• Idea Alive – startup accelerator switches from an equity base to a revenue base for its next accelerator – find out why
• Team retention is critical to a startup’s success – just as is customer retention – but do business angels pay enough attention to this?
• Nic Brisbourne asks what should startup entrepreneurs expect from a startup accelerator

and lastly, two articles suggesting the downside of crowdfunding

• Gizmodo is giving up giving on Kickstarter and Electric Pig has spotted fraud problems with the crowdfunding model too. Real warnings here that all the hard work of crowdfunding legalisation will be undone if promoters don’t take responsibility for quality.

Are business angels active or are they skint? Have they invested too much and are waiting for the VC industry to wake up and buy their stakes?

Do business angels like to act alone or are they hunting in packs?

Lastly, are they becoming more secretive or less?

Take our survey and tell us what you think. Results will be published at the end of May.

Business Angels and entrepreneurs are increasingly meeting in the context of a startup accelerator programme, so it matters greatly – to all of us – if the accelerator works or not.

(In fact, I have a vested interest here as I run Idea Alive – startup accelerator in Manchester, Liverpool and the NW of England.)

The doubt of whether accelerators work or not is beyond dispute in the US – where Y Combinators leads the way. However, doubts have been raised in the UK (and equally Europe) about whether this startup accelerator format can be transferred out of the USA.

The answer to which, I believe, is yes – but not in the same format!

Firstly, Y Combinators is a silicon valley based accelerator and as such is coloured by the nature of its local investor community.

After all, accelerators do exist because of – and for – their investor community whilst also being of great value to the local entrepreneurs.

The investor community in San Francisco might be contrasted with the business angel or early VC community in (say) Manchester, England. In Manchester, the business angel and early stage VC community wants to see revenue before investment.

Compare this to West Coast USA where hot ideas are backed with large sums of money before revenue. In the north England, it just isn’t like this.

Hence, entrepreneurs – based in Manchester – should move to Silicon Valley or Boston (or perhaps now London) if they want their project backed – pre-revenue.

The consequence of this difference is significant. Firstly, the scope of ambition in a pre-revenue startup in Silicon Valley – can be global or enormous – especially when the point of the business paying its way gets put back – such as Twitter – because additional funds can be raised on high levels of user growth.

Equally, the need to prove revenue early on typically means that the revenue driven business – found in UK regions and across Europe – will focus on a niche and then specialise.

The consequence of the early search for revenue is that the business becomes smaller in ambition.

I think this explains why the best UK startups are still sold to US tech companies.

Now, this fact should inform the startup accelerator in Manchester, Paris, Madrid and Berlin (although London may possibly be an exception) that regional (if I can call them that) startups accelerators would do better if they focused on revenue rather than growth.

Now, Nic Brisbourne recently wrote that all startup accelerators are essentially VC businesses – that is primarily focused on growth (not revenue) with the aim (hope?) that one business will make it big, IPO or sell and that this success will pay for all the failures. I agree with Nic that this is currently the case, but don’t believe it will continue to be so.

Firstly, there is a growing opinion in public sector funding circles that the startup accelerator model developed in the US doesn’t work in Europe.

Secondly, business angels typically want to see revenue and revenue growth before they commit just as they typically look for businesses that expand their area of business influence.

The conclusion is this – non London, Boston, New York or Silicon Valley etc… startup accelerators need to focus on revenue – not equity growth – because that is fundamentally what their local business angel community wants.

This then provides a second challenge – the regional startup accelerators need to stop trying to be Venture Capitalists – focused on a high value equity exit.

Instead, startup accelerators – and my Idea Alive startup accelerator is included in this – need to focus on revenue and earning its income from a share in the revenue generated by the successful companies – not just the hope of a big pay out – some day, way off in the future.

The mistake that startup accelerators in the regions and across much of Europe make is that they haven’t reflected - truly - what investors want.

And, by shifting to a share of revenue – from a share of equity – the regional startup accelerator becomes more like a publishing company working with an author or music group, instead of the venture capital firm that the region never had, and, very probably will never have.

When I look at the success of companies like Penguin, created hundreds of years after the invention of the printing press, or in their heyday (1970s) the music labels (50 years after the gramophone was invented), you can see that the publishing / royalty format works extremely well and that the UK and Europe has achieved and built significant companies with this approach.

It is time – I believe – for the regional startup accelerators to focus on revenue and build themselves as publishing companies – taking a share of revenue – and to stop trying to be venture capital firms.

We need to leave the creating of VC firms to the guys in the centres of hot startup money – or, move to those locations.

We will be making this move with Idea Alive – and will shift from an equity share to a revenue share with our next iteration of our startup accelerator.  Find out more at Idea Alive.

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Five wise men (or women) – one missing

The next iteration of Idea Alive – Manchester, UK’s
startup accelerator – is about to be launched with
five wise men (or women) as the business angels
backing the venture.

