Contents
1.Introduction 1.1.Welcome 1.2.Meet everyone 2.0 Introduction to Business Angel Investing 2.1. Background 2.2 Business Angel Investment in Europe 2.3 Female Business Angels 2.4 Female Entrepreneurs 2.5 Females Investing in Females 2.6 Section Summary 3.0 General Investing Overview 3.1 Investment Basics 3.2. Risk and Return 3.3 Security Analysis 3.4 Risk Assessment 3.5 Asset Investment Planning and Management 3.5.1 Asset Investment Planning and Management 3.5.2 Strategic Investment Management 3.5.3 Diversification 3.5.4 Asset Management Tools 3.5.5 Asset Management Tools 3.6 Section Summary 4.0 Start Ups and Business Angel 4.1 Start Up Stages and Types of Investment 4.2 Business Angel Investment 4.3 Is Business Angel Investing for You? 4.4. Solo and Group Business Angel Investment 4.5. Establishing an Angel Group 4.6 Female Business Angels 4.7.Section Summary 5.0 Business Angel Investment Process 5.1 Finding Deal Flow and Initial Screening 0
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5.1.1 Finding Deal Flow 5.1.2 Deal Flow Management 5.1.3 Initial Deal Screening 5.2Detailed Screening Coaching and Presentations 5.2.1Detailed Screening 5.2.2 Coaching 5.2.3 Presentations to Investors 5.3 Due Diligence, Term Sheets and Valuation 5.3.1 Due Diligence 5.3.2 Term Sheet 5.3.3 Valuation 5.4 Legal Agreements 5.5 Section Summary 6.0 Follow-on Finance, Post Investment Monitoring and Mentoring 6.1 Follow On Finance 6.2 Post Investment Monitoring 6.2.1 Purpose 6.2.2 Board Seats 6.2.3 Information 6.2.4 Danger signs 6.3 Mentoring 6.4 Exit 6.5 To Invest‌Or Not To Invest 6.6 Section Summary 7.0 Next Steps 7.1 Thank You 6.2.3 Resources 7.3 Keep in Touch
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7.4 Evaluation 7.5 References
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1.Introduction 1.1.Welcome
Hello, I’m Lynne Cadenhead, Chair of Women’s Enterprise Scotland, entrepreneur and business angel investor in Scotland. Welcome to our introductory programme on how to be a business angel investor.
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If you have any issues navigating through the course, please contact us or leave a comment on the relevant page.
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1.2.Meet everyone
Please introduce yourself to other course participants in the comments box below. Only share what you feel comfortable sharing publicly with others. You might like to include: A bit about yourself – your name, where you are based, any specific interests About your business – its name, what you do, links to your website
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Why you are here – anything you would like to share about what attracted you to this course, why you are thinking about becoming a business angel investor and what you are hoping to get from the course.
Find out more about Women’s Enterprise Scotland here and find out more about the SEEWBAN project here.
We have embedded additional links to further information throughout the programme. Please note that you do not need to read this additional information unless you want to – all that you need to get started as a business angel is provided in the main programme.
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2.0 Introduction to Business Angel Investing 2.1. Background We are delighted you are joining us on this Business Angel development course. It is necessarily a brief introduction to angel investment, but by the end of the course, you will understand what a Business Angel is, the fundamentals of investing in entrepreneurial companies, and be able to make an informed decision as to whether or not becoming a Business Angel is appropriate for you. Let’s start with some basic definitions: •
What is angel investing?
o Angel investing is when individuals invest their personal money (capital) in an early stage company – often known as a start-up •
Who are angel investors?
o Angel investors are typically individuals who invest their own money, typically in small amounts, and typically very early in the life cycle of a company (From “Angel Investing” by David S Rose, 2014) Business angel investors are generally High Net Worth Individuals (HNWI) who provide small amounts of finance (typically €25,000 to €500,000) at an earlier stage than venture capital funds are able to invest.
