Venturing with dragon slayers

Eight years since its launch, Mark Shuttleworth’s HBD Venture Capital company finds itself in a similar position as many a medieval explorer did. Instead of ships laden with gold, all they had to show on their return were collected curiosities and potentially tradable trinkets. But their importance, of course, lay in the routes they opened for their economies.

HBD, which stands for “here be dragons”, the annotation on ancient maps indicating uncharted waters, has yet to produce a profitable fund, but it has certainly pioneered new routes in South African business finance simply by being, truly, a venture capital fund.

This is in stark contrast to many South African funds called venture capital, which are actually no more than private equity seeking safe management buyout and merger deals among South Africa’s cosy club of corporates. None of them dares to come close to the true venture capital business model of backing innovative ideas that have the potential of huge returns but pose such a high risk that four out of 10 will fail completely, a few will be sold for a loss, one or two may break even and one may be so spectacularly successful that it more than covers the costs of the rest.

“They talk about the thousand percenter,” says HBD chief executive Julia Long. “What typically happens in that model, if you’re lucky, is that one of the investments covers all the other investments, the overheads, plus the returns.”

That is, more or less, the result of HBD’s Fund One, except that “the thousand percenter” is not in the bag yet. HBD launched Fund One in 2000 with R70-million and the hairy mandate of a true VC start-up fund: investments of up to R10-million in ideas that haven’t been formed into proper businesses yet.

The fact that Fund One managed to make only about eight investments in six years indicates the difficulty of pioneering VC in South Africa, and perhaps the steep learning curve that HBD was on. But the resulting handful of investments also throws light on some inventive flair among South Africans in the face of enormous odds against business success:

  • Red Five Labs: So far Fund One’s only profitable deal comes from the sale of the shares it held in this small group of smartphone software developers. HBD invested about R4,5-million and realised a cash profit of more than 100% when it sold its 23% stake to Fedgroup. Red Five pioneered software that allows smartphones to interpret different programming languages.
  • MetriCap: HBD is still maintaining its investment in the invention of a plastic cap that can measure precisely how much paste is squeezed from a tube. The difficulty is convincing the medical establishment that it works, says Long. The product has to form part of long-term drug trials before a breakthrough is possible.
  • Sterizone: An ozone-purifying system devised by the University of the Northwest. “The product didn’t work. I think one of the reasons was that there were too many opportunities, so it was very difficult to focus. And also what one discovers is that what the university means by commercialisation is not the same as in industry. We’ve learned a whole lot of lessons along the way.”
  • Kinetic: HBD sold its stake in the mobile customer relations management system back to the owners.
  • Shuttle Lighting tried to introduce plasma transformers, a new kind of transformer for lighting systems which has since become more mainstream. But it failed against the dominance of the incumbent players. “One doesn’t realise how difficult it is to enter a market like that with a new product and they really struggled. It is actually quite sad because the entrepreneur himself almost matched [our investment] rand for rand,” says Long.
  • Themepack: HBD still has a stake in the advertising company that targets schoolchildren by combining corporate advertising with educational messages on pencil cases.
  • My Beat: HBD has just sold its stake in this start-up based on the idea that a radio listener could SMS a number to receive the name of a song which he had missed. Surprisingly, it worked best with Classic FM, “but it didn’t really take off”. The company went on to manage SMS campaigns based on the revenue-sharing model it pioneered. “We made a small return. Nothing significant,” says Long.
  • Csense Systems: This is Fund One’s potential “thousand percenter”. HBD has yet to realise its investment, but Long says the troubleshooting software for the process industry is performing very well internationally, including the Americas, Europe and Australia. “It’s always slower than you expect, but it certainly has become successful.”

So Fund One may still turn a profit, though this seems unlikely. Perhaps the main indicator is the shift HBD took in 2006 when it appointed Long as chief executive, closed Fund One for new investments and launched Fund Two with R150-million and quite a different mandate.

Fund Two invests between R10-million and R25-million in businesses that have traded for at least six months. In venture capital terms it is an “early stage” financier as opposed to Fund One’s mandate as a “start-up”, “seed” or “greenfields” financier.

The risk is much softer because it can now invest in businesses that have to some extent proved themselves. In fact the mandate does not exclude established businesses, evidenced by some of Fund Two’s investments to date: R25-million in Moyo, the restaurant chain that already boasts a million customers a year, R25-million in IncuBeta, the highly successful internet search-word auction house, R15-million in EDH, the developers of the well-known golf, tennis and cricket ball-tracking system Flightscope, R9-million in Order Talk, a Cape Town-based online fast-food ordering system already used in 600 restaurants in the US and the UK, R36-million in awarding-winning South African mobile banking and payment solutions company Fundamo and R10-million in SA Cab, a GPS and call centre-based network of private taxis.

Long argues that HBD has not sold out on its idea of venturing into truly uncharted waters. An element of greenfields investment remains in Fund Two – building Moyo’s African experiential restaurant into an international hotel chain, for example. Furthermore, Fund Two fills a gap, says Long. Few other funds in South Africa specialise in early-stage investments of between R10-million and R50-million.

But the question remains: to what extent has HBD helped to open up the market for venture capital start-up funds in South Africa? Or has it confirmed fears that there is no market?

Long points to the fact that when HBD started in 2000, there were no other start-up VC funds around. Now there are several players, including the Canadian non-profit Enablis, the IDC’s Venture Capital Strategic Business Unit and Venfin’s Invenfin fund.

The case for more start-up venture capital for South Africa will certainly be clinched if HBD happens to make a killing with its Csense investment. But even so HBD’s shift from start-up to early-stage financing sends a signal that perhaps the start-up market is really as scary as it looks from the vantage point of a safe corporate office block.

In doing so HBD seems to be following the growth curve of nearly all entrepreneurship development projects in South Africa. After starting off with mass appeal aimed at a broad public and start-up businesses, it either closes down or matures to work with very carefully selected entrepreneurs.

HBD at first threw its net very widely, running The Big Idea workshops countrywide and dabbled in a township business fund, as well as an incubator project for university graduates. Now it’s opted for selecting only those entrepreneurs who have slain a few dragons on their own.

A lack of business knowledge
If nothing else, HBD must have gained an insight into the part of South Africa that dreams about making it as big as Mark Shuttleworth, who founded the venture capital company in 2000 after selling his Thawte internet start-up for more than $500-million.

According to HBD chief executive Julia Long, Fund One received more than 3 000 ideas and even today, after HBD moved from ideas to investing in functioning businesses, the company receives up to seven proposals a week and fields a further dozen phone calls.

Long says: ‘I find South African entrepreneurs are more inventors at the moment. We’ve got lots of world-firsts — ATM technology, the Kreepy Krawly and a lot more. [We are] very good at inventing. But I think after that we need help. There is this sort of one-man inventor syndrome and that doesn’t get anywhere. People don’t build a team. There’s a lot of help needed in that area.”

She also points to a lack of business knowledge and, particularly vexing for financiers, of how to value a business. ‘You can’t come with an idea and ask for R10-million for 10%. There’s a lack of understanding about what your business is really worth and how much money you can really get for it, and how much support you need.”

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