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.

Start-ups just aren’t feeling the love from banks right now

It may have been Valentines Day yesterday, but with banks’ reluctance to lend to businesses, they could push more start-ups into the arms of angel investors.

With UK banks still showing a reluctance to lend to businesses, companies could well be forced to look towards alternative sources to fund their ventures. The recession may be over, but with UK GDP figures just crawling over the line into positive territory, how are the banks doing? Those vital foundations of a functioning economy and an equally vital source of lending for start-up enterprises.

Banks may well have received an eye watering £850 billion of taxpayers’ money to keep them afloat but a glance through last week’s House of Commons Committee report, ‘Maintaining financial stability across the United Kingdom’s banking system’ the crisis of confidence that has haunted banks since 2007 appears to have a sting in the tail for businesses in the UK seeking funding.

Despite recent declarations that they are ‘open for business’ banks are still struggling to help those innovative start-up companies the country needs to help UK plc climb out of recession are still being starved of investment. Lending to business, as the report suggests, is ‘falling short of legally-binding commitments entered into by two of the banks that received the most support: the Royal Bank of Scotland (RBS) and Lloyds Banking Group’

The reasons for the banks’ inability to meet their lending commitments are unclear but when it comes to small or medium sized business, lending in a downturn is perceived as even more risky than usual. This creates a paradox where businesses are starved of the vital capital they need to grow which in turn can lead to the failure of those businesses vital to a flourishing economy.

This can only be bad news in the long term for banks looking to bolster their balance sheets. So where can businesses turn to for help? The obvious answer is angel investors.

What has become an age of austerity for the banks could be a golden age for angel investors, those wealthy individuals willing to take a calculated gamble on start-up companies. But it isn’t just start-up capital angel investors will need to provide if banks continue to refuse or give unfavourable terms to businesses hoping to borrow.

According to an article in this week’s Scotsman, angel investors in Scotland are increasingly acting as bankers to fledgling companies, providing £1 million in overdrafts or loans in the past twelve months. Angel investors are also being asked to act as debt providers in the absence of loan and overdraft facilities offered to businesses by banks.

It isn’t just in Scotland that banks are perceived as the villains for taking taxpayers’ money and showing reluctance to lend to businesses. Ask any business owner or entrepreneur in the UK and you are likely to hear that trust in banks is at a low-point.

This could well be good news for business angels, if not for entrepreneurs struggling to launch their businesses. As we have established angel investors are becoming more picky with the businesses they invest in, therefore for all but the most promising businesses, there will be no easy alternative and the door will remain firmly shut when it comes to accessing vital capital.

But what this means for business angels, who unlike banks require an equity stake in the businesses in return for investment, is they can now afford to be even more choosy when faced with more choice. Due to the perception that banks are the villains when it comes to lending, those businesses with the most potential will be more likely to take the angel investment route rather than approach the banks.

And for those entrepreneurs who do make it through the deal funnel, they can gain access to valuable advice and coaching from those who have been there before, rather than just cash from the bank.

There is a caveat. How many of these extra businesses seeking capital from business angels will be viable? According to the banks, one reason they haven’t been able to reach their lending target is the higher proportion of those companies needing credit not having viable business models.

This leads us to two conclusions. Business angels will need to be more wary when it comes to assessing the viability of companies. Banks meanwhile will need to be careful that their reluctance to lend now creates an irreversible trend of the best businesses turning to business angels for their start-up capital now and in the future.

Angelic Agreement? But will it stay heavenly?

More than half of business angel investments fail, but why? How much of this can be put down to the innate vulnerability of start-up businesses?

Surely having an enthusiastic angel investor on board, eager to provide a timely injection of funding to ensure success should mean failure rates i.e. those leaving the business angel out of pocket come exit time should statistically be on the better side of half.

Yet this clearly isn’t the case. In an ideal world entrepreneurs and the angel investors are made for each other, a real match made in heaven as the title to this blog suggests. Put simply most start-ups require money and if it seems like a good idea, most angel investors on the lookout for new opportunities  are eager to supply it – and make a decent return in five years or perhaps less. Perfect, the entrepreneur gets his money, establishes a viable business and the angel investor rides off into the sunset profit in hand ready to fund the next venture.

