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Angel delight

Angel investors are fast becoming the only funding option for early-stage companies. SmallBusiness.co.uk investigates.

Angel investors are fast becoming the only funding option for early-stage companies. SmallBusiness.co.uk investigates.

A stoney-faced bank manager wasn’t quite what Sally Chamley was expecting to find when she tried to obtain some expansion capital. Her online furniture retailer, Black Orchid Interiors, had enjoyed continuous growth over the past six years but it no longer ticked the right boxes for the bank, which ignored her burgeoning reputation in the national press and a cabal of rich clients in affluent West London and the home counties.

While she toyed with the idea of floating on PLUS Markets, going so far as to engage corporate adviser WH Ireland which assisted in drawing up a new business plan, Chamley was put off by what she saw as the lengthy flotation process. Instead, she spoke to the angel investor network Beer & Partners, finding eight high-net-worth individuals to back the business. They injected £300,000 into the company in return for a slug of equity.

‘It was a real eye-opener,’ she says. ‘I was used to dealing with bank managers who are only interested in your balance. But with angels you don’t only have access to the funds but also the expertise. They understand the risks you take as an entrepreneur that allow growth to happen. They’re looking for a good entrepreneur who can embrace those changes.’

Fertile ground for Angel Investing

Likewise, web-based business applications provider Workbooks – another early-stage company but with much bigger fundraising aspirations – also found angel investing to be pretty much its only option.

‘It’s tough getting venture capital money at the moment, but angels fill some of that gap,’ says co-founder and CEO John Cheney. ‘With banks not lending and VCs only investing in established companies, it’s almost impossible for smaller companies like us to raise money otherwise.’

Traditionally, angels have been associated with smaller, sub-£1 million sums, but the management team of Workbooks secured a hefty £4 million in two rounds of angel funding between 2008 and 2010.

Given that many venture capital firms have abandoned early-stage investment in the past few years, it seems that there is a growing number of private investors who are slowly filling the gap, attracted by lucrative tax breaks and better rates of return than can be obtained from standard saving schemes.

Bill Morrow, co-founder of investor network Angels Den, which has 3,700 angels on its books, says: ‘Since the recession, the number of people looking to become angels has more than doubled in our experience. The reason is that they’re looking to find investment that will give them more of a return than the banks are currently paying. A lot of them say they have lost their faith in the wealth management world.’

Jenny Tooth, business development director at industry body the British Business Angels Association (BBAA), says a poll of members indicates that this trend runs across the industry: ‘There has definitely been an increase in activity, plus we’re seeing more investors getting involved. And it’s certainly true that the amount of angel investment trumps the amount VCs are investing in early-stage businesses.’

Clubbing together - Angel Networks

The approach of angels is becoming more sophisticated, says Tooth, as they increasingly invest in groups and syndicates. ‘It is something we encourage as it helps new investors learn as well as pooling angels’ money, allowing them to spread their risk and increasing the amount that can be invested in any individual business. The other key issue is that angel investment is starting to be made alongside VCs and VCTs and bank finance.’

According to Tooth, the amounts raised by companies vary quite widely between regional angel networks throughout the UK. ‘A minimum might be around £50,000, going up to £750,000 at the top through a syndicate of angel investors, with companies in the South East generally going for larger sums. You could raise a much bigger sum, up to £1.2 million or more, but you’d have to obtain venture capital money or link up with one or two other networks in order to do so.’

Either way, if you’re prepared to give up a slice of equity, there is a considerable cache of money that the UK’s wealthy investors are willing to pour into high-risk growth prospects. Morrow says that investors joining Angels Den each need to have free assets of at least £250,000, making the combined wealth of his 3,700 angels more than £925 million.

Another network, Envestors, has helped more than 60 companies raise over £22 million of equity investment over the past three years. Bob Taylor, one of the founding partners, says that its network tends to see companies raising between £500,000 and £1 million, ‘but we also tend to do a lot with family investors now, who put in between £1 million and £3 million at a time.’

