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The global financial crisis and the resulting recession made a deep impact on seed funding

New venture funding is the lowest it’s been for a decade according to Nesta’s July report; Venture Capital Now and After the Dotcom Crash and that’s not all…

The BBAA’s glittering annual awards dinner and conference took place last Wednesday providing an  opportunity for business angels to meet up and share their experiences over the past 12 months. I wonder how many of those attending had read Nesta’s report on VC funding. Ok so we haven’t really witnessed the end of seed stage funding, but there has certainly been a huge decline.

The findings of this latest report which follows Nesta’s business angel report last year will likely have provided a sobering topic of conversation. What is interesting about this latest report is that it takes us back to the Dot Com crash of 2000 and compares it with 2009. It makes three alarming conclusions :

•    Fundraising in 2009 is the lowest in the past decade.
•    The situation now would be far worse without public funding.
•    It is taking longer for investors to see returns on their investment.

You could say this is all about VC investments and not really indicative of the likely performance of investments made by business angels. You might also think that it is understandable given the scale of the financial crisis and a deep global recession that there would be a temporary loss of appetite for risk – considering the millions rather than thousands VCs tend to invest.

But this report suggests something more than a temporary blip. It highlights a longer term decline in the performance of VC investments made in the past decade. It is worth remembering that 2009 was the start of recovery when most countries were beginning to move out of recession. Yet fundraising was also lower than it was in the last recession.

What is also alarming is that it was investment in seed and start-ups which suffered most between 2007-2009 dropping by 58 per cent. And this is an area that would be of concern angel investors who use their own money to help those early stage businesses.

Looking at these figures there appears to have been a marked loss of confidence amongst VCs and a dramatically reduced appetite for the risks involved in early-stage investing. So will business angels be filling in those funding gaps? Possibly, but rather than dive in and exploit all those growth businesses the VCs are missing out on it might be worth finding out why VCs have seemingly abandoned seed stage businesses.

Correct me if I’m wrong but I’m guessing the biggest reason lies in the time taken to exit. I recently read with interest a blog which talked about angels finally getting in on the act with all those seed stage businesses, however it won’t be a simple as a VCs out, business angels in scenario.

Owners of those businesses shouldn’t get their hopes up. The reason VCs are pulling out of investing in seed stage businesses is down to the time it takes to exit. Typically the patient investor would want to see a nice return on their cash and an exit in three or four years.

What this report tells us is that exit is more than likely going to come in seven years or more. Seven years is far too long. While not all exits will take this long, clearly there will need to be a considerable commitment. The landscape appears to have changed dramatically in the 10 years since 2000 when it took on average three years less to exit a company in the UK.

More worrying still is that the report says there is greater uncertainty now about the time taken to exit and there are likely to be more funding rounds now before flotation than ever before.  So more money is being pumped in than ever before and it takes longer to get your money back out again, if you make any at all and that is far from guaranteed according to last year’s report. This doesn’t sound attractive. The impact on those promising growth companies that should be helping to boost economies should also be considered.

On this evidence things can only get better and at that glittering awards ceremony in Manchester there was much to celebrate, but this latest report from Nesta certainly provides some food for thought.

There is a tendency among entrepreneurs to chase money wherever they find it. The pressure to find the financial resources so necessary to build a business can be over-mastering. Most of the time the partnerships which form between founders and angel investors are productive but, in a few cases, I have seen it turn very destructive. Companies that should have realized success have been held back by investor partnerships that have severely limited their potential or, in some cases, doomed them to failure.