But life isn’t that simple. Good relationships are crucial to the stability and success of a business. Relationships need not necessarily be cordial at all times, debate and alternative viewpoints are healthy and can be productive , but like all relationships in life, certain elements must be in place to ensure relationships don’t unravel and become destructive.

While some angel investors will be looking more at business structures and the ideas and innovations those businesses are bringing to their market, it would be wrong to ignore the importance of the individuals who run businesses – the management team and the person(s) leading them.

The most successful investors should put fairly large sums into two or three businesses they know something about and whose management is trustworthy, at least this is what the most astute investors like Keynes and more recently Warren Buffet would tell you.

Finding out if the managers of the business you invest in are trustworthy isn’t easy. First you must establish a relationship. We often speak of relationships as having the right chemistry and it is crucial for the angel investor to feel that chemistry when he meets the entrepreneur he’s willing to invest in for the next four, five or maybe more years.

This is no easy task. Not all angel investors are entrepreneurs and many entrepreneurs don’t have the right instincts or ideas to make their business a success even with the help of investment as the statistics show. There can often be gaps in age and experience between business angel and entrepreneur. Take for example an ambitious 18-year-old fresh out of college, full of ideas and exuberance, the business angel who invests in the business may have a wealth of experience to offer, but will he/she be able to pass that knowhow, as well as money, on to ensure a successful future? There may well be gaps in age and understanding as well as experience.

If both angel investor and entrepreneur lack experience of starting up and developing a business, the relationship might turn into a voyage of discovery for both which may then flounder on rough seas. No matter how much money is invested, at least one party should know how to make the best use of it and both investor and entrepreneur must be able to work together and have their interests in alignment to achieve success and a positive return on investment.

Increasingly these days, angel investors are opting to join business angel networks and groups to spread risk rather than be faced with the possibility of choosing the wrong business to invest in. While this approach may have its advantages it will naturally create a distance between them and the entrepreneur. The cash may well pour into the business, but can the entrepreneur be trusted? This is a major question to consider, and also is the entrepreneur self-disciplined to spend the money wisely?

Investing too much money too soon can be toxic for a start-up particularly when an entrepreneur may lack focus or is prone to taking risks with your money.This brings us back to relationships, put simply, the business angel’s role is to invest not only money but also add value. For the relationship to work, therefore, the entrepreneur must be flexible, be willing to be mentored, work as part of a team and frugal with the money at his/her disposal.

Keeping these tips in mind should ensure that at least (market forces permitting) it will be the business that fails rather than the business relationship.

Business angels often find it easier to work in teams.

We have already established that angel investing is a risky business but one with potentially high rewards. So is it better to go it alone? Or seek the company of others?

It is more often the case these days that angel investing is best pursued as a  team activity. While they still exist, the lone business angel poring over opportunities to ride to the rescue of the startup seeking that vital injection of start-up capital is becoming an endangered species, more an exception than the rule, but why is this so? Why do business angels increasingly work as part of a team?

While the high risk nature of angel investing is one significant factor there are also others to consider. It is true that angel investing is not an entirely altruistic activity (despite what many angel investors might tell you). While it may be satisfying to help nurture a fledgling business to growth and profitabilty, the main aim is to make money and lots of it when it comes to exit time.

With the odds stacked against a successful outcome, by working with other investors you can spread the risk and avoid sinking your hard earned cash into one single business which may, as statistics often show, fail and leave you with a loss.

But there are always those who prefer to go it alone and try their luck, after all if you believe the business you invest in has every chance of success and it’s in an area you’re familiar with, then why not?  You are able to help shape the direction of the business and for those with an entrepreneurial background this can be a way to re-live the excitement of starting up and hopefully watching a business grow thanks to your experienced input and investment.

Going it alone as a business angel means more direct involvement and greater access to the business you invest in. Working with a team of investors or a network often means a portfolio approach where a number of businesses and investors will be working together but in a less hands-on way. Therefore, on the one hand you are able to spread risk as part of a network, but the downside is you will also be sharing any profits and spending less time on individual businesses.

The main advantage of not having a business angel network in the middle is that you won’t need to pay the usual 5% of the sum invested as a fee and granting options to the network which would eat into any future success. Networks also have the incentive to increase the sum raised – so that they earn a larger percentage.

