Finding angels the easy way

Considering around two-thirds of small businesses are still having problems finding funding, business angels are almost as hard to find as their celestial counterparts.

Except they’re not. The UK is teeming with business angels, angel networks, early growth funds and intermediaries, all of whom are eager to put money – much of it their own – into innovative high-growth businesses. Once you’ve found them, it’s down to your business plan, concept/product, management team or all three if you are to secure the funding you seek.

Business angels are private investors willing to plough small amounts either individually, as part of a network or syndicate, or alongside traditional venture capitalists. Frequently retired venture capitalists or entrepreneurs, as well as working owner-managers, business angels can provide financing as well as their business experience and contacts.

With the ‘equity gap’ (a term the government uses to define the £25,000 to £3m funding required by smaller companies that often fall below the radar of traditional VCs) still in evidence, business angels provide manna from heaven for the engine room of the UK economy.

As Nigel Griffiths, minister for small firms has said: “Business angel investment is critical to the success of many SMEs, and it is growing in impact.”

Usage figures for the Enterprise Investment Scheme (EIS), a tax relief scheme available to private investors, show that business angel investment in start-up and early-stage companies grew into a £3bn market between 1998 and 2003. This doesn’t, however, include a large number of informal investments, including those of friends and family who don’t claim the available tax relief.

The prime source of business angels in the UK is the National Business Angels Network (NBAN), which has recently evolved into a trade association for the private investor market – NBAN’s previous remit was to raise awareness of the benefits of business angel investment, promote market development and lobby and inform government.

Five years after its launch, NBAN will now focus more on working co-operatively with the business angel networks (BANs) scattered around the country. “NBAN has historically been involved in the matchmaking process,” says Anthony Clarke, chairman of NBAN, president of EBAN (European Business Angels Network), as well as managing director of London Business Angels since 1998 and its sister company, London Seed Capital.

While NBAN (www.nban.co.uk) will continue to encourage angels to meet and talk to one another, using NBAN as a conduit, “the aim of the change is primarily to join up all the regional angel networks, of which there are about 50, to get them working with a trade body which they will ultimately own.”

Clarke says that, in the past, its computer database couldn’t keep up with the changing needs of investors and syndicates, while there was a suspicion that NBAN was in competition with regional networks across the UK. “It was unfounded,” adds Clarke, “but the suspicion didn’t help.”

ALL CHANGE AT NBAN

The next stage of public sector support is providing investment readiness programmes, with small businesses typically unable to afford professional advice. It’s an important part of the process, Clarke says, as “investors are not in the business of teaching companies how to get their money”.

A more significant change is on NBAN’s board: in the past, there was only one angel practitioner present, but now it will be built around all the practitioners. At the end of August, Clarke was joined on a new interim board by Martin Carr of Equity Link, part of Exemplas, and Mark White from NESTA (National Endowment for Science, Technology and the Arts). Ken Cooper of the Small Business Service has also joined as part of the government’s commitment to support NBAN until March 2006.

“We’re looking to be the conduit again, from the top,” says Clarke, adding that there will also be more emphasis on conferences and workshops, including training programmes for inexperienced angels themselves.

Angel networks, syndicates and early growth funds are the most visible fruit of that conduit, as finding individual private investors without help is almost impossible, short of being overheard at exclusive golf clubs. Many of these are regionally-based, working with local angels to match funding alongside co-investors, and can be found on the NBAN website. Examples include:

Great Eastern Investment Ventures, a £2.5m co-investment fund that was set up in April 2003 within the NW Brown Group to co-invest alongside business angels into promising businesses. GEIF Forum has already helped more than 150 early-stage companies raise in excess of £20m since its launch in 1995.

LOCAL KNOWLEDGE

The Thames Valley Investment Network (TVIN), launched in March 2003, links investors to companies seeking funding of up to £1m and is managed by Oxford Innovation and sponsored by the Thames Valley Economic Partnership, the South East England Development Agency and Business Link.

