As the entrepreneurial community calls for more funding from high net worth individuals, GB asks what it takes to be a business angel
Angel investors have long been a vital source of finance for growing businesses. These high net worth individuals may well seem heaven-sent to entrepreneurs desperate for growth capital. Angels have traditionally invested in early stage firms seeking more than even the most willing of friends and family can cough up but not nearly enough to get your average VC firm hot under the collar. However, with credit now well and truly crunched, more and more established firms are turning to the angels.
According to Bill Morrow, founder of Angels’ Den, which unites angels with those in need of capital at ‘speedfunding’ events and on the web, the age profile of businesses seeking angelic intervention is increasing. “If you are looking to raise money these days, where else are you going to go?” Morrow asks.
During 2008, the British Business Angels Association (BBAA) reported a 40-50% increase in the number of entrepreneurs looking for angel finance, as other sources of funding began drying up. However, what they found was an investor base compelled to focus their time and money on keeping their existing portfolio afloat. “We had this difficulty between existing angels with less money available, and more companies coming towards the community,” says Jenny Tooth, business development director at the BBAA.
So, as the organisation embarks on a major awareness campaign to try and get more investors into the marketplace, we asked some of the most prolific members of the investment community for the lowdown on the highs and lows of life as an angel.
What does it involve?
According to the BBAA, angels typically invest between £10,000 and £750,000 into businesses. However, Tooth sees an angel as a lot more than just someone who merely fronts the cash. “We don’t really call that angel investing,” she says. Angels usually bring more than just money to the table and research has shown that if you apply your own knowledge to choose your deals and then support the business, you’ll get a much better return.
“Think about what you can bring to the money, whether it’s finance, marketing or industry knowledge, where your interests lie and what skills you have,” adds Tooth. Angel investing often takes place through syndicates, but even then there will usually be a lead investor (sometimes called the archangel) who will sit on the board, give strategic advice and link them with relevant contacts. “The idea is that this helps them grow more rapidly than they would without the angel,” says Tooth.
Morrow says the first thing to ask yourself is whether you fully understand what the business actually does. “Often that’s difficult to get to grips with, either because the entrepreneurs don’t have the communication skills, or they’re spending too much time with people that understand three-letter acronyms,” he says, adding that those in the digital space are often the worst culprits.
Essentially, if you don’t fully understand the business, it’s very hard to add value to it. ”With an angel it’s often not the money that makes the big difference, it’s the contacts, the relationships and the little black book that will add big value to most companies.”
Michael Smith is fairly new to life as an angel. However, 18 months in, the founder of online gadget retailer Firebox and gaming company Mind Candy has already made eight investments. He too only invests in areas he has some experience of. “If you can’t get your head around an investment, run a mile. You need to feel comfortable, but secondly, entrepreneurs want you there not just for your cash but for how you can help them. If it’s got nothing to do with your background, then you’re not going to be much use to them.”
Smith, who likes to invest alongside other angels, says he’s not a very active investor, he doesn’t have time to be, but he helps the entrepreneurs out as much as he can. “I’d love to get deeply involved and sit on multiple boards, but my full-time job is running Mind Candy, and that keeps me incredibly busy,” he says. “I definitely won’t be stopping by the office every week. But I always help where I can, meet up for the odd coffee and introduce them to people.”
What to look for
No one can predict the future and no investment is ever a dead cert, but there are often telltale signs that a business is not a good bet. “Lousy financial controls is the easy one,” says renowned investor and entrepreneur Jon Moulton, who founded VC firm Alchemy Partners. “There’s almost no example of a company that had poor financial reporting and wasn’t a total loss.”
Moulton also looks for an accomplished chief executive and of course, a good idea. “For me, it’s usually 60% entrepreneur, 40% idea. Occasionally, you run a bit with the idea. I’ve got one investment at the moment where the management deserved 2/10 on the initial appreciation, but the product was 10/10. Now that we’ve got rid of the management the product is beginning to prosper.”