But despite the attractions of going it alone which also includes not having to work with other investors or share profits if the business is successful, weighing the pros and cons between being part of a team and going it alone,  it becomes easy to see why the chances of successful outcomes are greater when working alongside other business angels as a member of a group or network.

And there are plenty of business angel groups out there in the UK. For the less experienced business angels, these can be excellent starting points where experience and knowledge can be shared. There are a number of established angel networks in the UK, often regional, which meet regularly to discuss strategy and share experience and they can also provide opportunities to network with other investors with varying levels of experience.

You will often hear that the great advantage of being part of a business angel network is the chance to tap into deal flows. However, you can still find them, depending on the size and effectiveness of your network or you can even gain access through online business networking sites like Linkedin, but the effort of due diligence and supporting the business is high – especially if you are alone,  therefore, although you may find the deal, it is still better to get a team involved.

Networks can provide a ready supply of angel investment opportunities numbering in the hundreds or even thousands. The process is organised and unsuitable businesses are filtered out at an early stage with the help of video presentations, saving the time and effort usually required to find the best deals out there.

The responsibility for due diligence still lies with the investors themselves but this is one area worth spending a lot of time on. You also benefit from the variety of expertise and experience offered by your fellow investors. Due diligence can be complicated, so by dividing work among its members a network can offer a more complete understanding of a business when knowledge can be pooled.

Being part of a network can only lead to better investment decisions overall and those businesses seeking investment can also benefit from having access to broader knowledge. Angel investing is not for the faint hearted but there is relative safety in numbers!

Warren Buffett on a visit to Kansas University Business School

Have you ever asked yourself what would Warren Buffett do if he were a Business Angel?
 
Well, it might be a bit hard to ask Mr Buffett along to attend our investments seminars, so instead we have attempted to summarise the rules Warren Buffett applies to his investments to see if we can apply that to business angel investing?

Yes, we can. With a few adaptations.

From Buffett’s many rules and ideas our take on his work is that it can be summarised very briefly as follows

• lose no money (nor shareholder value)
• buy franchise business (with pricing power)
• align incentives (between management and shareholders)

 

Lose no Money means
Buy at fair price (neither too much nor too little). Too much and you’ll never make a return, too little and the sellers (who will probably remain in or retain an interest in the business) will resent your presence and are likely to undermine the financial outcome for everyone. What is a fair price? It has to be based on the likely throw-off of cash (net of capital reinvestment required to maintain the business, its assets and its brand) over the next 20 years. It is difficult to assess early stage business values, but that is no reason not to try and Buffett’s method is as good as any and provides a clear starting place.

There are two tricks when assessing future cashflow returns

1. Firstly, most start-up business plans predict steady growth over years one to three and then exponential profit growth. This just means that future costs are unknown, not that the business is likely to experience 80 or 90% profit margins. Nearly all businesses, especially if they wish to maintain growth, will revert to profit margins at or below 30% of revenue. Many mature businesses will have much lower profit margins but are much more stable and reliable. Therefore, use the industry standard profit margin for future returns and never above 30%.
2. Secondly, most businesses forget that they need to re-invest a given amount of cash into the business simply to maintain its value. A good example is brand advertising, which does not have a direct cash generative benefit, but without it the long term ability of the business to grow revenue will be harmed.

Lose no Money also means
Don’t speculate - but place your money on sure bets at good prices. However, this is not the environment of the business angel investor – who is in early investment sector. The truth is that the early stage investment market is not a sector that Buffett works in. However, the principle can still be applied – albeit that you accept that you are in a speculative environment. iBusiness Angel has written before on how to reduce the chances of losing your money- and it is important to keep these ideas at the front of your mind before making any investment. So Business Angels need to consider reducing the risk of a loss whilst Buffett can focus on ‘Lose no Money’.

Lose no Money also means
Invest in businesses that you understand. That means that if your knowledge is based on retail businesses, don’t invest in a tech start up, unless it has specific application to the sector that you know about. Buffett famously didn’t invest in Microsoft nor the tech boom. He made his money by sticking to what he knew well so that he could judge a good opportunity clearly and avoid the bad investment options.

Franchise business means
The business must be able to maintain its price position. Hence, it must be creating and delivering a product or service that is unique and protected by intellectual property rights or geography. Without this protection, whatever the business offers is vulnerable to´’cheap immitators’ or ‘me too’ competitors which might not put the firm out of business but will prevent the business maintaining its margin and therefore damaging shareholder value (see point 1 above).