We are looking for our 5th and final business angel.
Please contact me via iBusinessAngel if interested.

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The startup and business angel investment world is awash with phrases describing the stage of a business startup and the stage at which investment is made – concept, prototype, seed funding, crowd funding, series A funding, series B funding etc… 

… so how do we tell a startup’s stage of growth and the stage of funding? Here’s iBusinessAngel’s attempt to shed some light…

Startups may be at any of the following stages

1. Concept (usually without funding) - an idea that has been sketched out on paper or digitally, but is not a functioning product and has not been market tested in practise – albeit, it will be based on insight that result from conversations with potential customers. Many businesses on crowdfunding sites are at the very early stage.

2. Prototype (possibly with seed funding)- an idea that has been developed into a functioning product that can be placed in front of customer

3. Early revenue (possibly with seed funding) – once a business has revenue it has a choice. Keep its costs at nearly zero (ie don’t pay founders and partners) in order to keep equity within the core team, or take funding to grow faster by allowing partners to release more time onto the startup project.

4. Seed funding – typically a £50k+ size funding provided by business angels and pre-profit. The funding is required to move the business into a breakeven position (ie no profit – just survival). Sometimes there is a recognition that £200k might be required take the business to breakeven, but that the investor only makes an initial £50k investment. It is important to see additional funding as part of this same stage – not a new stage.

5. Revenue and profit Growth (possibly with series A funding) – increasing revenue and establishment of profit, ‘Growth’ or series A funding is required to grow faster – typically in response to competitor threat or a belief that there is a land grab for market share. Often, this stage is illusionary in a digital or software business which explains why it occurs less and less often and most VCs are either dipping into the seed funding stage of the business angels (perhaps co-investing) or moving out to the Series B funding stage.

6. Business expansion (possibly with series B funding) – typically taking the business model to new geographic regions – perhaps taking a successful UK model and expanding across English speaking countries with country managers and businesses in each country. This is where businesses raise money in the millions of dollars or pounds and aims to become a multi-national with a few years.

Often, at the third stage, early revenue, the business will take a path of external investment or will remain an entirely private business.

Of course, skipping the seed funding stage doesn’t deny the option of attracting series A or series B funding, but conversely, if a business takes on seed funding it will almost certainly need either a series A or B (or both) funding round.

The element that often gets overlooked – by entrepreneurs – is that concept and proto-type business are rarely suitable for seed funding – except in certain exceptional funding markets such as Silicon Valley. In the UK, for instance, business angels will very rarely back a business that has no revenue what so ever.

Equally, the number of startups actually achieving an initial revenue income are pretty rare too – so if you can do it, have a quality team and a clear business model in an exciting / high growth area, then funding will be possible. The only question will be whether the various parties can agree terms.

The UK government has developed the Seed EIS (or SEIS) to encourage business angels to make very early stage investments into new companies.

The company needs to qualify – that is, be unquoted, less than 25 employees, fewer than £200k of assets; spend all the money invested within 3 years and not be set up for the purposes of avoiding tax,  amongst a few other key points (eg total investment per company must not exceed £150,000 – including any recognised state aid – and each individual investor can own up to – but not greater than – 30% of the equity,  and the shares must be paid for on issue – and hence, not as part of the company registration process).

For more details on SEIS qualification please click here and investor qualification please see here.

However, it has been unclear how the tax rebate would actually work. Well, thanks to some very instructive examples on the HMRC Tax website – which we’ve included below – it should now be clear to everyone.

When discussing SEIS, we normally cover two parts – Income Tax relief – normally described as 50% relief and, for the 2012/13 UK tax year only, a capital gains re-investment relief too.

However, there is a third, critical element, and that is to preserve your right to sell your investment – in 3, 5 or 10 years time – and gain a tax relief on your capital gain.

1. Tax reliefs available – Income Tax relief

Income Tax relief is available to individuals who subscribe for qualifying shares in a company which meets the SEIS requirements, and who have UK tax liability against which to set the relief. Investors need not be UK resident.

The shares must be held for a period of three years from date of issue for relief to be retained. If they are disposed of within that three year period, or if any of the qualifying conditions cease to be met during that period, relief will be withdrawn or reduced.

Relief is available at 50 per cent of the cost of the shares, on a maximum annual investment of £100,000. The relief is given by way of a reduction of tax liability, providing there is sufficient tax liability against which to set it. Please note that the relief cannot be set off against the notional tax credit on dividend income, as that tax credit is not recoverable.

Example 1

Jenny invests £20,000 in the tax year 2012-13 (6 April 2012 to 5 April 2013) in SEIS qualifying shares. The SEIS relief available is £10,000 (£20,000 at 50%). Her tax liability for the year (before SEIS relief) is £15,000 which she can reduce to £5,000 as a result of her investment.

