We’re a new fund, and venture capital in general is new to Somaliland, so I want to explain how venture capital works and how we’re planning to work with founders and companies.
At the core, what we’re doing is finding companies that we think have a high growth potential and giving them money and operational assistance in exchange for a percentage of ownership. Typically, we’ll seek between 10% and 29% ownership in companies with an initial investment.
Venture capital is very different from loans. While loans in Somaliland can typically only be used to purchase physical equipment, venture capital can be used for whatever the business needs – whether that’s equipment, employee salary, variable infrastructure costs, marketing spend, or something else. And while loans have to be paid back, venture capital doesn’t. It’s pure fuel to help companies grow.
Another important difference is that venture capital aligns the capital provider with the business operator, while loans don’t. If a business owner gets a loan, all that the lender cares about is whether the loan gets paid back. The lender doesn’t care if the borrower’s business struggles for the next year, or if it stays exactly the same, or if it doubles year over year. All the lender cares about is whether the borrower pays back the principal plus 15%.
When you accept a loan, what you get in return is a debt. When you accept venture capital, what you get in return is a partner – a partner who only succeeds when you succeed, and who maximizes their success by maximizing your success.
There are downsides to taking venture capital. If you take venture capital, you’re reducing your ownership of the company and allowing a new part-owner to join your team. It’s not an easy decision to reverse, so you better be sure it’s the right thing for you and your company.
At Abaarso Ventures, we want to be minority shareholders. That way, the founder(s) can maintain significant ownership of the company and can manage the company day-to-day operations as they see fit. However, there are certain decisions in which we require approval rights – like the hiring of executives, executive salary, and sale of the company. It’s important for us to have these rights in order to protect the health of the company and our success as shareholders. For example, many companies have gotten into trouble because the founder, who had good intentions, hired a close family member to an important executive position when that family member wasn’t really the best person for the job. By providing input in those kinds of decisions, we can help the company stay on the right track.
Investing for growth
We generally want to invest in early-stage companies that we think can grow 100x from their current value.
Let’s say Abaarso Ventures invests $25,000 in a company in exchange for 25% ownership.
Essentially, this is Abaarso Ventures saying the company is worth $100,000 before our investment. In most or all cases, the founders wouldn’t actually be able to sell the company for $100,000 at that point. There just aren’t a lot of buyers who are looking to spend that kind of money on an early-stage company. And if somebody did want to buy the company from you outright, it would be worth a lot less, because a lot of the value of the company comes from the founders and their desire to continue working on the company.
So why are we willing to say the company’s worth $100,000?
It’s because we believe that by providing the company with money, connections, and know-how, and by working together with the founder for years, we can help the company be worth $10M or more. In this example, we’re trying to turn our $25K into (at least) $2.5M, and we’re trying to turn the founders’ vision and hard work into (at least) $7.5M.
That’s a hard hill to climb, and we won’t succeed in every case. So we try to improve our odds by picking founders, companies, and markets that we think have a lot of room to grow.
What kind of companies/markets are we looking for?
VC funds often characterize their target companies according to three filters – geography, stage, and sector.
We have a narrow geographic focus: Somaliland. We’re in the process of thinking through whether that only includes companies headquartered in Somaliland, or whether we should invest under some conditions (e.g. offices/employees in Somaliland) in companies founded by Somalilander diaspora outside of Somaliland.
Our stage focus is pretty narrow. We’re primarily interested in early-stage companies. In many cases, we will be the company’s first external investor. Using conventional VC terms, we’re investing in pre-seed and seed companies, with a smaller number of dollars going selectively towards Series A companies or more mature businesses.
In other words, we will invest in some companies before the founders have even built a product. In order to justify that kind of investment (often called a pre-seed investment), we need to believe that the company is solving a compelling problem and the founders have relevant experience and expertise. And always, no matter the stage, we only want to invest in founders with high integrity.
A seed investment is typically in a company that has put a product in market, and has learned enough from that experience to justify further investment – even though the company may not be profitable or may not have fully figured out their product or distribution yet.
A company that we’d consider “Series A” or “mature” often has figured out a repeatable way to reach and sell to interested buyers. We’ll invest in these sorts of companies if we think we can help them find an inflection point in their growth.
Because we’re reasonably constrained in stage and very constrained in geography, we think it’s important to have flexibility in sector. There simply aren’t enough early-stage companies and investors in Somaliland for it to be practical to substantially limit what sectors we target.
However, we do have several important ethical restrictions in what kinds of companies we’ll invest in. We won’t invest in any companies that are not Sharia-compliant or that are involved in the cultivation or trade of qat. While we might invest in companies that facilitate extraction of natural resources – like a business that helps oil drilling teams do their work more efficiently – we won’t invest in any companies that actually take ownership of non-renewable natural resources like oil and rare earth minerals.
Another reason why we’re flexible on sector is that we have a lot to learn. We have plenty of ideas about what kinds of markets and business models are conducive to breakout growth, but we need to be humble about what we don’t know. Somaliland founders have already taught us a lot about the market, and that will continue to happen over the coming years. We may narrow our sector focus as we work with more founders and get a better sense of what kinds of companies are most likely to succeed in Somaliland.
About the founders…
In an upcoming post, I’ll give more detail about how we evaluate founders. Especially at the earliest stages, our investment decisions will often be more about the qualities of the founders than about their company or the market they’re attacking.