Aligned incentives means
The incentives of the shareholders must be the same as the investors. This is often the case at the beginning of the start up, but if the management start paying themselves large salaries, then their incentive will no longer be to sell the shares but to hang onto the job. The control of future remuneration by shareholders – independent of the management – is critical for any start-up in its middle years. This control needs to be set up right (ie to ensure that shareholders can keep the incentives balanced or have an option to sellout) and it needs to be set up before the business angel invests.

Early Stage investors who can adapt Buffetts rules and principles and apply them to Business Angel Investing stand a far greater chance of success.

This approach does, of course, require a more systematic approach to investing – some might call it ‘professional’ – but the evidence is that this steady handed and cool headed approach is the most successful. And, for the epitome of a cool headed investor, we need look no further than Warren Buffett.

Ps. We’d strongly recommend you keep a copy of Mr Buffett’s thoughts and essays.

There are many books on Buffett, but there is nothing like going directly to the source yourself. The best of the bunch has to be The Essays of Warren Buffett: Lessons for Investors and Managers.

Beating the Business Angel Investment Odds?

We are living in risk-averse times and “Cash combined with courage in a crisis is priceless” according to Warren Buffet. But when does courage cross the line into gambling territory? Or to put it another way what if you had say, £50,000 to invest, and someone said you have a 20% chance of a return on it, would those odds appeal?

With a failure rate in the region of 80% if you look deeper into the stats, the odds are pretty well stacked against any kind of successful outcome. But there are ways to lessen those odds and increase your chances of success by following the advice of experienced business angels.

The latest instalment of the BBAA angel investor evenings held in Manchester provided an opportunity

to listen to the advice of seasoned business angels who have been there, made the mistakes and learned from them.

56% of exits failed to make a return according to the Robert E Wiltbank’s 2009 report on angel investment, a figure based on a sample of UK Angel investors – more than 50% of whom had yet to reach for the exit! Hardly a USP, and an unacceptable risk for those seeking a decent return on their investment.

The panel of seasoned business angels briefly removed their halos to provide insight into why indeed would anyone want to be business angel let alone in a crisis!

Robert Heise an angel investor with over 40 years of  business and technical experience to call upon described being a business angel as an “onerous task” but one that can be worthwhile with the right approach.

His pointed out that to get the most out of your experience as a business angel, you need to be altruistic to some extent. Investing in an early stage enterprise is also a two-way process which is unlikely to bring a successful outcome without a large degree of cooperation between the management team and the investor. When things get tough, which they inevitably will, be sure that you know the management team well enough to weather the storm.

A business angel should also be prepared to act as both teacher and mentor to the company they invest in, by bringing expertise in areas such as sales or the technical side of the business to the table. There is little point in simply writing a cheque and stepping back (a point I will return to later). Active involvement leads more often than not to better outcomes and more profitable exits.

Aside from increasing the chances of success, active involvement, from the point of view of the investors themselves, can also be more rewarding; providing a sense of achievement as well as an opportunity to have some degree of control over the direction of the business. .

Unlike other asset classes, investing in an early stage venture brings with it an opportunity to shape, create and drive forward ideas which brings a greater sense of satisfaction for your average business angel.

While it may provide a rewarding venture for some investors, the panel put forward some good reasons not to become an angel:

•    Angel investing will not bring a regular source of income.

•    An early stage business will generally take years to begin showing real profits with the average exit feasible in just under four years.

So what about those who are thinking of becoming a business angel, have money but no time to devote to the business they invest in?

The experienced angel investor practices ‘business be awareness’ which means you should have at least some active involvement in the business you invest in; this may only be a place on the board even if you simply choose to observe.

This will at least ensure your cash is being put to good use and tip the odds in your favour. It is no coincidence that, statistically, businesses where a business angel has taken an active role are more likely to achieve a profitable exit. If you only have money to offer without time or expertise then angel investing probably isn’t for you.

For those who still believe angel investing is for them, it can be an extremely rewarding and profitable experience as long as you’re prepared to exercise patience choose your management carefully and, importantly, get involved!  That way you can beat the odds against a profitable exit.

With many companies – particularly early-stage ones – the Board of Directors is seen as little more than a legal necessity. But it can be so much more including an important force for growth and a gyroscope that keeps things on course and sure-footed.

