky to use her Property to set up a factory. Together they agreed that Vicky’s Property is worth UGX 20M but since Tom didn’t have cash, Vicky extracted a premium in the deal and doubled the price to UGX 40M. Tom proposed to give Vicky 10% of the business being created and a deal was struck.
Tommy Sauce Limited was born with two shareholders: Tommy with 90% and Vicky (silent partner) with 10%. In reality Vicky was an angel investor.
Now Tom knows that he can’t get funding from the bank at this stage and must rely on his network to raise money for the factory and working capital so he approaches his friends and family and manages to raise UGX 50M for 10% of the company. This is usually called a Seed Round. Being an astute marketer Tom convinces a couple of restaurants in town to pre-order his Tommy Sauce and pay him in advance. This advance of UGX 20M means that he now has enough resources to work on his dream. Notice the advance payments do not attract interest and shareholding and that Tom is still sitting on 80% of the shareholding of his new company.
Tom bets it all on his idea and in under 6 months the factory is up and running and in spite of a few hiccups here and there Tommy Sauce is a hit on the market. Sales are now approaching UGX 20M per month and the company is now valued at close to UGX 800M just after two years since it started. Tom is now eyeing an export deal to South Sudan and to export to other countries he must raise new capital. He figures out that he will need a new capital injection of at least UGX 400M which Values the company at UGX 1.2 Billion (Post Money). This is usually called a Serie A. Light Ventures a Venture Capital firm based in Kampala – Uganda agrees to lead the fundraising round offering UGX 200M for 15% of the company but Tom must find other investors for the deal to close:
Tom approaches a couple of investment clubs but they turn him down since they don’t know how private capital placements work and consider it too risky in spite of the possibility of high returns. He pitches to another seven investors but no one wants in. However he soon strikes Gold when his former workmate says he is in with UGX 12M for 1% of the company. This guy is well connected and once he invests a lot of others guys decided to follow him. In a space of 2 Months, 40 other individual investors joined the fray taking a 14% stake in the company for UGX 188M.
Tom is elated but he also worried that now his Capital Table (Cap Table) has a lot of individual shareholders. Note that Tom still owns 50% of the company and his net worth is UGX 600M in the space of just 3 years.
Tom’s idea has created wealth in his community but we can also say it has made him rich. Note that Vicky’s stake in the company is now worth UGX 120M and she can regularly expect to receive a dividend from Tommy Sauce Limited if it does well and if the export deal goes well, the value of the company will likely skyrocket. Of course the opposite can also happen and the company can lose money and everyone would lose too in the process but today we will stay with the promise that it works out well for everyone involved and that we need a lot of Toms to step on the plate. We also need the Vickys and friends and families of the Toms to believe in their dreams that only entrepreneurs can conjure up.
So these are the important things I want you to remember
1. Private companies can accommodate between 1-100 people.
2. They can have a minimum of 1 director.
3. Private companies are not run like SACCOs where one man one vote applies. Here the number of shares you hold equal to your votes which are exercised for or against the company decisions. Each individual will use their voting rights based on the number of shares they own.
4. Shareholders in Private companies can be family and friends; some of them can hold staff positions in the company as Founders, directors and/or be part of management at the same time.
5. Investors/shareholders join on a basis of believing in the dreamer (entrepreneur) first and the idea second. The ability for the dreamer to execute is of paramount importance for that is how value is created. If more value is created, valuation goes up. If less value is created, valuation can go down. Usually Private companies are only valued for the purpose of capital movement (usually in or out).
6. Company Valuations are not business costs. They are only useful when raising capital but not when computing business profitability.
7. Some investors hold their shares until a time when it appreciates and they sell when the company is acquired or goes public on the stock market. This usually creates exits for the initial capital providers.
8. The time frame for exiting a private capital placement usually averages 8 years. So if you plan to invest in someone’s idea let be people that share your beliefs and value systems.
In the next article I intend to write about company valuations and business costs and how the two relate to each other.
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The Author, Livingstone Mukasa is a Financial Advisor, Entrepreneur, People’s Professor of Streetnomics and the Author of “The Great Financial Rebuild” & “Investing for the Future”