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.

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!