Look Beyond the Checkbook

It may be hard to be discriminating when you are in the heat of the ‘money hunt’ but the sins of omission you commit while chasing investors can return ten-fold to destroy any chance of success. The problem can become acute because of the incredible range of circumstances, experience and interests that angel investors bring to the table. Their having money to invest is not enough. You need to understand their basic motivations and what is driving them to act as an angel investor. You also need to understand that all investment money is not the same. Some money will help you succeed while other investments will be a poisoned pill that will reduce your chances of building the business you envision. Here are some ‘sacred cows’ that you need to slaughter:

• Angel investors are in it for a return on their investment: Well, how can you argue with that? You would assume that the primary driver is always a return on investment. But, as you will read further on, that is not always the case. I know angel investors who are simply bored and looking for something to do and others who are frustrated CEO-wannabees. For some investors, it is all about a return but for others the return is secondary. You need to sort these two groups out. Do not listen just to what they say; it is what they do that is important.
• They have money so they must be smart: This is another fallacy. Some of the dumbest and most self-destructive people I have ever met are wealthy. I have found only a weak correlation between wealth and intelligence and a slimmer one between wealth and wisdom. Many a destructive hubris has been built on a fat bank account. Investors have an important role in start-ups but pretense, omnipotence or omniscience can warp an investor’s understanding of that role. Smart investors play their part in a highly professional and constructive manner. Seek them out; they are most likely the winners you want to associate with.
• They have been successful in business so they will know how we can be: Past success is not always a good indicator of wisdom going forward. In fact, great success can be counter-productive when they decide to work with start-up companies. I know one investor who continually regales his CEOs with stories of how he ran his company. Of course, the company was running over one hundred million annually when these stories took place. The CEOs, wanting to emulate his success, take steps that are entirely premature. The result is wasted resources and a dysfunctional corporate culture. Past business success is not a good indicator of professional performance as an investor. Remember, you are seeking an investor, not a shadow CEO.
• They will become my close personal friends and advisers: Not a good idea; the correct focus of investors should produce a tension in the relationship with management. If you want a friend, buy a dog.

The Bad and the Very Ugly

The problem with writing about angel investors is that they come in an amazing variety. I have met lots of them and there is always something different about each. The ease of entry into the field may have something to do with it. The only real entry requirement is wealth beyond current needs. That’s all it takes to become an angel investor. There are no educational requirements, courses to take or certifications to merit. Only a bank account and a decision to ‘invest’ are required to hang out a shingle and open up for business. Watch out for the following:

• The Shadow CEO: I have met investors who purposefully pick weak or inexperienced CEOs to work with. Their real agenda is to run your company from the back seat. These investors are very intrusive and will push you to make decisions and commit resources that will put your company at risk. They are mostly successful entrepreneurs who have built and sold a business. In the process, they have lost touch with the necessary energy levels and passion that is essential to building a start-up into a going business. Mostly they remember the later stages of their company and the extended staff they had. Then they turn the CEO into a kind of executive assistant and attempt to run the company by proxy. Most of the companies in the portfolio of this type of investor remain very small. They generally have very complex Excel spreadsheet projections and poor records in meeting them. Stay away from the Shadow CEO; they are very dangerous investors.
• The Crazy, Rich Uncle: This is probably the most dangerous type of angel investor because they are so easy on the management team. They are mostly retired and living comfortably. Their mission in life is to ‘give back to the younger generation’. A clear indication of this type is the total lack of performance metrics and a weak statement of expectations. They can be very seductive to entrepreneurs but there is a dark side. Without stiff set of performance metrics, the company can develop a culture of permissiveness. That will feel good until the money runs out. A key indicator of this type is the feeling that the amounts of money involved are, at least initially, not sufficient to cause them concern. The expenditure patterns are not carefully monitored and discussions do not turn serious until the money is spent and the wolves are at the door. As an entrepreneur, you need to seek out investors who will be hard on you; insisting on strict performance metrics and precise definitions of roles. Take the easy way out and you will be in for a ride to nowhere with a crazy, rich uncle. Sure you will enjoy the ride but, in the end, you will be let off the bus in the middle of nowhere with a tarnished reputation for failure.
• The Gaggle: Remember the old saying about a camel being a horse designed by a committee? These gaggles are fond of that kind of engagement. The investments that they make are very often selected in a very casual way and supervised fairly loosely. The problem comes as the group itself is very loosely organized. Different participants might have significantly different understandings of what it mean to be an investor and what that status entitles them to. This can range from complete indifference to total immersion in the management of the company. This situation can result in lots of pulling and pushing of the management team without an overarching strategic vision. Investments should be made based on clear and concise understandings codified in a detailed investment agreement.
• The Bottom Feeders: You will meet some investors who are really only interested in your intellectual property. They ‘drag the bottom’ of the entrepreneurial community looking for weak teams with good ideas. Mostly they insist that their funding be used to develop the technology rather than developing revenues. Once the money runs out, they regretfully inform management that they are closing the company down and taking the intellectual property as compensation for their investment.
• The Lead Broker: I have seen these lead brokers promote themselves into central roles in companies without putting much of any of their own money on the line. The net result is that the bulk of the investor group gets involved without much direct knowledge of the business or the management team. In one case, such a broker put together an investment in excess of one million dollars without making any investment of his own. He still managed a seat on the board and a dominate role in the management of the company. Be particularly careful of the broker who can invest but does not. This situation can turn nasty if expectations are not met. Finger pointing and recriminations can come to dominate the relationships among the investors. This could seriously damage chances of follow-on investments by the group.