So what questions should you be asking of a potential investee? The risk/reward profile will vary depending on the maturity of the business, but even in an early stage business you want proof of concept. Is there a market for the business? How big is it? Have they found a niche? Have they looked at the competition and can they show you how their product or service is differentiated? Is it scalable? Where will the business be in five years and does the entrepreneur and team have the right experience and capabilities? Are they aware of any skills gaps? “In other words, can these people actually do what they say they can do?” says Tooth.
You also want a balance between the fantastic and the fantasy, adds David Soskin, the former CEO of Cheapflights who co-founded investment vehicle Howzat with his long-time business partner, Hugo Burge. “You want an exciting business plan, but a plausible one,” he says.
What to expect
A recent survey of 1,080 deals by the BBAA and NESTA found that the average rate of return for angel investing was 22% over four years. Moulton has enjoyed some phenomenal success. His stake in Ashmore Plc, for example, initially an angel investment, is now worth around £70m and he admits that he has made more money as an angel than through working.
However, he is keen to stress that it is an extremely risky business and not one for the fainthearted. “Angel investing is a very dangerous, difficult game where, on average, people lose money,” he says.
“It really is quite a nasty game – you’re much more likely to lose money than make a gain on any individual position. If you take the top 10% out, you’d literally break even.”
Indeed, the research found that angels lost money 56% of the time. Moulton has lost at least a third of the cash he has put into angel deals, while a handful of investments have made over a thousand times the money.
He is also reserving judgement on the BBAA campaign. “Pushing people into it is not a very clever thing to do,” he argues; although Tooth counters that they are by no means encouraging anyone to go into it on a whim. The BBAA will also be running workshops to help people learn exactly what is involved.
“We hope by the end of it we’ll get a lot more angels to put money into small businesses, but also to do it well. We don’t want them to get their fingers burnt. You can’t just tell people about it and send them off to do it,” she says.
The BBAA recommends undertaking at least 20 hours of due diligence, or what Soskin calls ‘kicking the tyres’, before closing a deal. When you’re investing in a start-up, there isn’t always that much to go on, so when it comes to early stage deals, Smith prefers to invest in people he already knows and trusts. Otherwise, he likes to invest alongside other angels he respects who have time to undertake sufficient research into the business. He also has a portfolio of investments, to spread the risk.
“If it is a new person walking in through the door, you need to follow up with every single conceivable reference you can find, both personal and professional, and spend as much time as you can understanding what makes them tick, because you really are investing in the person,” says Soskin.
Before investing in Cheapflights, he hired a firm of media consultants who actually put one of their staff members into the company for a couple of weeks. But you can also do a lot of checks yourself, to make sure any claims they have made about their product, service or market really do stack up. If they’ve got one major customer, for example, talk to them. Ask them if they’re doing a good job and if they plan to buy more going forward.
“Often that is just as important as looking at an income statement or a balance sheet, which can be rather deceptive, because a balance sheet is just a snapshot and an income statement is historic. What you really want to know is the potential,” Soskin says.
Similarly, experienced investor Moulton doesn’t place too much emphasis on the business plan. “They sometimes make a difference but only if they’re really amateur, at which point they’re more likely to switch you off than switch you on. Financial models and projections are usually less accurate than astrology so they rarely get you anywhere, I’m afraid,” he says.
The current financial position of the business is key, however. You have the right to ask about any existing loans or debts they might have accrued. “Make sure they haven’t got such a lot of debt that your money is not going to go into growth,” advises Tooth.
For those new to angel investing, Tooth adds that investing as part of a syndicate can help to mitigate risk. “You’re not on your own and you can go in as a novice with experienced angels who really know what they’re doing,” she says.
The BBAA also recommends seeking legal advice, and copies of key documents are available on its website. Get the due diligence, negotiation and documentation right, and you may well have some legal back-up and recourse if things go wrong.
Is it for you?