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In the UK, 88% of angels invest under £100,000 per investment and investments usually start at £5,000-£10,000 per individual, with the vast majority of group investments being in the £100,000 to £2million range. The UK Business Angel Association has some useful reports on the UK business angel market and trends, as does the European Business Angel Association.
Angels may invest on their own or in groups/syndicates and they may have a focus on a particular sector, stage or size of investment. All however will focus on high-growth, scalable opportunities with a strong management team. Business Angels usually contribute much more than money to a young business, acting as mentors and helping with both contacts and industry/management insights. They will often take Non-Executive Director (NED) board positions in the companies in which they invest. 0
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Over the past ten years, formal angel investing organisations have moved from being a mainly US and Western European phenomenon to being active and visible around the world. Much of this expansion has been driven by the financial crash of 2007: less institutional funds were available to young companies to fuel their growth and Business Angels stepped in to fill the funding gap. This article explains a little more about early stage angel investing. This is a useful video introduction to business angel investing. And have a look at this video to see what a typical angel investor looks for in an investment.
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2.2 Business Angel Investment in Europe The importance of business angels to the equity capital industry in Europe has grown significantly in recent years, and in 2016 business angels invested two-thirds of all early stage investing across Europe. Whilst most investors still generally prefer to invest close to home (75% of angel investments are made in regional or national companies), this local investment approach seems to be changing and cross-border deals are becoming more frequent.
The United Kingdom is the largest and most well-established European business angel market with €98 million of investment in 2016, followed by Spain, Finland and Germany.
Amongst the members of the SEEWBAN consortium, 2016 business angel investment in the countries is as follows, with all countries showing a gradual but substantial growth in business angel investing:
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Italy, €14 million
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Hungary, €5.5 million
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Bulgaria, €5 million
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Slovenia, €3.3 million
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Greece, €3.2 million
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Cyprus, €0.8 million
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The main sectors in which European business angels invest are in ICT, healthcare and media, with the majority of investments being made in pre-seed and seed stages of a company (broadly defined as research and conception) and during the start-up phase (broadly defined as product developed and revenue being generated). One other key characteristic of European angel investing is in the creation of business angels’ networks, which grew 17% per annum from 20032012. Whilst the growth rate of has slowed to 1.3% per annum as networks become more consolidated and formalised, as of 2016 there were over 470 Business Angel Networks in Europe. This trend of investing through groups and syndicates, as opposed to solo investing, appears set to continue. You can learn more about the European business angel market here. Some countries have tax breaks and incentives to encourage people to invest as business angels. Check the conditions in your own country.
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2.3 Female Business Angels Although it is estimated that half of the world’s net wealth is in female hands, very few women are active in business angel investment.
In the USA-based angel networks, 26% of their members are women. A 2010 survey of European Business Angel Network (EBAN) members indicated that on average less than 11% of European business angel network members are women. However, there are significant differences between European countries with Central and Eastern Europe showing the highest ratio of women investing as business angels (30%), compared to 11% in Western and Southern Europe.
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You can read more about female business angels in Europe here and also in USA here.
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2.4 Female Entrepreneurs Starting and growing your own business is hard for any entrepreneur. Resilience and persistence are pre-requisites to survive and thrive through the entrepreneurial journey. But it can be even harder for female entrepreneurs as they face additional challenges when starting and growing their businesses. These challenges include gender-based discrimination, unconscious bias, societal expectations, juggling caring commitments… all factors which hinder the true economic empowerment of women in our global entrepreneurial society. As of 2016 in Europe, women are 52% of the population, yet only 30% of start-up entrepreneurs. In SEEWBAN countries, the 2016 ratio of women to men in entrepreneurship is as follows: •
Bulgaria 0.8
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Greece 0.7
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Italy 0.6
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Hungary 0.5
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Slovenia 0.5
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UK 0.5
Some stark statistics reinforce the challenges faced by female entrepreneurs:
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Only 9% of all capital raised goes to female-led businesses
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Females are 50% less likely to receive venture capital funding than male-led businesses
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Females start their businesses with one third of the capital than men do
Yet positive female gender-based characteristics such as advanced risk awareness and diversity of thought make females excellent entrepreneurs, leading to more sustainable businesses in the longer term. And despite starting their businesses with less capital than males and being less likely than males to seek angel investment, on a like-for-like basis female-owned businesses perform just as good – if not better – than male-led businesses. And the very same positive gender characteristics make females insightful, thoughtful, considerate and savvy investors! Here is a useful video that defines what an entrepreneur is. And here is a recent report on female entrepreneurship.
