Finance: How to find an angel to watch over your business

A small, growing firm may need private investors. David Harvey offers advice
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Finding capital for growing businesses is a critical issue. The environment for fundraising, especially for smaller companies, continues to be testing; enterprises looking for pounds 20,000 to pounds 150,000 have the toughest time.

The banks remain wedded to scoring potential investments on a basis of least risk to the investor. Venture capital, by its nature, is a risky business, and in other cultures is offered for a promising idea or individual. The absence of formal structures to promote investment in small to medium- sized enterprises has fostered the rise of the informal investor. The "business angel", which derives its title from the theatrical world, has now emerged as a key player.

Since the early Nineties, government, small firms and advisers have invested high expectations in business angels - to provide the filling to fund growth in the so-called equity gap, where the bank says no to further cash, and where the business is too small to be of interest to venture capitalists.

By definition, informal venture capital is just that: a direct investment in a business by a wealthy individual.

But finding an angel is easier said than done. Most business angels value their privacy. No one wants every Tom, Dick and Harry with a half- baked business proposition knocking at the door. Research suggests that some 60 per cent of business angels are found through family and friends. Thus, although there has been steady growth in such investment through registered networking groups, in reality we have little idea how many angels there are.

The British Venture Capital Association (BVCA) believes that there are about 5,600 business angels registered with a variety of networking groups. Many others do not register with anyone; the Bank of England suggests that there may be 18,000 active and potential angels out there. Other sources put the number as high as 80,000. The number of angels is probably determined by the size and regularity of investment. So there may be 10,000 angels each investing more than pounds 25,000 every year, for example.

How much do angels have to invest? The BVCA estimates that 373 of its 5,600 networked angels invested more than pounds 19m in the year to June 1997; as research demonstrates, business angels invest cautiously and take a great deal of persuading. Colin Mason, of Southampton University, suggests a "ballpark" estimate of current annual business angel investment activity of around pounds 500m in some 3,500 businesses. Mason believes that between pounds 2bn and pounds 4bn a year is out there, if only angels could be persuaded to invest.

Where did these angels come from? In 1979 the Wilson Report into small firms admitted that, in the UK, "investment by Aunt Agatha", the old name for an angel, was virtually extinct, killed by high tax rates. Research by Colin Mason and Richard Harrison first suggested that the Eighties drive to revive an enterprise culture was creating the right climate for angels to reappear.

What is the typical deal? Patrick Coveney and Karl Moore, of Oxford University, suggest that the average initial investment by an angel is pounds 70,000, but most make a second investment at some point, pounds 113,000 being the average total stake. On average, the angel takes 35 per cent of the business. Where the enterprise makes it off the nursery slopes, the returns are excellent, on average 58 per cent for both the angel and the business owner.

A plethora of schemes have been set up to encourage potential angels. The Government's Enterprise Investment Scheme is targeted to provide convenient vehicles with attractive incentives for angels. Locally, almost every Business Link or TEC has or works with some 43 local "dateline" services designed to marry local business-angel investors with growth businesses. For instance, Techinvest provides an introduction service for private investors in the North-west.

Vivienne Upcoff Gill, Techinvest's manager, says, "Since the launch of the service less than five years ago, small and new businesses have raised more than pounds 5m in amounts ranging from pounds 3,000 to pounds 500,000 with our help and contacts." There are a number of national agencies, such as Venture Capital Report and LINC, which network across the country. The banks have established a similar network.

To make business angel networks more effective, researchers have been trying to find out who the angels are and what makes them tick. Most can be easily stereotyped; they are middle-aged company director types. A survey by NatWest found that there are three main categories of angel. "Patron angels" come at the top of the tree. These are wealthy individuals with a net worth of pounds 5m plus, either built up in business, or as a family fortune. Such individuals know that they will be targeted, and rely on informed investors coming to them.

"Entrepreneur angels" make up the largest category. These are usually successful business people who can both afford to invest and take a professional interest in the business, backed by wide experience. The third category consists of "occupational angels", individuals with relatively small sums, perhaps around pounds 50,000 of life savings or a redundancy pay-off. Unlike the other two categories, this group is investing cash they cannot afford to lose. To this list should be added "archangels", entrepreneurial types who assemble syndicates of other angels.

Why do angels invest? The NatWest survey puts good old capital gain as the prime motivator for 88 per cent, but enjoyment is the second most important, for 64 per cent. Other factors fall some way behind.

Only a small proportion of proposals are attractive enough for the angels. Various studies suggest that between 93 per cent and 97 per cent are rejected. Why? Above all, Mason and Rogers suggest, many angels start with a negative disposition and take some persuading. They look first for five key factors:

Products and services with a unique selling-point or competitive edge;

A complementary fit between their own skills and investment experience, and the new investment opportunity;

Emerging markets - but not those that are highly competitive;

Management with a strong record, able to minimise operational risks while maximising the up side of the investment;

A real financial commitment by the entrepreneur.

Other factors may shape a business angel's considerations. A lower return may be acceptable if there are non-financial returns, such as interest and involvement in the project. Exit routes will be important. Most angels invest for three to five years, but they will want to see a clear way out.

But the thought process angels use to screen proposals is fuzzy. Preconceptions appear to be important. One investor quoted in Mason and Roger's research makes the initial comment on a proposition: "Rowing machines. Having been to a gym once or twice in my life, I can see the possibility ...." These comments are not atypical of the way in which a number of projects are assessed. These preconceptions can work against, as well as for, the entrepreneur. Another investor was not sure what competition there was in the rowing machine market, but thought it was "quite a lot".

Some seem to use a "three strikes and you're out" approach. One or two possible reasons for rejection they may overlook, but a third is a definite no. Having preconceptions, many angels also make inferences that may not always be entirely rational. Behind this there is also a strong need for personal empathy with the client.

As angels are under no pressure to invest their cash, personal preferences are significant. Some angels have a geographic territory in which they invest, others prefer to avoid a particular trade. Wetzel, in the US, recognised that each angel is influenced by a series of "hot buttons", such as personal altruism and interests. Thus one of Mason's angels assessed a proposal as he was "interested as an engineer to see how the product is different".

With the pitfalls and the failure rate of proposals, how do you maximise your chances of attracting an angel's support? First, many small firms will not consider a business angel in the first place. The Bank of England's 1993 report on small firms showed that only 10 per cent of small firms would even consider a business angel as a source of investment, of which two-thirds took the notion no further.

If you are willing to consider the business angel route, your presentation must knock on the head as many preconceptions as possible. It must tell the investor why the product will win, why it is in the right market, what are the critical success factors and why the management team is right. It must do this on page one. Then, hopefully, the angel will read the rest.

How should the new business angel learn the ropes? The virgin angel could do worse than invest alongside an experienced angel. On their own, new angels should, first, be sure that they can afford to lose their investment. Experienced legal and accountancy advice is essential, as is a clear plan of how you will achieve a return from your investment, and how you will sell it. Roger Holcroft records that his business angel did "a thorough job of detective work on me, he wanted to know about my experience and record".

"He also made sure that there were no skeletons in the closet, such as bankruptcies or directorships of insolvent companies."

Informal investors are an increasingly important means of filling the equity gap, but, currently, invest in a limited number of businesses. The very informality of business angels may make it difficult to make formal efforts to maximise their investment potential. Yet that potential is clear. For instance, in the US, business angel finance accounts for five times as much investment in technology-based firms as the formal venture capital sector.

David Harvey is secretary to the ACCA's Small Business Committee.