For Scottish entrepreneurs Archangel is a good bet. It was formed when a group of Edinburgh-based entrepreneurs and investors joined forces to help fledgling companies source equity-based finance and offer hands-on experience. It was one of the first business angel groups to be formed in Scotland and has now provided in excess of £30m equity funding in the last 10 years. The Scottish Co-investment Fund (SCF) is a £20m equity investment fund set up by Scottish Enterprise to invest from £10,000 to £500,000 in companies operating between the £20,000 and £1m mark.

London Business Angels invested £2m in 17 companies in the calendar year 2003, which was matched by £5m of additional equity. By the end of October 2004, the amount is closer to £3m, although in fewer companies, suggesting that deals and syndicates are getting larger, as well as more picky in what they invest in.

The Viking Fund provides finance for start-ups and fastgrowth technology-based businesses in Yorkshire and the Humber region, with investments typically of £50,000 to £100,000 in early-stage businesses, matching the investment made by business angels and private investors.

And Oxford Innovation Opportunity Network (OION, affectionately referred to as Onion) is a technology business angel network, operated by Oxford Innovation. It has raised £14.8m for 61 companies over the last four years

A common factor in the success of these regionally-based networks is that private investors tend to prefer to invest in companies within one hour of their home address. “Region is key at the smaller end,” says David Beer, chairman of Beer & Partners, a private regional business angel network, and one of the best known in the UK. “People want to invest in an area they live in – it’s important to them and to you. If they have local contacts and local knowledge, they know who’s around, including accountants and other local investors. However, at the top end, there are a number of investors who don’t care where the business is – it’s about sector.”

The prevalence of syndicates in angel networks can provide benefits for both investor and investee: a larger number of investors can deal with smaller amounts of cash (£25,000 is a common syndicate starter), and therefore risk. Additionally, the investee only has to deal with one or two appointed ‘leading investors’, generally chosen as the most appropriate for the sector and the ‘best match’.

Syndicates also benefit the investors, by “hunting in packs, which means less emotional involvement,” says Beer. This can prove crucial in a long-term post-investment relationship, when a leading investor is likely to be involved in your company’s board of directors.

Regional networks also facilitate a fundamental part of any angel investment: presentation events. Most networks have several events per year, providing a small number of pre-prepared companies to pitch to up to 50 investors – Alastair Cavanagh is manager of Oxford Early Investments, a new business angel network designed to help innovative companies at the very early stages of technical and commercial development. Investee companies can raise investment capital of up to £150,000. He says that OEI filtered 45 plans per month into just five carefully selected presenting companies.

SURVIVAL OF THE FITTEST

Beer & Partners typically sees around 3,000 companies per year, before selecting 150 to 200 as clients. While not an investor itself, a network such as Beer & Partners has to apply the same criteria as its investor members: How much money is needed and when, what is the track record, what management is in place, what are the company’s growth plans and where is the exit route?

Ultimately, the primary customers for the majority of angel networks are the angels themselves: companies will come and go, but understanding the investor and building a relationship with them should eventually lead to more focused opportunities being pitched at them. The level of trust between the networks and angels is a crucial factor in the process: all business angel investments, because of the early stage companies they are investing in, are a risk.

That relationship, the understanding of what an angel wants, and which sector they’re interested in, can pay dividends. “Investors have been doing this a long time and, in general, they are sector specific. But they are also prepared to put money into sectors and companies where their own network has done the due diligence and seen a good opportunity, so they’re prepared to take more of a risk,” adds Cavanagh.

Angel investment isn’t the only option available to earlystage businesses, but for those that pursue it there are challenges. “Lots of companies try business angels too early,” says Cavanagh. “They should try to secure an R&D award – although the DTI has mucked that up a bit. They should also be aware of grants, help from friends and family or the Small Firms Loan Guarantee scheme at a push.” The problem, though, is that awards can depend on the time of year, while friends, family and remortgaging the home can put added emotional pressure on already struggling entrepreneurs.