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2.5 Females Investing in Females Taking these factors together, there is a significant global economic opportunity waiting to be realised by more females starting up their own businesses‌and by more women investing in female-led businesses, giving them the patient capital and gender-specific support they need to grow. In Scotland for example, a country with just over 5 million population, if women started up businesses at the same rate as men, there would be an additional £7.6 billion contribution to the economy.
As Christine Lagarde, Managing Director of the International Monetary Fund (IMF) recently said: • 0
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“Promoting equality in opportunities can be an economic game changer. Increased financial access means more economic activity by women, including as entrepreneurs. This translates into higher economic growth and productivity, a more equal income distribution, higher profits for businesses, and greater economic stability.” •
More female business angels investing in female-owned businesses plays an absolutely crucial role in realising the significant economic opportunities available to all and in our society benefiting from a more gender balanced economy. By participating in this course and subsequently investing in and supporting other women in business, your pioneering approach will help to drive positive change and economic growth in the world for many years to come.
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However, before you actually make your first investment, there is quite a bit to learn about business angel investing. Before we do that, it is useful to start with a brief overview of the principles of more mainstream investment. This will help to put angel investment in context as a diversification option for your overall personal investment strategy. If however you are comfortable with the general principles of mainstream investing, you can easily skip Module 3 and go directly to Module 4 on angel investing.
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2.6 Section Summary
In this section we covered an introduction to angel investing, the size of characteristics of the angel market in Europe and some of the specific issues facing female entrepreneurs is raising capital to grow their business. Note your thoughts and comments on this in the comments section below. And think about who you can speak to locally to find out more about angel investment and female entrepreneurs.
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3.0 General Investing Overview 3.1 Investment Basics Learning the basics of investing is like learning a new language and it’s easy to be overwhelmed with all the different terminologies, so let’s start with some basic explanations of key terms.
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Investing is defined as the “act of committing money or capital to an endeavour with the expectation of obtaining an additional income or profit”. The main goal of investing is to put your money to work in various investment vehicles in order to spread your risk whilst maximising your return. The most common investment vehicles are in the financial markets:
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Stock Market (also called share or equity market), in which stocks (or shares) of a company are bought and sold. Stocks are simply shares of ownership in a specific company. For example, when you own a share of Apple, you own a tiny piece of that company. Stock prices fluctuate both with a company's fortunes, and the economy at large.
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Bond Market, in which you can buy or sell a bond. Buying a bond issued by a company means you're lending money to that company, which it can use to grow the business.
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Mutual Funds, a diversified and liquid financial product, consisting of stocks and/or bonds from more than one company. This financial product is managed by a professional expert, working on behalf of the investor. Mutual funds are good for beginner investors.
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Real Estate, where an investor can purchase a security called a Real Estate Investment Trust (REIT), which combines the benefits of stocks with the tangible property of almost any kind of land property (e.g. shopping mall).
However, the entrepreneurial start-up phenomenon, with approximately 137,000 new businesses being started globally every day, is driving a new field of investment opportunity. These young growing businesses often need additional funding and support to help them grow and they turn to Angel Investors or Business Angels for the resources they need. We will come back to this later.