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I work with a lot of CEOs who are trying to move their companies out of the mid to high single digit run rates. The journey from five to twenty million in annual revenue is one of the most difficult in the evolution of any company. CEOs need to reinvent themselves at least two or three times during the process.

The senior team at five million will be radically overhauled and resourced by the time the company hits twenty million. The cottage culture will have given way to an increasingly professionalizing one. The competition that the company faces in their business development efforts will be better resourced, smarter and more efficiently managed. 

By the time a company reaches the high teens in annual revenue, the whole question of governance becomes a significant issue. Management will be spending a lot more time managing the business. The original team, with their overblown titles, will have been replaced with new faces that actually have the skill sets necessary to carry them.

In the best of all worlds the recruiter who had the title VP of HR is now replaced with an individual who understands, and can effectively deal with, the HR issues that can bring a company down. The controller who had the title VP of Finance or CFO has been replaced with a person who can manage banking relationships, oversee an increasingly complex financial reporting system, keep track of a complicated options and equity ownership situation and effectively manage relationships with investors and potential investors. There may be a more experienced COO and possibly even a Chief Administrative Officer (CAO) on the team.

One of the most significant changes in corporate resourcing occurs with the board of directors. Partially as a result of Sarbanes-Oxley and partially as a result of the demonstrated risks of inadequate board supervision, there are many more good boards and more good directors on boards than there used to be. The change began with public companies to be sure but has begun to spread to private ones. Even emerging companies are organizing and recruiting board members to serve on audit and compensation committees. The more enlightened institutional investors are increasingly insisting on having experienced board members in lieu of their own representatives.

A CEO who is facing the need to overhaul an existing board in order to support and control faster growth faces a set of challenges that can be daunting even in the best light. Here are just a few guidelines for board membership and management that may help:

1. A Working Board: Make sure that you organize a small working board. Large boards tend to be passive audiences for presentations by management. You need to have a manageable group of committed people who will sit around a table and actually engage in collaborative discussions about issues, trends, plans, challenges, etc. For most companies below the twenty million in annual revenue, five or six is more than enough and a dozen is way too many.

2. Avoid Celebrities (or people who are convinced they are): I once gave a lecture to a class that was focused on entrepreneurial issues. They had been divided into teams and charged with developing a business concept and working through the planning stage. My lecture was on advisory boards and how to build them as business development engines. One of the projects had a higher-education twist and the team had thought to recruit college presidents. I pointed out that these people don’t work for a living anymore. They are fundraising celebrities. Another CEO had put together a board of successful entrepreneurs who had cashed out of their businesses and were ‘hobbyists’ board members. She was frustrated because none of them wanted to do any heavy lifting. Celebrities like to think that their name is important enough to make a difference. This is mostly untrue. Workers tend to focus on making meaningful contributions to present problems. Pick the workers every time and your board will work for you.

3. Independent Directors: Your board should have a majority of independent or outside directors. The best possible board will have only one insider – the CEO. In fact, it is rarely a good idea to have the CEO also be chairman of the board. The two roles are inherently in conflict. The function of any board of directors is to protect and extend shareholder value. They do that by effective oversight of management. Independent directors can meet that fiduciary responsibility much more effectively. The brutal fact is that a group of inside directors who see each other on a regular basis and have been regularly drinking the corporate bath water is a waste of time and money. It is also an indication that management has an aversion to adult supervision.

4. No Service Providers Please: Keep your lawyers, accountants, investment bankers, commercial banks, business partners and, if possible, your investors off of the board. For most of these categories, you’ve already paid for their best thinking. All of them will have agendas that will, sooner or later, conflict with their obligations as directors. By the way, I do make one exception to this rule – intellectual property. If the company is involved in the development and deployment of new intellectual property, I consider it prudent to have the counsel that covers those issues on the board.

5. Avoid Promoting Corporate Espionage: Don’t allow your board to become a link to your competition. Be very careful who you allow into that inner sanctum. The board should be privy to the innermost trade secrets of the company. In order to do their jobs effectively, board members will have to understand the strategic and tactical plans that the company is operating under. They will also need to be familiar with innovations that are about to be launched against competition. Board members who have conflicts of agenda or loyalty should be avoided.