There is also the option of debt financing, although its biggest problem, as NBAN’s Clarke says, is that “you’ve got to pay it back – it’s a liability on your balance sheet.” Jeff Harris, partner at PKF, accountants and business advisors, adds: “Debt funding in principle is better but the companies that want the money typically don’t have either the assets or the cash flow to secure the debt and either the principals don’t have the private assets or don’t want to put up the personal guarantees to secure debt in these circumstances.” Intermediaries such as Hotbed and PiCapital provide a level of hand-holding for those who don’t want or don’t have time to get too involved in the investment process. Hotbed started out in March 2002 with no investors, and has since completed 27 deals, raising around £39m in the process for companies requiring up to £5m of equity, although the average deal is nearer £1m.

Claire Madden, business development director of Hotbed, says the key to its investment strategy is to focus on the private investors themselves: “They don’t want to be overexposed on one deal, so we find opportunities and manage them on their behalf.” According to Madden, Hotbed has completed more transactions and raised more money than the majority of networks in the UK.

Unlike some networks, Hotbed offers all opportunities to its members in units of £25,000, and directly manages the syndicate on behalf of the company. “From the owner-managers point of view, all they see is us, and the reporting goes back through our members. We’ve gone one step further where we can put syndicates of investors together, while other angel networks simply introduce them, and then that company has to go through their own due diligence and solicitors.”

It also, adds Madden, avoids management conflicts. “It’s a bit more dispassionate than someone who’s written a cheque for half a million in the company.”

However it is managed, the long-term relationship between investors and investee is a crucial one and worthy of considerable deliberation. “It’s important that a company understands who it’s getting into bed with,” says Kevin Caley, manager of the Advantage Early Growth Fund, part of Advantage West Midlands. “Like a marriage, it’s difficult to unravel once it’s happened, and if it’s a marriage of inconvenience, that’s negative from everyone’s point of view.”

However, giving up any kind of control or equity is always the first difficulty for an owner manager, but whether you are looking to partner with a venture capitalist or a business angel syndicate, “you’re going to have to get over that particular hurdle,” says Madden.

ATTRACTIVE ENVIRONMENT

As with much in UK business, there is a feeling that the government has not done enough, and yet it shouldn’t get too involved or ‘meddle’. According to Clarke, the tax regime for investors in the UK is the most attractive in the world. And Gordon Brown’s last Budget helped incentivise more investment through improvements in tax regulations on EIS and VCTs (venture capital trusts, which now have 40% tax relief for investors), along with greater emphasis in signposting financing opportunities for SMEs, especially through early growth funds.

There is a greater emphasis needed, says Clarke, on making investments in micro-businesses more tax efficient, while many others feel that a focus on helping investors through quality over quantity will see more angel investors providing more money in the long run. “They’re not experts, they’re politicians,” says Nick Smailes, director of SETsquared, the largest government-funded, privately-backed support programme for high-tech ventures in the UK. While Smailes is pleased with government support so far, he adds: “The business angels that do it for a living are better at picking out what is good and what isn’t. We don’t want civil servants investing lots of money in companies.”

In terms of costs, most networks or intermediaries demand a front-end fee, and then a success fee (generally in the range of 3% to 5%). Investors often carry out their own due diligence and this, along with legal costs, could be carried by them, but can be open to negotiation.

“One of the advantages of angel finance is the relatively low cost,” adds PKF’s Jeff Harris. “However, they will probably need help with a business plan, projections and hand- holding through the process, plus tax advice. It is not hard to see it adding up to £30,000 plus. Plus any legal costs and due diligence that the angel might want to carry out.”

You should always look for transparency in terms of costs, as well as researching a network or intermediary’s track record on deals and post-finance relationships. Ultimately, you should be looking at a number of networks and options, choosing your financial partner in much the same way you would a partner in the supply chain.