Essentially, entrepreneurs make good investors. “I definitely believe that the people who are best placed to invest at the early stage are those who have built companies and successfully exited them,” says Julie Meyer, founder of investment and advisory firm Ariadne Capital and co-founder of networking phenomenon First Tuesday, which was sold for £33m.
In a downturn market, investments will carry a higher risk, but on the other hand valuations will also drop. “Rule number one of making money from investing is buy low, sell high. The valuations are much lower in this market, but the higher risk should lead to higher reward,” she adds.
Morrow has also witnessed valuations plummet. “It’s up for grabs, but the power is very much with the angels these days. Valuations have collapsed by two-thirds in the last year; it was around six times earnings, it’s now maybe two,” he says, adding that entrepreneurs are becoming more accepting of this as other funding options are removed.
With a minimal rate of return from savings at the moment, angel investment is looking like an increasingly attractive option.
Contrary to what the BBAA is finding, Angels’ Den has actually seen an increase in angels signing up in the last year, with more than 120 registering each month. “It took me by surprise,” admits Morrow, “But what they’re saying is, if they’re fortunate enough to have £300,000 in the bank, at the end of the year the bank will reward them with a cheque for £4,000. That’s not in the least bit exciting. If they’re not investing money, they’re not making money.”
On the other hand, putting money into a business carries a much higher reward if you get it right, which isn’t just financial. “It can be tremendous fun and very energising to see a small business take off,” says Soskin.
Making it work
Before you spread your wings, there are a number of things to bear in mind. First and foremost, you need to click with the person or people running the business, and be certain they have the right team and skills in place. Morrow says his angels usually meet the whole team and when things go wrong, most will say they made a mistake by backing the wrong team, not the wrong idea. “It doesn’t matter how good the business is, or how familiar you are with it, if the people aren’t good then you’re never going to get anywhere,” says Soskin.
According to Meyer, angels often run into turbulence when they fail to set directives from day one. “You need to hold the entrepreneur accountable, and to document what milestones they’re going to achieve,” she says, adding that angels typically invest against a forecast, the achievement of which could trigger a break-even position, or future funding at an agreed price.
She warns that entrepreneurs, who often feel they can convince anybody of anything, will sometimes get to thinking they’ve got the angel on tap no matter what. “I see a lot of angel investors who put money into companies without a lot of governance or thought, where they think they’ve got a good relationship with the entrepreneur and it’ll be OK. You have to over-communicate before you put the money in: ‘These are the terms; I’m expecting you to achieve this milestone, and if you don’t, I won’t give you any more money, so don’t come back to me in 12 months’ time.’”
You should also look into whether your investment qualifies for the Enterprise Investment Scheme (EIS) tax relief, which can also help to minimise your exposure to risk. “Even if the business goes badly, you still get your 20% relief on the exit of the business,” explains Tooth.
The BBAA is currently campaigning for the rate of EIS relief to be increased for angels who are willing to seed-fund early stage start-ups. “The tax relief at the moment doesn’t differentiate between whether you’re going into a more developed small business or at a very early stage. We’re suggesting that the government put 30-40% tax relief where the risk is that much greater,” she adds.
Arguably the most important thing to remember is that it has to be money you can afford to lose. “You don’t bet the farm when you’re angel investing,” says Meyer. And Moulton agrees. “Investing in small companies carries very high levels of risk and doesn’t carry commensurate returns in most cases. If I could have found a way of only investing in the top 10%, I would be a much, much richer man,” he says.
And finally, don’t forget to have some fun with it, says Smith. “You’ll lose a bit of money, but you’ll also learn a hell of a lot along the way.”
Where to go
The British Business Angels Association (BBAA)
The BBAA has 25 angel networks, home to around 5,000 angels. The networks vet the business plans before they are presented to the angels.
Morrow says the great thing about Angels’ Den is that there are no gatekeepers. Any business can put their idea forward. 156 deals have been closed since the business launched two years ago.