6. Facilitate Contact Between Board Members and Management: Make sure that you encourage your directors to interact with and have access to key members of your senior team. For a board to do its work effectively members need to have well based assessments of senior team members and their thinking on critical issues. Most board meetings will involve presentations by selected members of your team. Give directors the opportunity to evaluate those people before they are asked to evaluate their ideas. A benefit from this policy is that over time senior management will get to know individual members of the board. Often important mentoring relationships will develop – major advantages result as the experience of your board members works in service to your team.

7. Set and Enforce Metrics: Board members are properly accountable to the shareholders – and to the shareholders alone. It is very important that there be a clear set of metrics for continued board membership. New board members should understand what is going to be required of them, be clear that their fiduciary relationship is to the shareholders rather than the management and be aware of the various reasons for which they may be removed prior to completion of their term. Accountability yields results.

8. Thievery is Seldom a Good Policy in the Long Run: Don’t steal the time of those who would help you. Companies that do not compensate board members for their contributions end up with ‘charity boards’. Even at the early stages, you need to recognize the willingness of very substantial people to help your company grow. At first, equity accumulation in the form of options may be all that you have – and that is what you need to use. But, as the business grows, you should stand up a policy that includes a retainer, honorarium for meeting attendance and a formal way to recognize extended service. You also need to be sensitive to the risks that board service brings. In the early days you may not be able to afford D&O insurance but you should put a policy in place as soon as possible.

9. Disclosure is Vital: Complete and open disclosure to your board members is critical not only to the future of your company but to the financial well being of the directors. Board members tend to react negatively to lies by omission – and these lies always come out – so don’t do it. As a matter of policy, err on the side of more disclosure. Full disclosure is one of the best ways to build trust between your team and board.

10. Oversight is the Name of the Game: An effective board is all about management oversight. If you build a corporate culture that sees them as outsiders and ‘enemies of the state’, you will lose the battle to reap benefits from the board and, over time, will lose key members of that board. I recently watched a substantial portion of a board dissolve because senior management had formed a cabal which cut out most of the board members. As a result, and within an amazingly short period, some very important resources left the board. It may seem easier, and even rational, to avoid the close scrutiny of an effective board but, in the long run, avoidance is simply a bad option. Subject your team and yourself to board oversight and the chances of succeeding with your company will go up sharply.

A couple of comments about the process of overhauling existing boards might also be in order. First, most early stage companies take a rather informal approach to constituting their first board. In many states, there are requirements for a minimum number of members and those are generally selected from the team and their immediate family. The process of overhauling or professionalizing a board can cause serious stress when it becomes necessary to remove charter members. As daunting as this process may seem, it is important that it takes place. All board membership should be seen as temporary and the decisions about who will be on or who will leave the board should be solely in the hands of the shareholders. As a company grows it needs a more and more effective and well resourced board of directors. You ignore these needs at not only your own peril but at the peril of other team members, the future of your company and the interests of your shareholders.

Finally, the restructuring of an existing board is best done with an outsider’s eye overseeing the process. This may be either a consultant who specializes in board design and population or a sitting outside board member. In any case, management should have only a contributing role in the restructure. The alternative is equivalent to letting the foxes design the hen house.

© Dr. Earl R. Smith II

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Dr. Smith is a proven senior executive, successful entrepreneur, published author and public speaker. He serves on boards of directors and advisory boards or as a strategic adviser to CEOs. Dr. Smith specializes in turnaround management, strategic planning, leadership development and executive coaching. He also works as an executive and/or life coach in the areas of personal growth and spirituality. 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

Crazy Risk Taking Business Angels?

Business Angels come in different shapes and sizes. But are they really like? Crazy? Successful? Generous or in it for the money?

That is a question that not only entrepreneurs ask themselves, but also the Business Angels too.

Why?

Most investments that gain Angel investment will have not one single investors but a small team or committee or even a board. And one Business Angel is going to want to know who they are investing alongside. If the Business Angels don’t have mutual respect among them, then the investment is at risk.

This is why Angel investors will often form a small team and, collectively, invest in a number of projects. 

Sometimes the investor team will include a Venture Capitalist and a passionate / dedicated individual in the role of the Business Angel / board or non-exec director. Sometimes the investors might be a group of Business Angels who may have different expectations

However, the image of Business Angels as someone who gives not just his (or her) money (with conditions) and his time, network and experience (more or less for free)… is often not correct.