The Good

Good angel investors always take a highly professional approach to the process and their portfolio companies. They generally focus in industries that they are familiar with. It is a good idea to avoid angel investors whose portfolio companies do not fit a close pattern. The best angel investors will often forgo the option of claiming a board seat and, instead, insist that an independent board member with professional experience be appointed. Beware of investors who seem to see investment in your company as an opportunity to enhance their reputation by sitting on yet another board. Here are some positive things to look for:

• Success Breeds Success: There are angel investors who have the knack to help their portfolio companies thrive; while others seem to doom them to failure or stagnation. I know of one angel who specializes in little deals and has a well developed ability to keep them that way. Other investors seem to have the opposite skill. Their companies grow and prosper. It is a good idea to do some diligence on the track record of the investor. Go with the successful ones even if the deal terms are less generous.
• The Investment Agreement: There ought to be a detailed investment agreement agreed to before any funds are transferred. This agreement should be very specific when it comes to the roles and responsibilities of each party. The best agreements provide for an earn-in by management based on performance. It also sets the ground rules for further investment. Good angel investors will require this as a matter of course. The worst ones will simply require a term sheet and then write a check. Remember that the absence of planning is the road to failure. Think of the investment agreement as a strategic plan for the relationship.
• Strategic Agreement on Roles and Responsibilities: Good angel investors will insist that the roles and responsibilities for each party be very well understood from the very beginning. These roles will be codified in the investment agreement and specify the actions that each party will be able to take under a range of possible outcomes. Although such an agreement can complicate initial negotiations, it will help greatly when performance does not meet expectations and realignment become necessary.
• Use of Proceeds: I have seen investors write rather large checks without insisting that there be an agreed upon use of proceeds. You can imagine what happened then. Entrepreneurs initially like the freedom to simply take the money and spend it as they see fit. But, more often than not, this leads to waste and spending on things that do not connect directly to the success of the company. One company, upon receiving funds in this way, spent a lot of the money on new laptops and cell phones with expensive service plans. They replaced very serviceable units. Another CEO kept paying his salary, even through results fell far below projections, and failed to pay suppliers. The result was a law suit that is almost certain to shut down the company. It is good business practice for the angel investors to insist on a detailed use of proceeds and for control over the spending of their money.
• Insistence on Performance Metrics: As a CEO you should be insisting on performance metrics for every member of your team. That is just good management. Your investors should take the same approach. It may seem initially easier to deal with angel investors who are very lax about this, but it is far from best practices. I am not just talking about Excel spreadsheet metrics. They have to be much more detailed than that. Good performance metrics detail the responsibilities of each member of the management team and the way their performance will be measured. Everybody from the CEO to the receptionist should have a job description with metrics attached. And the metrics should be sufficiently detailed to drive evaluations based on performance. Performance should be the driver in determining both compensation and earned-in interest in the company. Performance metrics are a sign of a professional and productive organization. Start-ups with that culture have a much higher chance of success.
• Focus on Governance Issues and Oversight: “Who’s minding the store?” If the answer to that question is “nobody but us entrepreneurs”, consider that a red flag. In the short-term, it may feel good to be free from oversight but, in the long-term, you are guaranteed to make more mistakes and waste more opportunities. The board of directors has a very important role to fill in any corporate structure and it is not just making sure that the investors get to a liquidity event as soon as possible. Good governance means overseeing the strategic planning process, dealing with issues of succession, audit and compensation, and providing for the protections and expansion of shareholder value. This fiduciary relationship with the shareholders is an important part of the corporate structure. Without it, management is under no effective supervision and the investment looks more like a roll of the dice than an investment.