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3.2. Risk and Return Let’s turn now to the concept of risk and return, which is at the heart of any investment you will undertake. Whether it is investing, driving or just walking down the street, everyone exposes themselves to risk. Your personality and lifestyle play a big role in how much risk you are comfortably willing to take on. •
Definition of Risk o
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Risk is defined as the chance that an investment's actual outcome will be different than expected. This includes the possibility of losing some or all of the original investment.
Definition of Return o
Return is defined as the expected growth rate of an investment. However, return is dependent upon on the risk contained in the investing action and thus the actual return may not correspond to the expected return.
When financial realisations correspond exactly to expectations, there is no risk. This trade-off between risk and return is a basic premise in investing. The more risky the investment is, the bigger the loss or gain will be. For example, buying lottery tickets involves a very high risk of losing your money but the possibility of an extremely high reward. On the other hand, a savings account at your bank is low-risk, but you will not make a high return as interest rates are so low.
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Various components cause variability in returns. These components are known as elements of risk and they divide broadly into two groups systematic risk and unsystematic risk. •
Systematic Risk o
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Businesses are part of a dynamic society. External economic, political and social changes can influence a company’s performance and hence their expected returns. Such changes will affect all organisations to varying degrees. Hence the impact of these changes is system-wide and the portion of total variability in returns caused by such changes is referred to as systematic risk.
Unsystematic Risk o
A company’s returns may vary due to certain factors that affect only that company e.g. raw material scarcity, labour strike, management inefficiencies, etc. When the variability in returns occurs due to such company-specific factors it is known as unsystematic risk. This risk is unique or peculiar to a specific company and affects it in addition to the systematic risk.
Additionally, returns are also classified into two groups: expected return, where you have taken into account the expected risk; and unexpected return, where the outcome is attributable to unforeseen events. The sum
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of these two amounts, gives you the total or actual return of your investmen
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3.3 Security Analysis A “security” can either be a stock, bond, company equity or anything else that can be traded in a financial market. Security analysis is the process of estimating risk and return. It helps an investor to calculate the value of assets and the effect of market fluctuations on these assets. Security analysis can be done either on a market, industry or company basis, or all three combined. This will help an investor to estimate a security’s intrinsic value (the actual value of an asset based on an underlying perception of its true value) and its future value. There are two basic approaches of security analysis: •
Fundamental Analysis o
This is the study on a company’s qualitative and quantitative aspects, using basic financial variables to determine a company’s intrinsic value. Such variables include sales, profit margin, depreciation, tax rate, sources of financing and asset utilisation. Additional analysis could involve the company’s competitive position in the industry, labour relations, technological changes, management, foreign competition and so on.
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Technical Analysis o
This is the search for identifiable and recurring stock price patterns by using mathematical equations and ratios.
When evaluating securities, be aware that investments are made under conditions of uncertainty. There is no magic evaluation formula which will always work for any investment and the performance of investments should be continually monitored.
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3.4 Risk Assessment
Risk Assessment is defined as the determination of quantitative or qualitative estimate of risk related to a well-defined situation and a recognised threat. Quantitative risk assessment requires calculations of two components of risk: the magnitude of the potential loss, and the probability that the loss will occur. Time spent on risk assessment is extremely valuable and is important in determining your overall investment strategy.
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Key takeaways from this section are to understand: •
there are different types of securities (e.g. stock, bonds)
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the concept of risk and return
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the importance of security analysis
Understanding these will help you determine which type of investor you are:
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conservative (low risk/low return investments)
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moderate (medium risk/medium return investments)
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riskier (high risk/high return investments)
3.5 Asset Investment Planning and Management
This section is an introduction to asset planning and management. Understanding the principles from the broader financial markets will help you determine if business angel investment should be factored into your overall asset management plan. All of the concepts that apply in general financial markets also apply to business angel investment in a broadly similar way. .