There are a number of different types of Business Angel – and I propose these these profiles as personal observation – so do feel free to contribute your own.

Quiet Angels – these Business Angels have never invested before – possibly they were an FD in a highly successful company and saw a big payout on sale – and so tend to be looking for that next entrepreneur that will re-create riches like last time. These are perhaps the most nervous of investors as they are not entrepreneurs themselves and are not used to being on the front line.

Sold Up Entrepreneurs- many entrepreneurs who have sold a business just love being around new ideas and are naturally restless. These are probably your ideal investor but they may get bored quickly and want a quick return. Richard Branson might be an example? Hugely charismatic but a bit of a problem if he decides he doesn’t like the direction of the business. May be looking to sell their stake before the founders would wish.

Professional Directors - some investors are professional non-exec directors and have seen a number of business sales plus been on the purchasing side too. These guys have probably seen a few founders ousted by the board. Their knowledge is invaluable and probably they would bring a calming influence. They probably have the greatest ability to play the long game – think Warren Buffett.

Trader Angels - some entrepreneurs made their money less by building a business than by buying low and selling high. They may add great energy to your sales team and have the best networks in your area but they wouldn’t hesitate to sell and do so on their terms.

Institutional Investors - these guys hail from the VC industry and will expect things to be played by the book. Probably they have the least to offer in terms of business expertise and many smart VCs have learned to team up with expertise in the form of Business Angels as this increases their success rate. You might call them the professional money men.

Some investors will, of course, be a mix of all these profiles or even, make take on different roles at different times. Feel free to contribute your profiles of Business Angels – click Comments at the top of this post.

Is the Iceberg Melting?

I am not suggesting for a moment that all Green businesses are bad investments, but I am suggesting that whenever a bubble appears or to there is much enthusiasm for an idea, that a number of the businesses ideas sold to unquestioning investors will turn out to serve the middle men far more than the money men.

As the investors, the business angels, we need to be on our guard.

There appear to be two dangers with the current alternative or green energy fad.

The first is the classic investment risk taught by Benjamin Graham and discussed in his book The Intelligent Investor. Graham, the mentor of Warren Buffett, took apart the reasons for investing in the 1950s boom industry – the airlines.

His analysis has been proven to be right as Buffett now claims that in 50 years, airline investors taken as a whole still have not had a return on their money.

However, Graham did spot that a large number of companies supplying the new industry did make a lot of money for investors. Airports, retailers and caterers have done well.

Graham’s conclusion was that it is far better to supply a growth business sector than to be a part of a great swam of investment as inevitably too much money will be invested too easily squeezing the profit margins of good ideas.

The second risk is that climate change will turn out to be a Malthusian idea that solves itself as population growth, mutually assured destruction and other apocalytic senarios usually do.

This is illustrated by the increasingly sceptical scientific community which is beginning to raise its head against the slavish commitment to all forms of greenery.

I and my fellow investors are not scientists, but it is worth noting their scientific concerns as it could up-end a few business models and a lot of start up ideas.

Firstly, there is a generally held view by the (admittedly few) academics that I know that if a scientist wishes to receive funding for research he is well advised to research ‘the affects of climate change’ and that research into ‘climate change – the myth’ isn’t currently being funded. By making the assumption that climate change is real, researching get money, if not then not.

Therefore, the scientific literature being published is already biased by the incentives of the research grant process and therefore, can needs to be viewed as biased in favour of climate change. The latest report from the IEA (International Energy Agency which made the front page of the Financial Times) might be a good example as it take it as proven that global temperatures are rising).

Next, dissent is beginning to break out in normally green magazines such as the UK’s Big Issue (sold on the streets by UK homeless) as well as larger circulation magazines such as The Economist.

In fact, a recent letter to the Economist by Horst-Joachim Luedecke, retired professor of physics, Heidelberg set out three reasons to be scepitcal of green alarmists.

1. There has been no discernible increase in storms, hurricanes, floods or droughts according to the Intergovernmental Panel on Climate change.
2. Rises in sea levels of 1-2mm per year have been occurring for many centuries and therefore this is not evidence that sea levels are rising as a result of any climate change factors.
3. Mean global temperatures have actually declined since 2001 and the research scientist, Professor Mojib Latif of University of Kiel, predicts further declines over the coming decades.