Keep This In Mind

An angel investment creates a relationship that will help determine how successful you are going to be. Your skill in crafting that relationship is a test of how dedicated you are to the success of your company and team. If you take the easy way out, your chances of success will drop significantly. If you opt for the limp relationship with an inattentive investor, your prospects will suffer. Angel investors, the good ones, bring much more than money to the table. The good ones have helped their companies succeed and will help you do the same.

© Dr. Earl R. Smith II

~~~~~~~~~~

Dr. Smith is Managing Partner of The Federal Circle. The Federal Circle partners with teams and existing companies. We help them up their game and win big in the Federal space. We also arrange funding for acquisitions and expansion by acquisition. Our model is based on the belief that, if you select the very best and work with them in a highly professional and focused manner, the results will be truly amazing. He is the author of Amazing Pace: Turbo-charged Business Development – a book that shows how Advisory Boards can dramatically increase revenue. Dr. Smith is also the author of Dream Walk: Parables for the Living – a book of Raven Tales and exploration.

CGT rise will put the squeeze on business angels

It’s the day after one of the most eagerly anticipated, or should that be dreaded? Budgets of recent times. Budgets are becoming like buses, normally you wait ages for one and suddenly two come along in just a few months.

There was little in the last one to encourage business angels or entrepreneurs in the UK, but in this latest emergency Budget the Chancellor has gone out of his way to show that Britain may be weighed down by a mammoth budget deficit to reduce, but it is still open for business. Or is it?

Business groups on the whole have welcomed some of the measures introduced to help entrepreneurs and owners of SMEs. The 1 per cent cut to companies’ tax the new £5 million threshold for entrepreneurs’ relief on CGT have been applauded as have measures to reduce National Insurance liabilities.

This all sounds too good to be true, is Mr Osborne really giving a leg up to entrepreneurs so that they can get Britain back on the road to recovery and avoid the possibility of a double dip recession in the UK?

Perhaps, but as with all Budgets, it depends how you look at it. Sure all the headline grabbing measures will show that enterprise is being encouraged. It is also worth noting that entrepreneurs can now claim Capital Gains Tax relief on up to £5m worth of business sales in a lifetime – this is up from £2m in March.

To help fast growing SMEs starved of growth funding the government plans to introduce a new Enterprise Capital Growth Fund to provide a £37.5 million boost of equity finance to SMEs. The Enterprise Finance Guarantee is also being increased by £200 million to support additional lending of up to £700 million to for small businesses until the end of March 2011.

All this funding is great if you are a growing business and able to gain access to it, but as we have seen in the past 12-months start-ups are struggling to secure funding from banks. But the banks have been holding onto their purse strings, which means start-ups have had to turn to business angels for help. The problem is that again there is little in the budget to encourage business angels.

The sharp rise in Capital Gains Tax from 18% to 28% is likely to discourage rather than encourage investment in the UK. Despite the headline ‘good news’ the entrepreneurs relief doesn’t cover all of those involved in the investment chain. Those business angels who are affected by this hike in CGT are likely to decide that the risks outweigh the rewards when it comes to investing at seed stage. This would cut off the vital supply of capital needed by those start-up businesses who can’t secure funding elsewhere, stifling innovation in the process.

Britain had the lower CGT rate (18%) than most other countries, until last night just behind Brazil (15%) and the US (15%). According to a table compiled by Ernst and Young, Britain has now dropped from 7th to 15th with a higher CGT rate than China’s 22%.

Britain’s slide down the scale of competitiveness with these other countries is a concern, and could make it more attractive to invest abroad where the rates are more attractive.

It could have been worse. The worse case scenario of a rise to 40% and without the measures introduced in the Budget to help entrepreneurs would have dealt a heavy blow to hopes of recovery. Everyone in the UK knows that payback time has come, but time will tell if business angels will still be willing to take a risk on early stage growth businesses. The incentives should have been spread more evenly between entrepreneurs and those other links in the investment chain.

A budget that would please Alan Sugar?

Capital Gains Tax will rise less than expected from 18% to 28%, which is what makes the Entrepreneurs relief of just 10% is so attractive.

