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.

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

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.

Let me give you an example – a business developing a piece of technology to reduce fuel usage – if the business plan goes up in smoke you are left with the patents. It may be that the business size or level of marketing funding wasn’t sufficient to manufacture and deliver the product at a profit – but that doesn’t mean another firm – probably a large auto parts firm – can’t add your patent or product to his range and turn a profit right away.

Hence, what you are really investing in is the patent and the technology. This is the tangible and sellable business asset and what is left once you’ve paid for someone to come and take the spare desks and tatty old notebook computers away.

Another example, if you are investing in a website, what is left if the business fails? The domain name perhaps? You are unlikely to get anything for the web technology for two reasons; firstly, anything clever done today will be copied and available free tomorrow – so there is no lasting value in we technological innovation other than the opportunity to exploit it which falls only to the business that created (and hence can’t be sold on); or, the web development is so clever that no one else can quite understand it (ie they can’t copy it) hence it will be impossible to sell it.

Therefore, web businesses – without a real business behind them – are likely to be worthless in a firesale situation – with one exception – the brand!

Let me give you a final example; I am often asked ‘can you give me a list of buyers willing to buy my product’ to which I can answer ‘yes and no’. This means that I can give you a list of any group you like – it is relatively easy to build such lists – just start a group on facebook or twitter – but, I can not guarantee that they will either read anything I write (or any sales pitch that I pitch) and I have even less confidence that if you do read my marketing copy that they will act on it.

Okay, so how do you increase your email marketing open rates? Easy. you send it from a branded email address where that brand has built a reputation of intelligent and useful ideas and information.

Therefore, the thing of value here is the brand not the list. Oddly, the list of customers is probably the least valuable thing – but buyers of distressed assets don’t always recognise this, so the customer list may still be the asset that generates most cash.

So, getting back to the question – ‘what am I investing in’ the answer will be

a) the creation and development of assets
b) the development of a business model to exploit the value of those assets

If the value of the assets developed will always be greater than your initial investment, then you can see the investment is low risk.

On the other hand if 95% of investment money is going to fund purely a marketing effort (that will either succeed or fail but either way, end quite shortly) then your money is at huge risk.

That is why the way to resolve investment risk is to ask ‘What am I investing in’?

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By the way – have you subscribed to iBusinessAngel? If you do – you’ll get updates when ever an interesting article is added to the site…

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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?

Simple, every investment needs three critical factors to be in place. And if any one of those elements is missing, the investment and underlying business is most likely to fail.

These factors are

1. a great business idea
2. a great management team
3. a great mentor(s)

If any one one of these elements is missing or weak then the business is unlikely to succeed. Instead, the investor would be better off encouraging the start-up entrepreneur or management team to seek to improve their idea, management team or mentors before parting with cash.

As Doug Richard says of his first Dragon’s Den investment; ‘I backed a great jockey (management team) but the horse (the business idea) was dreadful’.

It is easy to get seduced by an energetic entrepreneur who believes in their idea. And you may be correct to assume that this entrepreneur will make a success. However, you have no guarantees that the entrepreneur will succeed with THIS idea.

Hence, whilst conventional wisdom says ‘I’d rather back a great management team than a great business’ investors would be wise to ensure BOTH are in place!

Why? The failure rate of start-up business – that go down with your money – is somewhere between 56% and perhaps 80%. So why risk it?

In fact, the successful angel investor needs to remain cool and clam and slowly (over a period of weeks) decide if this proposal is the right one – that this proposal has the right business idea, the right management team and the right mentors to see it to success.

So, how do you remind yourself to stay cool? Keep this idea in mind

80% or so of business that GET funding fail! That means, only 1 in 5 of funded businesses make it!

So, find 4 businesses that get funding that you would NOT invest in, before you look for the 5th that you do back.

If you can explain why others have invested in the four likely failure, why you have not and how your investment is different, then you have a much high chance of success.

If you can’t explain this distinction, then keep looking but hold onto your cash.

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.”

However, when VC firms invest alongside angel investors two key issues arise. Firstly, VC firms want to purchase preferential shares, whereas angel investors look to take ordinary equity as this is often suitable for the tax reducing EIS (enterpise investment scheme).

The other issue that arises is that an experienced angel investor will often invest his time and expertise into the start up or growth business whereas the VC will not.

However, Catapult solve this issue by ensuring that the angel investor buys his shares at a lower price than the VC, in return for agreeing to act as a non-executive (and unpaid) director.

The pay off for the angel investor is that he gets to influence his investment and increase the likelihood of success. The benefit of this structure for the VC firm is that experience is brought to bear on the fledgling firm AND that neither is the cost base increased by the non-executive director nor does the non-exec receive a salary.

Instead, the non-exec will see a return on his time and money investment when the business succeeds.

This structure ensures that the interests of the VC firm and the angel investor are aligned and that the risk of the non-exec drawing a cosy salary for NOT challenging the management team is significantly reduced.

As an investment strategy, this structure can ensure a much higher chance of success as well as encouraging both parties to work together with the management team.

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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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.

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

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.