Let’s not enter the green / not green arguments here.

Let’s simply take this as a warning and a reminder that green start-up business are at greater risk of hype and hyperbole, rather like dot coms in 1999, and therefore each idea needs to be scrutanised much more closely.

Or indeed, that if you are not an expert on this sector, simply do not allow yourself to be drawn into it on the promise of easy winnings.

If you want to read some more science based sceptiscm on climate change then head over to http://cfact.eu/

Most angel investors, when funding a start-up, ignore the structure and operation of the board of directors. Most early-stage companies that I work with have only a casually structured board that seems to exist to satisfy legal requirements. Accumulated experience has shown me that this is a very risky approach. A board has defined obligations that are important to the future of any company. Boards unable to fulfill these obligations severely limit possibilities. Here are some of the guidelines that I offer when working with these start-ups: 

Composition: A well functioning board is independent of the management team. Friends and family do not meet that test. A board, which is simply a rubber stamp or doormat, creates an imbalance within the organizations culture – key functions are untended or receive short shrift. A functioning board should have a majority of independent members. In my view, the term independent excludes both members of the senior team and investors.

Balance: All the rhetoric aside, the tendencies of management are inherently tactical and self-serving. The CEO is – or should be – focused on implementing the strategic and tactical plans. All implementation is inherently tactical. The team’s compensation – if it is correctly structured – should depend heavily on meeting those metrics and delivering on the plans. Even the most experienced CEO work this way. That implies an unbalanced emphasis on the tactical. An independent board acts as a counterbalance to this tendency.

Professional Members: Board members need to have the accumulated experience and refined judgment that will allow them to help formulate an effective strategic plan. Their vision needs to be long-term. They fulfill their fiduciary responsibility to the shareholders by balancing short-term tactical issues with longer-term ones. One of the changes that I have seen in recent years is a tendency among angel investors to seek out professional board members to take the seats that their investment entitles them to. Angel investors can draw on two pools of talent. The first is successful serial entrepreneurs and the second is professionally trained directors. Both bring important knowledge and experience to the board – both add significantly to the corporate culture.

The Business of Business: As I have written elsewhere, most start-ups fail (one in ten makes it to their fifth anniversary) because the team fails at the business of business. Most start-up teams have a good grasp of the business of the business. A well-functioning board will help make sure that the ‘non-technology’ aspects of the start-up are not the ones that bring it down. One of the most important of these is oversight – both strategic and tactical. Professional board members have the experience to tell when a management team is blowing smoke or missing the point. They also have the ‘stiffness’ to confront the CEO and force the necessary changes.

Standards and Metrics: One of the biggest dangers in a start-up is constantly moving goalposts. The double diversions of constantly evolving Power Point slide stacks and constantly reworked Excel spreadsheets can eliminate the possibility of holding the management team to any metrics at all. A functioning board will insist that performance meet projections and aggressively oppose the proposition that projections should be adjusted to match performance. The later is one of the most serious diseases that can infect any start-up. A management team that constantly lowers expectations to match failure is an amateurish gaggle.

Holding to Account: In most simple terms, if you cannot say what you are going to do and then do it, what is your word really worth? If you say you are a CEO, make statements about what your team is going to accomplish which induce investors to risk wealth based on those statements and them fail to deliver on those statements, you are not a CEO – you are a highwayman. A well functioning board will detect these bandits and take steps to replace them with people that are more professional and productive.

There is a tendency to overlook the impact of governance on the fortunes of start-up companies. My view is that this is a mistake. A well-structured and focused board significantly improves the prospects of any start-up. The cost of such a board is incidental when compared to the risks that it helps control and overcome. ‘Adult supervision’ alone is worth the investment. However, the other benefits – such as a wider range of contacts, introductions to important decision-makers, support in implementing effective control systems, professional evaluation of performance and more, make a well functioning board one of the most valuable assets any start-up can have.

© Dr. Earl R. Smith II

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Dr. Smith is a proven senior executive, successful entrepreneur, published author and public speaker. He serves on boards of directors and advisory boards or as a strategic adviser to CEOs. Dr. Smith specializes in turnaround management, strategic planning, leadership development and executive coaching. He also works as an executive and/or life coach in the areas of personal growth and spirituality. 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.