In addition, to help fast growing SMEs starved of growth funding the government plans to introduce a new Enterprise Capital Growth Fund which will provide more than £37.5 million of equity finance to SMEs. the Enterprise Finance Guarantee is also being increased by £200 million to support additional lending of up to £700 million to for small businesses until the end of March 2011.

And, businesses outside of London and South and East can benefit from no employers national insurance on upto 10 employers.

Various firms have been developing psychometric tests to identify the personality traits of a successful entrepreneur and it turns out, that there is no agreement on whether any of these work.  So what can research tell us?

In fact, funding of research into entrepreneurial issues in the academic world is beginning to dry up – as Durham University have closed their department for entrepreneurial research, partly in response to the failed hope of being able to teach entrepreneurial skills to carefully selected students.

So, if business angels can’t find a common personality trait, what should an investor look for when interviewing cash hungry entrepreneurs?

Well, there appear to be two ideas that can be supported in the accademic research.

Firstly, becoming a highly successful entrepreneur is a process. It takes time and you can make a pretty good judgement – after interviewing – where someone is on their business path. A colleague of mine suggested that a really experienced entrepreneur is someone who has built a business and lost it, built a second and exited with a healthy gain and now is on their third business.

Okay, you can discuss alternative formula – but you get the idea.

Secondly, how the entrepreneur is able to respond to what is going on around him or her is a critical factor that determines if they are likely to succeed. Or perhaps, to put it another way, how do they deal with uncertainty and difficult situations?

This reminds me of the famous story of the criminal who said ‘I had no choice, I became a criminal because my father was a drunk’ and his brother said ‘I had no choice either, I had to succeed’ . The successful brother became CEO of a global business.

So, in summary, you can forget personality and therefore personality testing. Look instead for where the entrepreneur is on the path and then asking searching questions about how they dealt with uncertainty.

So, the good news is that there is evidence of there being a way to systematically identify likely successful entrepreneurs – and also the quality of the team – and your fellow investors – that surround the entrepreneur.

Good luck.

Less than 5 per cent of the UK’s angel investors are female and Women into Investing is a series of training events and investment opportunities to increase their numbers.

The organisers believe that breaking down the barriers in male dominated investment communities will increase the flow of equity to ambitious businesses as well as giving female investors the potential for substantial returns.

Women into Investing is launching at The Roof Gardens, Kensington, London on the 9th June from 12 till 2.30pm. Attendees will learn about the background to business angel investing and hear first-hand accounts from experienced female investors.

The FSE and the BBAA’s joint initiative will also include a member-led female investor club later in the year.  Sally Goodsell, CEO of FSE said: “I have always believed that business angels are the lifeblood of early stage businesses, investing some £800m-£1bn annually across the UK in growing young companies.

However, despite the high number of successful women in the UK, with women accounting for nearly half the millionaires in Britain, currently only about five per cent of business angels in the UK are women. We want to change this figure for the better which is why we have joined forces with the BBAA to engage more women in this interesting and potentially highly rewarding activity.

Women are in a great position to bring both their financial capacity, business skills and experience to support the growth and success of innovating SMEs, offering the potential for significant returns.”

Finance South East has a unique business model. Whilst its funds are managed on a commercial basis to meet investor requirements FSE is a not-for-profit entity that does not distribute surpluses. The organisation has offices in Camberley and Ipswich, and works across the South East of England and surrounding areas. The team has won many awards for its innovative approach to funding SMEs.

Where Business Angels Fear to Tread?

Investors in early stage and start-up businesses are known as angel investors. The tag ‘angel’ coming from their tendency to operate in the margins where venture capitalists, banks and other backers choose not to go.

They also help plug a major funding gap to get such ventures off the ground and they happen to be the kind of investors who are prepared to take a risk, rely on their instincts and invest large sums without too many hard questions asked.

At least this is the accepted view.

But we may well be seeing a new breed of business angel emerge, one that takes a more conservative approach in these risk averse times.