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3.5.1 Asset Investment Planning and Management An investor’s main goal is to maximise profit and in order to achieve this goal, she should make a solid investment plan with specific timelines and expected profit. This is known as asset investment planning. It is about creating and sticking to an investment plan and it factors in your risk tolerance, diversification and asset allocation. Before choosing your investments, you should first assess your risk profile. Ask yourself some of these questions: •
What would happen if I lost some or all of the money I am putting into investments?
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Are my goals short-term (less than five years) or long-term (more than five years)?
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Am I willing to invest in something which is high risk?
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Will I feel comfortable making short and risky investment decisions?
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Or would I rather be cautious and have low returns over a long period of time?
Once you have identified how much money you intend to invest and what type of investor you are or want to be (aggressive or conservative), you can start to draw up your investment plan.
No matter what kind of an investor you are, one key way to minimise your risk is to diversify via a well-maintained portfolio of investments.
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3.5.2 Strategic Investment Management Strategic Investment Management is the process of planning, acquisition, operation, maintenance, renewal and disposal of assets. Put more simply, it is about the way in which an investor looks after her assets, both on a day-to-day basis and in the medium to long term. The components of most investment strategies include asset allocation, buy and sell guidelines, and risk guidelines. Investment strategies can differ greatly from a rapid growth strategy, where an investor focuses on capital appreciation, to a safety strategy where the focus is on wealth protection. The most important part of an investment strategy is that it aligns with the individual's personal goals. The most basic investment strategies and their purposes are as follows: •
Financial Plan o
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A financial plan is a comprehensive evaluation of an investor's current and future financial state by using currently known variables to predict future cash flows, asset values and withdrawal plans. Most individuals work in conjunction with a financial planner in developing their financial plans.
Capital Growth Strategy o
An asset allocation strategy that seeks to maximise capital appreciation or the increase in value of a portfolio or asset
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over the long term. Portfolios with the goal of capital growth consist mainly of equities. •
Capital Growth Investing o
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Conservative Growth Strategy o
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Conservative investing is an investing strategy that seeks to preserve an investment portfolio's value by investing in lower risk securities such as fixed-income and money market securities, and often blue-chip or large-cap equities. Conservative investors have risk tolerances ranging from low to moderate.
Cash Neutral Strategy o
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An investment strategy that aims to grow invested capital over the long term. This strategy focuses on minimising risk by making long-term investments in companies that show consistent growth over time. Conservative growth portfolios feature low asset turnover, or a high percentage of fixed assets on their balance sheets, and should employ a buy-and-hold investment philosophy.
Conservative Investing o
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Growth investing is an investment style and investment strategy that is focused on the growth of an investor's capital. Those who follow the growth investing style typically invest in growth stocks or companies whose earnings are expected to grow at an above-average rate compared to its industry or the overall market.
An investment strategy that requires no net cash in order to enter perform the transaction. In general, cash neutral
strategies require simultaneous buying and (short) selling of instruments. These strategies are popular with hedge funds, since they do not require money to be tied up in order to earn returns. •
Defensive Investment Strategy o
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A conservative method of portfolio allocation and management aimed at minimizing the risk of losing principal. A defensive investment strategy entails regular portfolio rebalancing to maintain one's intended asset allocation. Such strategies are meant to protect investors against significant losses from major market downturns.
Offensive Investment Strategy o
With an offensive or aggressive investment strategy an investor tries to take advantage of a rising market by purchasing securities that are outperforming the market for a given level of risk and volatility. Both offensive and defensive investment strategies require active management, so they may have higher investment fees and tax liabilities than a passively managed portfolio. A balanced investment strategy combines elements of both the defensive and offensive strategies.
Regardless which strategy an investor decides to follow, there is one common key factor which will make an investment better: diversification.
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3.5.3 Diversification
Diversification is a risk management technique that mixes a wide variety of investments within a portfolio. A portfolio constructed of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio. Maintaining a well-diversified portfolio of 25 to 30 stocks yields the most cost-effective level of risk reduction. A broadly similar principle of diversification applies to business angel investment – we will return to this later.