Using business angel networks or going it alone

While such networks clearly have the attraction of gathering so many investors together in one place, Workbooks’ Cheney is one of a number of entrepreneurs who shrink from the fees involved when using business angel networks. Typically, an upfront fee of up to £1,000 is accompanied by a ‘success fee’ amounting to
5 per cent cut of the funds raised. Cheney says he and his partners had previously completed two trade sales, including the exit of their last business, BlackSpider Technologies, for a fivefold return. This gave them greater leverage when negotiating terms.

‘We did look at some of the angel networks,’ says Cheney. ‘If you have no other options then I’d say it probably makes sense. But we weren’t prepared to pay for introductions, and I am slightly nervous about paying an upfront fee for what they’re offering. We had a core of loyal investors after BlackSpider who were happy to spread the gospel. It was mainly word of mouth – angels talking to other angels. We went round meeting people and presenting our plans. We now have over 40 investors.’

Similarly, Sue Harrison, who co-founded the Student Gems website, which ‘matchmakes’ students with SMEs that need small jobs done at a reasonable price, went on an informal round of various angel groups. ‘We were put in touch with various investment organisations identified by the [state-funded] Innovation & Growth team in High Wycombe and now have ten investors and two on the board. It probably took us 15 months to get the money in the bank.’

Enterprise Investment Schemes (EIS) tax breaks

As complimentary as entrepreneurs are about the government’s Enterprise Investment Scheme (EIS), which provides various tax breaks to further encourage investors to back small companies and has contributed to millions being raised, many people continue to believe that changes are necessary.

Cheney says: ‘There is a cap of £2 million [a single company can receive] in any one year – that should be removed, along with the £500,000 limit per investor. If there are people who want to invest, it makes little sense to prevent them.’

Angels Den’s Morrow argues that EIS could be improved in ‘a great number of ways’. He suggests that company founders should be allowed to claim EIS relief on investment in their own companies, and that the upfront tax relief should be increased from 20 per cent of the amount invested to the 30 per cent afforded to venture capital trusts.

Tooth of the BBAA complains that limiting the EIS scheme to ordinary shares gives VCs ‘an unfair advantage’, as they have more flexibility to use preference and other types of share.

Vested interests

Some entrepreneurs may be dissuaded from angel finance by the prospect of having too many interfering stakeholders. This can be particularly irksome if the sums involved aren’t meaningful enough to accelerate the growth of the company. That said, Harrison does not feel under pressure or harassed by her ten investors, claiming that she hasn’t been set a strict timeline for an exit. She feels she is being helped along rather than chivvied: ‘They are not totally hands-on, more supportive and very interested and committed to the business. We have already more than doubled in size.’

As Tooth reasons, ‘The difference is that VCs and venture capital trusts are looking after someone else’s money. Angels are less pressured for an exit as a VC has much stricter targets and much less flexibility. With VCs, there are also going to be more instruments tying up the entrepreneur and potentially more strings attached.’

Workbooks provided two board seats as part of its funding rounds, but enjoys a similarly relaxed relationship with its backers, who are, says Cheney, ‘mostly pretty passive’. Likewise, an exit is not an urgent issue: ‘At some stage we will look to return money to investors, whether that’s through a dividend or a trade sale. But we were very clear at the start that this would be a ten-year project, and so they are happy with that; those that weren’t didn’t invest. You’ve got to be upfront about it.’

The trick is to manage expectations from the beginning. Be clear about what you want to do with the business and how long it will take to execute. ‘You need to understand that it’s nothing like getting money from a bank; it’s almost like a marriage,’ says Black Orchid’s Chamley, whose investors’ representative attends a monthly board meeting and speaks to her once a week over the phone. ‘I’ve really found the experience to be worthwhile, but some people don’t embrace bringing external investors on board. People who don’t like working in teams won’t enjoy it.’

See also: Are you on course for business angel support?

Related topics: Angel investors, Banks, Black Orchid Interiors, Equity, Finance, Raising Finance, SME finance

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