Times, as Bob Dylan once sang, are a-changing as we see a trend emerging both in the UK and the US for a more cautious approach to investing in embryonic stage businesses. With many investors’ fingers burnt by the financial crisis it is hardly surprising that the appetite for risk remains limited – which in turn is making it increasingly harder for start-up businesses to attract funding.

According to the latest NESTA report on business angel activity in the UK, 83 per cent of angel investments were made with co-investors and a significant proportion (28 per cent) were made within just 50 kilometres of home. Working close to home and in the company of fellow investors shows that most business angels need security like anyone else and are careful where they put their money. The figures debunk any myths suggesting otherwise.

This is further borne out by statistics released in the US where an article this month in BusinessWeek suggests angel investors are getting pickier based on their analysis of data supplied by Angelsoft, an internet based company supplying online tools to angel investors.

The study looks at the share of companies seeking angel funds passing through each stage of the ‘deal funnel’ between 2007-2009. Not surprisingly, given the economic climate in the past two years, a glance at the chart reveals a dramatic decline in the number of businesses getting even as far as the screening process between 2007 and 2009. The statistics make worrying reading for anyone hoping for an easy ride when they approach potential investors for their start-up if the pattern is repeated her in the UK. .

More worrying still, just 2.8% of businesses made it as far as the due diligence stage, a fall of more than 50% on 2007/08 figures. This would indicate that angel investors in the US have become, as the article suggests, more ‘picky’.

But is it simply a case of angel investors becoming more picky? The figures reveal that just under half of businesses make it through screening to the due diligence phase, which is a pattern that has been broadly repeated since 2007.

However even though there were around 50% less businesses making it through the deal funnel, when we reach the end of the funnel and to what those business are striving to achieve i.e. investment, the proportion of those businesses making it through the final stages, is shown to be higher in 2009 than in 2007 or 2008, with 2.8% making it to due diligence and 2.1% securing investment.

Herein lies the good news for those businesses who sought funding. The proportion of businesses receiving funding in 2009 compared to 2008 suggests that if a business made it to the due diligence stage, there was a significantly better chance of securing investment.

The small percentage of businesses that made it through screening and the presentation phase also stood a greater chance of making it to the end of the deal funnel. This may suggest that angel investors are indeed becoming more choosy, but it could well be more a case of less money in the angel investor’s pot making it tougher to get past this initial screening process.

We know that more than half of investments fail; therefore it doesn’t take a great leap of the imagination to conclude that angel investors are willing to take fewer risks than they once were. This will be bad news for many start-ups and there will be many innovative businesses that fail to get a vital injection of capital. The number of businesses that have slipped through the net since 2007 is anyone’s guess.

It isn’t all bad news, according to the figures in the US business angels are choosing to invest in a greater proportion of those businesses that make it through screening. But we may be seeing that even business angels have their limits.

Pounds and Pence

In the first recession investors wanted business plans that offered new simplified services or goods that make things work better (ie. increase efficiency – such as self-service on the web for better prices) or that reduce costs (such as better conferencing or collaboration on the web allowing businesses to cut corporate travel).

However, as opinions strengthen that stocks have rebounded too fast and property assets have not fallen far enough, entrepreneurs and investors need to start thinking about how to handle the second recession.

Now, this is not to say that a second recession is guaranteed, simply to say that the risk of a second recession is sufficient for it to be a part of your plan.

And this is where it gets difficult…

Not only are we unsure if there will actually be a recession or whether we’ll simply suffer a long U shaped recovery where we bounce along at zero growth for years…. but we have very little idea of what this period of secondary recession will be like.

We do know that sooner or later the Governmental stimulus for car purchases (scappage bonuses), property prices (artificially low interest rates) and consumer spending (stimulus and reduced vat) are all going to be withdrawn and accompanied by severe public spending cuts (more unemployment) and higher taxes (lower disposable income for consumer spending for those with a job).

