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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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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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.