Example 2

James invests £20,000 in the tax year 2012-13 in SEIS qualifying shares. The relief available is £10,000, as above. His tax liability for the year (before SEIS relief) is £7,500. James can reduce his tax bill to zero as a result of his SEIS investment, but loses the rest of the relief available.

There is a ‘carry-back’ facility which allows all or part of the cost of shares acquired in one tax year to be treated as though the shares had been acquired in the preceding tax year. The SEIS rate for that earlier year is then applied to the shares, and relief given for the earlier year. This is subject to the overriding limit for relief each year. Please note that there is no SEIS rate for a year earlier than 2012-13, so there is no scope for carrying relief back before that year.

2. Tax reliefs available – capital gains re-investment relief

This relief is for the tax year 2012/13 only. If you dispose of an asset which would give rise to a chargeable gain in 2012/13, and reinvest all or part of the amount of the gain in shares which also qualify for SEIS income tax relief, the amount reinvested will be exempt from capital gains tax. The £100,000 investment limit which applies for income tax relief also applies for re-investment relief. The ‘carry-back’ facility applies for capital gains re-investment relief as it does for income tax relief.

The asset does not have to be disposed of first; the investment in SEIS shares can take place before disposal of the asset, providing that both disposal and investment take place in 2012/13.

The HMRC Capital Gains Manual gives guidance on when an asset is disposed of for CGT purposes, starting at paragraph CG14250.

Example 1

Neela sells an asset in June 2012 for £200,000 and realises a chargeable gain (before exemption) of £80,000.

If she makes qualifying investments of at least £80,000 in SEIS shares in 2012/13, and all other conditions are met, the £80,000 gain will be free from CGT. She does not need to invest the whole £200,000 sale proceeds in order to get full exemption.

Example 2

Benjamin sells an asset in June 2012 for £200,000 and realises a chargeable gain (before exemption) of £80,000.

If he makes qualifying investments of only £20,000 in SEIS shares in 2012/13, £20,000 of his gain will be exempt from CGT and he will be liable to CGT on a chargeable gain of £60,000 on the disposal of the asset in June 2012.

(The remaining £60,000 chargeable gain will still be eligible for any other CGT reliefs that are available, and allowable losses and the CGT annual exempt amount can be set off against it in the normal way).

3. Tax reliefs available – capital gains disposal relief

If you have received Income Tax relief (which has not subsequently been withdrawn) on the cost of the shares, and the shares are disposed of after they have been held for at least three years, any gain is free from Capital Gains Tax.

Please note: if no claim to Income Tax relief is made, then any subsequent disposal of the shares will not qualify for exemption from Capital Gains Tax. 
Examples were taken from the HMRC website which you can visit here.

The framework of the bill is particularly interesting in that it only allows crowfunding for websites that are SEC approved. In the UK the equivalent of the SEC is the FSA, and the UK’s FSA recently approved Seedrs.

In addition there is a $1m limit that any business can raise through crowdfunding and there are limits too on how much any individual can invest. These are

• For investors with an income of less than $100,000, investments will be capped at the greater of $2,000 or 5% of income.
• For investors within an income of more than $100,000, investments will be capped at 10% up to $100,000.

In additon, the SEC approved portals are required to offer investor protection, including investor education materials on the risks associated with small issuers and illiquidity.

Interestingly, there is no requirement for the crowdfunding websites to select or filter the opportunities – simply a requirement to limit the amount that business angels can invest.

Here are some of the more interest insights from the business angel and startup fund raising world.

How do you share the equity in a startup – when there isn’t any money? Read my article on Rags to Wreckages of how we have used startup team assessments with a tool for devising 3 dimensional equity share models.

Y Combinators – yes, the startup accelerator that helped generated £3bn worth of business in 5 years, is exploring the idea of working with management teams with out an idea. In effect, if Y Combinators can make this work, then this will move the management team up the value chain. So, instead of valuing an idea – per say – we may find that the emphasis shifts to the team.

Of course, this is simply putting things the right way around – ie. business angels care about the team – more than the idea. For the investors the team implies a series of ground breaking innovations and new products – which the market loves – rather than a one-off lucky strike.

Have you ever thought of what life for VCs is like? Well, they answer to someone as well – limited partners of LPs – as Nic Brisbourne explains. This useful article helps to shed light on why VCs demand certain things – they need it to demonstrate to their customers / investors that they are doing a good job. Now, many business angels are of independent means, but that doesn’t mean that they don’t have to account to a husband or wife, or in many cases, their fellow business owners. It is useful to be reminded that we all report to someone!

Seed Enterprise Investment Scheme – or SEIS – will go live in the UK on the 6th April, 2012. Here the BBAA provide slides from a recent HMRC presentation on the operation of the scheme.