Nor are banks lending on speculative ventures, so don’t expect a pick up in business investment and the VC industry is sharply reduced in scope.

So, against this misery, it is worth reminding ourselves that great companies – Oracle and Microsoft for example – emerged during past recessions and no doubt, it will happen again.

However, the scary part of the recession for entrepreneurs and investors is just before you enter – because the only thing you know for sure is that your business landscape and market place will change radically in ways you can not predict.

So, what do you do? Stop?

Stopping is rarely an option for a commitment already made, but there might be an option to delay or mothball. This may be the smart move for investors and entrepreneurs.

Alternatively, if the only option is to continue, then preparing the business before the storm is the critical act.

Imagine a sail ship at sea which knows a gale is on the horizon – what does it do? Batten down the hatches, prepare for the worse and reduce sail.

A sail boat heals (or tilts sideways) less when it has less sail area exposed to the wind. This increases its chances of withstanding the storm.

So, in the case of business what would be the equivalent of reducing sail? Converting fixed costs into variable costs.

A business needs to convert fixed costs into variable costs as this allows the business cost base to be reduced to whatever your future revenues turn out to be without additional restructuring costs which you may not be able to afford in the future or morale problems.

The classic fixed cost of most start up businesses and all service led businesses is a staff employees on normal employment contracts – which increases your liabilities for redundancy on an annual basis and for which your employees will be incentivised to protect their jobs (ie keep to the letter of their contract) rather than take risks searching for new sources of revenue or business. The impact of this structure of employment law is highest in continental Europe, still high in the UK but lower in the US.

A variable cost is a contract or freelance employee – which can be shrunk to 3 day a week working or 2 days a month or asked to take a 3 month holiday. More importantly, this change can be implemented among freelance staff without loss of goodwill in a way that simply can not be achieved with standard employees.

Therefore, a business that wishes greater certainty that it is going to survive and hence, later thrive, is a business that has moved all or nearly all costs onto the variable part of the equation and away from the fixed cost side of the business.

In this environment, the business that will succeed is the one which has the better implementation – NOT the one with the best idea. This is a novel idea for angel investors who are used to looking for the killer idea – and not necessarily killer implementation.

It is easy – when looking at a new business or start up – to be seduced by the quality of the idea. It happens to both entreprenuers and also investors.

So, in a second recession – if that comes to pass – the survivers will not be the ones with the best idea, but with the best implementation. And that means preparing your business or venture for the worse case scenario. And that means shifting your costs from fixed to variable.

Now, if the second recession does not appear – will you be worse off by making this change? Probably not, as the costs of the redundancy paid now will pay back by a reduced national insurance cost and also a greater ability to adapt your workforce to the demands of your business which in turn is responding to the nervousness of your customers.

In previous boom times, when we enjoyed the famous ‘war for talent’, such an approach might have curtailed your ability to grow your business. In a recession with growing unemployment it is likely to have an opposite effect. Not only will it give your business added flexibility but it also gives your staff more flexibility too – and this, in my experience, increases their satisfaction rather than diminishes it.

However, most importantly, staff on a contract or freelance basis have a much more flexible attitude and are willing to go for the new source of revenue or untapped market and are unlikely to fall back on the old tried and tested ideas that no longer work.

So, with an entirely freelance team, some working from home – some based in your office, you’ll have the flexibility to adapt to all storms that hit your business and at the same time, your crew will be happier. And, if you get your contracts right, there is no reason why those freelancers can not act and behave as an integral part of your business. In fact, it is in their interests to get to the heart of your business and make themselves indispensable.

This is the type of business that will succeed, not necessarily the one with the best idea. After all, who said that Microsoft made the best software in the world? No one. They were just better at marketing.

In this second recession – the differentiator between success and failure will come down to implementation rather than ideas.