Business angels

What are the pros and cons of using a business angel as opposed to the more conventional channels of investment like venture capital and bank loans? Faith Glasgow investigates

There is something strangely addictive about the sight of ill-prepared entrepreneurs being ritually humiliated by a panel of business people with flinty smiles and caustic tongues, as anyone who has tuned in to the BBC series Dragons’ Den will agree. Yet there were over 3,000 applications to take part in the third series. Of those, just over 30 were selected to make presentations and nine received funding offers.

Why are so many prepared to put themselves through such an experience? Leaving aside any ‘15 minutes of TV fame’ considerations, the difficulty for many entrepreneurs and fledgling companies is that they are caught between a rock and hard place when it comes to getting financial backing. Banks will not look at them because they represent far too high a risk, while venture capital trusts (VCTs) are interested in much bigger fish to fry. Business angels – the Dragons in the Den – help to fill that gap on a more informal basis, providing not only financial backing but often their own time, contacts and business expertise as well.

Dragons’ Den has done great things in raising awareness of the existence of business angels – yet, according to Anthony Clarke, chairman of the British Business Angels Association (BBAA), ‘most entrepreneurs know nothing about them, especially if they are operating on their own. Business advisers tend to suggest either bank loans, which are very hard to get, or organic growth as the way forward’.

The flip side of this equation, of course, is the fact that the vast majority of these enterprises are never going to be suitable for angels to back anyway. ‘Not only must they be viable, but they have to be potentially fast-growth businesses, because business angels are typically looking for a realisable capital gain in five or six years,’ continues Clarke. ‘That means creating a saleable business from which they can exit through a takeover, management buyout or even flotation.’

So who are these people with the power to turn business dreams into reality? They are high net worth individuals with a taste for what Clarke describes as ‘a specialist minority sport’ – investing money, experience and/or personal time in embryonic businesses, in the hope of backing the next eBay or Easyjet. Many are themselves successful encashed entrepreneurs; others are senior managers, or business specialists such as accountants.

The bottom line is, of course, the chance to make money, lots of money – a consideration to which we will return in a moment. But there are other motivations. ‘Some are bored with their life of leisure and want a focus for their energies,’ says Clarke. ‘Others like the challenge of making a business work because, as entrepreneurs themselves, it’s in their blood.’ But factors such as altruism and ‘giving something back’ play their part too.

There are also substantial tax advantages in investing for at least three years in an Enterprise Investment Scheme (EIS) company, notably 20% tax relief on investments up to £200,000, plus exemption from capital gains tax on sales of shares and the opportunity to offset tax from existing capital gains against an EIS investment.

Individual investments can be any size from £10,000 to £750,000 or so, but are most commonly in the £20,000 to £35,000 range. However, investing in start-ups is not for the faint-hearted: four out of 10 deals will not return the initial stake money, according to the BBAA. It is important, therefore, that investors are wealthy enough for losses not to matter too much in real terms. Research shows that most business angels invest no more than 5%–15% of their overall portfolio. It is equally sensible for angels to aim to spread their money over a portfolio of several enterprises, rather than staking everything on a single venture.

Around one deal in 10 produces a big win for the backers. Angels who hit the jackpot typically get back eight to 10 times their original stake, according to Anthony Clarke, but it may be much more. Take successful angel Vanish Patel, who has made eight investments so far. In 2001 he invested a £25,000 stake as part of a 15-angel syndicate in a company producing software to ‘marry’ website pages with appropriate advertisers. At that time the company had five employees and a monthly turnover of £5,000–£10,000; it now employs 150 staff and turns over £1m per month. ‘The company will IPO in the next year or so and I’m expecting a return of around 20 times my investment. But, of course, it could all go horribly wrong before then,’ Patel adds cheerfully.

In terms of practical involvement, the role of angels depends on their personal preferences, and the needs of the business in question. Some enterprises need little more than money and a few handy contacts, but others are actively seeking angels who can contribute marketing, sales or strategic expertise. So there is a place for angels who are effectively sleeping partners, but also for others happy to offer hands-on management, or take a mentoring role as chairman or non-executive director for an energetic but inexperienced team. The key is to find the right fit between angel and enterprise.

This is where business angel networks come in. The BBAA website includes a list of over 50 member and associate business angel networks in operation around the country. They serve a dual purpose.

First, they provide a forum where investors can meet each other and establish affinities and alliances that may form the basis of effective investment syndicates in due course. Angel syndicates can take on much bigger propositions, and they are also able to pool experience in the all-important selection of schemes to back.

Secondly, network organisations run regular evenings where entrepreneurs can take the floor and present their innovation and their business plans to investors. Some, such as London Business Angels (LBA), run a rigorous sifting process and provide help with presentations, so that only relatively strong and well-equipped contenders make it into the LBA dragons’ den. As Anthony Clarke, who runs LBA as his day job, explains: ‘We receive around 800 applications a year for funding, of which we select around 5% to meet the investors. Of those 40, around 15 will get funding.’

Spot the potential

At the Yorkshire Association of Business Angels (YABA), things are done rather differently. ‘We don’t run a screening process at all – we don’t have the resources to assess companies but, in any case, our angels say they prefer to see all the presentations “in the raw”, rather than groomed,’ says chairman Peter Wells. ‘In the end, it’s about people meeting people and seeing potential.’ Around 10% of the 50 or 60 entrepreneurs who present to YABA in the course of a year will receive funding from angel members.

In practice, however, angels may not actually invest money at all. Tristan Cowell applied to YABA, looking for backing to market an innovative way of hanging up Christmas cards in the home. He eventually teamed up with a former director of Hallmark Cards, Graham Davies, but by that time financial support was no longer necessary. However, Davies’ experience was highly relevant, and he is now working one day a week with Cowell in a non-executive capacity.

‘The fit with Tristan isn’t just the greeting cards connection,’ he comments. ‘I’m used to working with high-volume, low-margin products and businesses, and that’s the market Tristan is in. I’ve also worked across a range of corporate skills, including sales, product marketing, warehouse and distribution, production and financing, so I can advise at all levels of the business.’ From Cowell’s perspective, the partnership is already making an impact. ‘Graham has an enormous wealth of skills and it’s fantastic to have him on board,’ he says.

Useful contacts

• BBAA: www.bbaa.org.uk
• London Business Angels: www.lbangels.co.uk
• Yorkshire Association of Business Angels: www.yaba.org.uk
• FiSMA (www.fisma.org) is a useful website enabling entrepreneurial companies and their advisers to communicate directly with investors, by posting business plans and other documentation for them to assess.