#1 of a series of 4 articles on my early experiences with start up companies looking for Angel investment
In the last few years, I’ve been fortunate to have some money to invest, and was attracted to becoming an “Angel” investor. But my experiences quickly led to frustrations with the system and with many startup businesses themselves
In my twenties, I was a reluctant entrepreneur — there was a terrible recession and few good jobs to be had, and, faced with redundancy and a young family, went into business on my own, latching onto something that enthused me, used all my talents and that “just might work”. In those days there were no Angels, and I had no rich family. Like everyone else, I went begging to the banks, and got mortgaged up to the hilt. Even then it was a struggle, but I survived through further recessions and finally came good.
“If only”, I thought — so I became an Angel investor, purely (please believe me) with the altruistic aim of helping a few brilliant but misunderstood young entrepreneurs succeed sooner and less painfully than I did. I’d like to help, not only with money, but with my time and experience.
So far, I’ve often been disappointed by what I’ve found. Of course there are some great new business ideas out there being turned into reality by inspired and competent individuals who will become successful business people, delivering valuable goods and services that make the world a better place for the next generation to live in. But there are far fewer than I expected….
In this short series of articles, I’ll explain my thinking, say what I see as wrong with the Angel “ecosystem” (how I hate that word!) and offer thoughts on improving it. These are all my personal opinions, and you may disagree. I’m very open to comment and constructive criticism.
1. 80% of new businesses fail, so why take the risk of Angel investment?
Why do investors keep pumping in money when most start-ups fail? To an extent, it’s blind faith, but a lot can be attributed to the EIS tax avoidance system. This was perfectly illustrated in a recent presentation I attended.
This isn’t exactly what was said, but I think it’s a fair illustration:
- An investor puts a total of £100,000 into 100 startups — £1000 each — making the following assumptions:
- 80 will fail, so that £80,000 will be lost
- 10 will trade successfully (but not phenomenally) and the investor will get their money back eventually, let’s assume with no premium.
- 8 will be sold at an average multiple of 3x the original investment
- 1 will sell at a multiple of 10x
- Just one — the nascent “unicorn” — will sell at a multiple of 50x, netting the investor £50,000
So overall, the investor will get back £94,000 — which looks like a loss of £6,000 on the original investment. But in fact, through the EIS scheme, the investor immediately recovers 30% of their investment as a tax rebate, so the original outlay is only £70,000. Assuming the above scenario takes 5 years to realise, that’s the equivalent of 6% compound interest. But it gets better, as there is no Capital Gains Tax to pay on the eventual sales — so, assuming a CGT rate of 20%, the equivalent average interest rate is 7.5%. Right now, with interest rates at an all-time low and fears of another stock market crash, that’s a very attractive return.
On top of that, even for the hardest-headed investor, the excitement of gambling comes in. If fewer investments fail and the ones that succeed sell at higher multiples, then the potential gains are far greater.
Most Angel investors wouldn’t recognise it as gambling.
Some will study the business propositions, talk to the principals and feel like they are making sound business decisions. Others will accept the recommendation of “funds” or angel investment groups, and assume that the startups have been thoroughly vetted by others. Often, though, they’re deluded.
Throughout my own business life, I was always told that it was essential to have, and maintain, a Business Plan. Apart from needing it to show the bank and any investors, it was held out to be essential as a thought-out road map that would help focus and drive the directors of the company. I became a True Believer. I’m told that it’s still described in the same way and taught in MBA courses.
So why do so few start-ups arrive in front of investors with no Business Plan — or perhaps, at best, an inadequate one? The belief seems to have been fostered that all that’s needed is a “Deck” — a set of PowerPoint slides. This may be a US-driven concept; certainly it’s quite common for executives in the USA to only read Executive Summaries and only look at slide decks. That would be fine, if the financial numbers displayed could be justified by studied facts — but what’s common now is simply to present the high level, with numbers that could have been (and quite possibly were) plucked out of thin air.
In the next article in this series, I’ll expand on my thoughts on business plans and initial valuations.