iBusinessAngel

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

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By Dr. Earl R. Smith II
DrSmith@Dr-Smith.com
www.Dr-Smith.com

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.

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Where are your Dollars Going?

The biggest question for angel investors – and hardest to answer question – is ‘what am I actually investing in’?

However, if we ask the question another way, it does become easier.

If we take the approach that the task of the investor is first and foremost not to lose his money, then the first question that comes to mind will be this:

‘if the business plan as presented fails and the business assets are liquidated, will I get any or all of my money back’?

The answer to this question will tell you whether or not you are investing in anything tangible or whether you are well and truely taking a punt.

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56% of ventures invested in by angel investors will fail, according to recent research by Nesta..

However, as Nesta warns, the figure could be even higher as their statistical sample was taken from angel investors who have remained active over a number of years.

Therefore, the rate of failure could be as high as 80% , or to put it another way, 80p is lost of every £1 invested.

This rate of failure is too high and the networks and businesses that depend on angel investing are beginning to recognise that it needs to be addressed.

So, how do you, an angel investor, increase your chance of success?

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“Venture Capital funds available for start-up and growth businesses has dropped 70% since 2000″, said Anne Glover chief executive of Amadeus Capital Partners at the BBAA Annual Awards Dinner.

This means that businesses seeking new capital that are unable to raise bank finance (and who is able at present?) will need to increasingly turn to Business Angels.

In the view of Anne Glover, this represents a huge opportunity for Business Angels as the Venture Capital businesses will not be able to take all the best deals and leave the angel investors with the left-overs.

In fact, a theme that developed during the recent BBAA event was that Venture Capital firms want to work with Business Angels.

A number of VC firms, such as Catapult, look to invest alongside Business Angels.  Rob Carroll, managing director of Catapult said “investing alongside experienced entrepreneurs and angel investors increases our chance of success.”

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The BBAA (British Business Angels Association) trade body is today organising its annual awards ceremony and conference at the Belfry.

The event is sponsored by Advantage West Midlands, the redevelopment agency for the West Midlands.

It will include both an opportunity to recognise key contributions made to this growth sector during the year at the annual awards dinner as well as create a platform for discussion about how this new sector should grow during the conference session on Thursday.

Many business angel networks and agencies have seen an increase in activity in 2009 as a result of high net worths looking for greater influence over how their money is invested as well as more business start-ups turning to business angels to provide initial funding.

However, converting interest into actual funds invested; and, funds invested into business success is where the industry still needs to prove its mettle.

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The FT neatly describes the difference between Debt and Equity when it argues today, that the tax treatment should be the same for both.

Of course, the fact that it is not has led investors to structure their deals to take advantage of the difference.

And, flavour of the month is convertible debt. But more of that in a minute…

Firstly, why debt rather than equity? Well, because the interest payments that a business makes on debt are tax deductible for the company. Similar returns going to equity investors (in the form of dividends) are not!

Therefore, companies make bigger profits if they leverage up with debt rather than seek equity investment.

And, in this current environment where banks have either withdrawn funding or increased the cost, more start up businesses need to depend on Business Angels for a greater part of the initial investment.

This gives the Business Angels greater power to negotiate convertible debt. That is, a cash sum which earns a particular level of interest each year (and the company can off-set this interest cost against profits) with the magic ability to convert into equity at a pre-defined ratio, should the investor so desire.

However,  it isn’t just for tax reasons that convertable debt is popular. It is also because business plans are less clear and timing of exits are less certain that a debt investment structure means that the investor still gets a return on his money whilst waiting for the market to pick up and the company to be sold for a profit.

Hence, it is tax efficient for the company and great for the investors. Now that the business owners have fewer options, it seems that business angels are able to negotiate and agree these structures more easily.

The 9 things every direct business investor or business angel needs:

1. Deal Flow
   There are more and more sources of direct business investment opportunity – you need to find a way to track them and pick out those that deserve more attention. Firstly, you’ll join networks or groups, which is often free, and then you’ll begin to see a flow of deals. Often, the network will consist of some industry specialists and you may find that it pays to get to know those who work in industries that you know or wish to invest in.
2. A Nose for a Deal
   Over time your gut will tell you whether to invest or not. George Soros always says that he sold when his back hurt! However, until you reach that exalted status, you’ll need to track and watch what happens. Key to this is to figure out which companies don’t get funding and become successful anyway! And which companies DO get the money, but fail anyhow!
3. Advice
   Firstly, understand what each persons motivations are. Some advisors are on commission others have a stake in the business etc… This will impact on the degree to which you are wise to trust any advice. Equally, if you can, find a willing mentor who can guide you through your early investments
4. News
   The business angel industry is move from a cottage industry status to become a more established source of finance. As it does, there are better websites and more information and news which you can follow.
5. Standard Contracts
   Legal fees can kill a deal. The levels of business angel investment (from £50k to £1m) mean that legal fees can easily eat up the stake invested if both parties are not careful. Therefore, judicious use of some standard tools or contracts is wise. Then bring your lawyers in to make the final tweaks to those contracts.
6. Checklists
   Checklists are a great way to make sure you don’t forget that all important question! Also, don’t forget that the companies looking to raise finance will be keen to promote the positive aspects of their opportunity. In many ways, your role is to spot the weaknesses and decide if any of those weaknesses are serious enough to kill the idea.
7. Strategy
   There are a number of different investment strategies that business angels use. These strategies will help you build a portfolio of investments rather than help you make a decision about a single investment. Questions you’ll need to answer include how much to invest and how many investments to enter into? One sector or many? Geographically close or distant? etc…
8. Exit
   How can I find out about exit strategies – for example, on straight equity vs debt that converts to equity?
9. Share
   Be willing to share experiences and learn from others. Investors can teach other a huge amount, but only if they are willing to share. Find a group you are comfortable with – who share you ideas and values and start sharing stories and experiences

Small businesses and start up ventures can no longer access easy investment from banks and therefore need to turn to private individuals – or business angels.

These business angels also often bring a degree of industry experience and knowledge that can be invaluable for small or start-up companies.

The UK has the highest number of angels in Europe, nearly 5,000 active investors in 2007. They invested €73m in 388 deals in England and Wales and a further €41m in 61 deals in Scotland. The average amount raised per deal is €327K and with many investments starting at or around €20k per stake.

The number of wealthy investors in the UK looking for an alternative to investing in stock markets and property is growing rapidly, we believe, and they are looking at the Direct Business Investment option with greater interest than ever before.

In response to a surge in interest in this sector and to serve this growing community of business angel investors we will launch www.iBusinessAngel.com in the early autumn of 2009.