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3.5.4 Asset Management Tools As an investor you will need to keep track of your traded funds, individual stocks and bonds. You will want to examine your investment returns, fees and asset allocation. This can be done by hand or on an Excel spreadsheet but there are also some excellent investment portfolio management software solutions available. Some useful options to consider are Personal Capital, Mint, Ticker or Morningstar.
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3.5.5 Asset Management Tools Short-term investments are designed to be made only for a little while, and hopefully show a significant yield, whereas long-term investments are designed to last for years, showing a slow but steady increase. •
Advantages of Short-Term Investments o
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Disadvantages of Short-Term Investments o
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These have the potential to gain small amounts of money over a longer period of time. The slow but steady pace allows for a much greater degree of stability and a much lower risk than short-term investments.
Disadvantages of Long-Term Investments o
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There tends to be more fluctuation in short-term investments and they are therefore riskier. Whilst there is a good chance that you will make money with a shortterm investment, there is also a chance that you'll lose money. This is especially the case when trading on the stock market as many of the short-term investments involve precision timing when selling.
Advantages of Long-Term Investments o
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The main advantages to short-term investments are the potential for fast growth and that the term may only last a few weeks to a few months.
They increase in value slowly and can take years to mature. For those individuals who need a high yield in a short period of time, long-term investments are not
appropriate. Additionally, there are usually penalties or fines for early withdrawal. An essential component of risk determination and investment planning is influenced by your liquidity requirements in the shortterm (1-5 years), together with your need to provide for retirement, hence long-term growth in investment values. The process of dividing assets into short/long term investments mitigates the prospect of you having to sell growth assets to meet immediate needs too soon after the initial investment Considerations such as need for cash retention, health, life expectancy, future spending expectations, amount of initial investment capital, preferred investment returns, past exposure to investment products, and other personal issues will all impact on your investment preferences. However, your personal tolerance to risk and investment time horizon are probably the most important determinants in shaping your investment strategy and portfolio structure. A cautious person may develop a conservative approach to investing and will have a low tolerance to risk and intuitively a lower expectation of return. The opposite would be true of a business angel investor who would have a more speculative, higher risk investment portfolio. Your investment time horizon will also have a significant impact on the nature of your investments. For example, property is generally unsuited as a short-term liquid investment. Business angel investors have long-term
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investment horizons - hence the name “patient capital” - holding investments for 5 or more years…and in many cases much, much longer. According to the 2016 European Business Angel Network (EBAN) Study, 69% of total business angels’ investments have a medium (5 to 10 years) or longer time horizon. To summarise, when it comes to investing, it is important to find the right balance between risk and return for you and your individual situation. Set clear goals, diversify your investments and, when appropriate, work with a financial planner to help you balance your portfolio. If you would like to learn a little more about investment, have a look at this video.
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3.6 Section Summary
In this section we covered some general principles of mainstream investing. We considered the concepts or risk and return, how to analyse securities and undertake a risk assessment, the difference between short and long term asset management and the importance of diversification. Note any comments or queries in the section below and consider how these principles apply to your mainstream investment strategy and potentially to a business angel investment – could this be an interesting and beneficial diversification for you?
