companies with predictable cash flows and partly use huge sums borrowed from banks to do so. They then hire new management who are incentivised with significant equity stakes.
The reasons for this are compelling from the private equity firm’s point of view. The large size of the deals means the management fees (1% to 2% on the capital raised from institutions) pay the private equity team fat salaries. Added to this are performance fees (typically 20% of profits made after the benefits – in good times – of heavy leverage from bank debt) that are also large on big and successful deals.
All of this means the private equity principals get rich provided they hire the right management to run their companies and the economy is stable so that leverage works for, and not against, them. The financial collapse in 2008 did, however, bring the risks of the highly leveraged deal into sharp focus.
Regrettably, today there is only a small and declining number of specialised venture capital firms who will consider investing in small start-up or early-stage ventures and they do very few deals.
Government-sponsored funds
Successive governments have expressed alarm at the decreasing number of VCs who make smaller investments. To counteract this trend, both the UK government and the European Community have sponsored a wide range of providers of equity capital for young businesses. Often, though, the availability of this capital depends on where a business is based, or is to be based, and the investment focus is often driven by job creation.
The problem with such funds is they are institutional in nature. They can be obsessed with due process – no doubt because they are accountable for the public funds they invest. They thus tend to be slow and bureaucratic. Added to this, almost none of these funds, in my experience, seems to understand how to structure a young company’s balance sheet.
The angel investor
The bottom line for companies wanting to raise less than £2m (and some would say rather more) is that they find it very hard to raise equity finance from the VC world. Which is where the angel investor comes in. Even though angels are rather harder to find than VC funds, they are a vital source of capital for smaller ventures.
As an angel, it is worth remembering how important your money can be to the venture when you are asked to invest. You, and your fellow syndicate members, may be the only source of equity capital available.
Government stimulus for angel investing
Throughout this book you will find many references to the Enterprise Investment Scheme (EIS), which is a series of tax advantages for private individuals investing in smaller companies. It is described in detail in Chapter 6.
To complement the EIS, in 2011 the government launched the Angel CoFund for companies based in England – with Scotland and Wales having their own regional funding through Scottish Enterprise and Finance Wales. It is a £50m fund which is prepared to invest amounts from £100,000 to £1m alongside a syndicate of angels and on the same terms. It is of particular importance that applications to it must come from the angel syndicate and not from the company that needs money.
The CoFund is discussed further under ‘Angels and syndicates’ in Chapter 3.
Why angels are attractive investors
How entrepreneurs compare angels and VCs
There is no doubt that VCs have an image problem.
In May 2012 Coutts – a bank with many entrepreneurial clients – published the results of a survey amongst those clients. The results were interesting. Nearly 25% of those who had never used venture capital believed it would increase the risk of their business failing compared to 19% who believed VC would help deliver sustainable growth. Ironically, of those who had used VC only 13% regretted it. This boiled down to previous users of VC being twice as likely to use it again compared to those with no experience of it.
Coutts acknowledged that for many fast growing companies seeking less than £2m venture capital is not the best form of funding and that capital from wealthy individuals or investment syndicates (i.e. angels) is a better alternative. The research showed a real reluctance amongst many ambitious entrepreneurs even to consider VC support.
The VC community should be deeply concerned by these results. On the other hand the increasing opportunities for angels to prosper are clearly apparent when the once main supplier of equity capital is held in such low regard.
How angels and VCs differ
It would be wrong to think of angels as just another source of capital because angels have a number of characteristics which are quite different to other investor groups – particularly VCs.
I touched on these differences earlier in the chapter and I shall now amplify them, together with their consequences from the entrepreneur’s point of view:
1. Angels invest their own money whereas VCs invest other people’s money structured into a fund
This makes the angel a more sympathetic and supportive investor. He can be more loyal and less brutal when hard decisions have to be made. He will also work harder to protect his own money – a normal human trait. An angel rarely invests only for financial motives.
2. Angels are quick decision makers. They don’t need to consult others when they invest – in contrast to VCs
Many angels make decisions based on an informed view of the opportunity and a liking for the management team. Due diligence is usually a softer and less bureaucratic process than with venture capital.
3. Angel syndicates can be difficult to pull together because they make decisions independently of each other whereas a VC writes one cheque once he and his colleagues have agreed to invest
A major issue with angels is pulling the syndicate together. It can be very helpful to have a facilitator involved – which is what many angels’ networks and syndicate managers do.
Despite this, the VC’s ability to write one cheque does not mean he is faster to invest. The reality is that the VC can be the slowest of all funders (see the case study later in the chapter).
4. Angels will usually opt for a simple investment structure (the EIS requires it) and ask for simpler controls on decision making as the venture develops
In the UK it is common to see a small amount in equity and most of the money in a loan stock with interest and repayment. This is the method preferred by many VCs but it is an inappropriate structure for early stage investments (see ‘The benefits of ordinary shares’ in Chapter 5).
On the other hand angels will usually invest in some kind of ordinary shares and are required to do so if they want EIS tax reliefs. This is without doubt the best structure from the early-stage investee company’s point of view.
5. Angels can add value from their own experiences and contacts. All VCs say they can but it is not always true
In the UK, angels are often older and more experienced
