The global financial crisis and the resulting recession made a deep impact on seed funding

New venture funding is the lowest it’s been for a decade according to Nesta’s July report; Venture Capital Now and After the Dotcom Crash and that’s not all…

The BBAA’s glittering annual awards dinner and conference took place last Wednesday providing an  opportunity for business angels to meet up and share their experiences over the past 12 months. I wonder how many of those attending had read Nesta’s report on VC funding. Ok so we haven’t really witnessed the end of seed stage funding, but there has certainly been a huge decline.

The findings of this latest report which follows Nesta’s business angel report last year will likely have provided a sobering topic of conversation. What is interesting about this latest report is that it takes us back to the Dot Com crash of 2000 and compares it with 2009. It makes three alarming conclusions :

•    Fundraising in 2009 is the lowest in the past decade.
•    The situation now would be far worse without public funding.
•    It is taking longer for investors to see returns on their investment.

You could say this is all about VC investments and not really indicative of the likely performance of investments made by business angels. You might also think that it is understandable given the scale of the financial crisis and a deep global recession that there would be a temporary loss of appetite for risk – considering the millions rather than thousands VCs tend to invest.

But this report suggests something more than a temporary blip. It highlights a longer term decline in the performance of VC investments made in the past decade. It is worth remembering that 2009 was the start of recovery when most countries were beginning to move out of recession. Yet fundraising was also lower than it was in the last recession.

What is also alarming is that it was investment in seed and start-ups which suffered most between 2007-2009 dropping by 58 per cent. And this is an area that would be of concern angel investors who use their own money to help those early stage businesses.

Looking at these figures there appears to have been a marked loss of confidence amongst VCs and a dramatically reduced appetite for the risks involved in early-stage investing. So will business angels be filling in those funding gaps? Possibly, but rather than dive in and exploit all those growth businesses the VCs are missing out on it might be worth finding out why VCs have seemingly abandoned seed stage businesses.

Correct me if I’m wrong but I’m guessing the biggest reason lies in the time taken to exit. I recently read with interest a blog which talked about angels finally getting in on the act with all those seed stage businesses, however it won’t be a simple as a VCs out, business angels in scenario.

Owners of those businesses shouldn’t get their hopes up. The reason VCs are pulling out of investing in seed stage businesses is down to the time it takes to exit. Typically the patient investor would want to see a nice return on their cash and an exit in three or four years.

What this report tells us is that exit is more than likely going to come in seven years or more. Seven years is far too long. While not all exits will take this long, clearly there will need to be a considerable commitment. The landscape appears to have changed dramatically in the 10 years since 2000 when it took on average three years less to exit a company in the UK.

More worrying still is that the report says there is greater uncertainty now about the time taken to exit and there are likely to be more funding rounds now before flotation than ever before.  So more money is being pumped in than ever before and it takes longer to get your money back out again, if you make any at all and that is far from guaranteed according to last year’s report. This doesn’t sound attractive. The impact on those promising growth companies that should be helping to boost economies should also be considered.

On this evidence things can only get better and at that glittering awards ceremony in Manchester there was much to celebrate, but this latest report from Nesta certainly provides some food for thought.

Tax doesn't have to be taxing for angel investors

The recent Budget could well have helped create the conditions for the growth of business angel investing

It’s been nearly a week since what could turn out to be the current UK government’s final Budget. On reflection there was little in it to make those on higher incomes start popping their champagne corks. Hardly surprising though, given that there is the small matter of a General Election around the corner. The Chancellor Alastair Darling continued his vote winning assault on the big earners with the banks and those earning over £150,000 shouldering a larger portion of the state debt burden as a result.

Hard to swallow for some, but further attacks on income and wealth are not out of the question whichever government takes power in May. We could well see another Budget within 50 days of the election should the Conservatives claw their way back to number 10.

Politics aside, with stealth tax avoidance now even more of a concern for those on high incomes, has the Budget, despite its shortcomings, unwittingly opened the door to those considering angel investing as an alternative to losing yet more cash to higher rates of tax?

Taken at face value, the Budget appeared to be aimed at nurturing economic growth and more about helping small fledgling businesses than those hoping to invest in them.

The banks were once again targeted with those who run state-subsidised RBS and Lloyds having their arms twisted once again to lend £94bn to small businesses as part of new targets set by the Chancellor. This was greeted with a chorus of approval by those in the embattled small business sector, starved of funding for most of the last two years. Whether or not the banks will keep this promise remains to be seen however – particularly in the light of recent failures to meet lending targets set in 2009. The banks missed their target by more than 50% in one case.

As a result those involved in angel investing in recent years have enjoyed the pick of the promising start-ups as banks have become more conservative with their lending.

Despite this only 44% of those investors (according to NESTA) made substantial gains, which suggests that either the quality of seed stage businesses they decided to invest in were dubious or it may have been a case of the quality being diluted by the quantity of those applying for funding  which affected outcomes.

The same NESTA report recommended that angel investors receive higher levels of Enterprise Investment Scheme (EIS) tax relief. This, as the report suggested, would help mitigate the risk of investing in high risk enterprises. Perhaps, not surprisingly then the call for the current EIS 20% tax relief to be raised to 30% fell on deaf ears even though it was responsible for more than half (57% ) of the investments made through investors in the NESTA survey.

In the event the Chancellor chose not to provide UK business angels with further tax incentives to waste on underperforming investments.

Assuming that the banks do meet their lending target to small business, this could well mean a reduction in businesses seeking funding from business angels. This is happening at the same time as business angel investing is being heavily promoted not just as a way of boosting economic growth through investment in start-up enterprises but also as a way to avoid stealth taxes.

As a result, 2010 could well turn out to be a year where there are less businesses seeking funding from business angels and more high net worth individuals becoming business angels as a way of avoiding the imminent rise in the top rate of income tax as well as capitalise on the EIS.

This should create an environment where deal flow is reduced and the more promising businesses more visible.

Whether this will lead to a larger proportion of successful angel exits in the next three to four years depends on two things – the quality of fledgling businesses seeking funding and the ability of angel investors both new and existing to spot the winners.

Angel investing remains risky even for the most experienced, but the environment we find ourselves in now means that those businesses that have survived the worst the recession could throw at them could well be in a position to make better use of the help they receive from angel investors.

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.