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4.0 Start Ups and Business Angel
Now you have a broad understanding of the general principles of mainstream investing and feel comfortable with the concept of risk and return we can look at angel investing in more detail. Angels invest very early in a company’s development, but there are distinct types and stages of fundraising associated with each growth phase. It is useful to understand these to see where business angel investment fits in. 0
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So in this section, we will cover: •
The different types of start up/early stage investment
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The difference between start-up accelerators and incubators
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How angel investors differ from venture capitalists
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The benefits of angel investment for entrepreneurs
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When angel investment is appropriate for a business
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4.1 Start Up Stages and Types of Investment Before we look at the different types of investment, it’s useful to first look at the start-up funding landscape which has changed significantly over the past few years, especially in Europe. Certain types of investors appear at certain fundraising stages which are: •
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Early stage of a start-up: o
Pre-Seed Capital - when an entrepreneur has an idea, maybe a working prototype and is looking for funding that will allow her to focus on her project full-time
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Seed Capital – often described as the capital necessary to start a company and to try and find product-market fit
Growth Stage of a Start Up: o
Series A – usually when start-ups have figured out their product and the size of their market, but need capital to scale and improve distribution systems
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Series B – when a start up is successful with an established user base and a business model that is working but wants to grow even more
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Series C and following stages – when start-ups are fully mature. The business model is working, whether the company is profitable or not, the user base is expanding, and acquisition may be in the minds of the executives leading the company. Exits will be in sight, through
acquisition by a bigger company or via IPO (stock market flotation). Start-up companies have a variety of funding options available to them. These are summarised as follows: •
Friends and Family – friends and family actually invest the most money in start-up companies at the earliest stages, but it tends to be in small amounts. For an entrepreneur, seeking funding this way can be an ideal way to get their idea off the ground. These types of investors tend to base their involvement in the business more on trust in the founder, as opposed to belief in the actual business concept. They are motivated more by loyalty and support rather than by strict return on investment.
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Banks – a bank loan may be available to help start-ups. A bank will want to see a detailed business plan and a thorough description of the business and its prospects. Loan-seekers will usually be required to produce proof of collateral or a revenue stream before the loan application is approved. Banks are usually therefore a better option for slightly more established businesses (in start-up companies, during the growth phase).
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Venture Capitalists (VCs) – Venture Capital firms invest on behalf of their clients and their sums of money are usually higher (millions of pounds as opposed to thousands) than every other type of early stage investor. They usually show interest after the early stages of a start-up, when the business is growing and the
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risk has been reduced somewhat. In return for providing capital they secure an equity stake in a company (shares). They can provide portfolio companies with exposure, connections to customers and help establish partnerships. In addition to the above types of investors, there are several other sources of funding for entrepreneurs:
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Start Up Accelerators – these organisations can offer pre-seed and seed capital in return for equity. Start-ups are admitted in classes and work in groups. They are generally given deadlines to complete intensive training programmes (1-6 months) and usually finish with a demo day where they pitch to investors. These accelerators can be a good source of investment opportunities for business angels.
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Start Up Incubators – these organisations are established to support the development of start-up companies in the early stage. Usually this incudes 1-3 years of access to facilities (office and lab space), resources and development programmes, potentially including mentoring. These incubators can also be a good source of investment opportunities for business angels.
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Incubators differ from accelerators in that accelerators focus on acceleration of growth in a shorter defined period of time whereas incubators develop the company and the product over a longer time period. In both cases, the support and networking with peers is very useful for the entrepreneur.
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Peer-to-Peer Lending - Peer-to-Peer lending is a fast and accessible way of getting a cash injection into a business. However, it is really only suitable for more established businesses. No equity is released – companies pay interest on a loan, much like they would with a traditional bank.
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Crowdfunding – This is a relatively new concept. It is growing in popularity but there are still risks associated with it for both entrepreneurs and investors. As the name implies, the funds come from the crowd. The financial support for a start-up is via many smaller amounts from many investors (the “crowd”), rather than large amounts from fewer investors. It is usually used after the very early stages of a start up as the risk is lower. The most successful crowdfundings normally have a very strong premarketing and post-marketing campaign. There are two types of crowdfunding: o
The “donation-based” or “reward-based” crowdfunding, where sites like Kickstarter and Indiegogo are global leaders. Users can back the projects they like and get something material in return (physical or digital products and services), receiving no equity or goods from the teams or companies providing the goods.
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The “equity-based” crowdfunding, where investors in the start up get equity in return, thus becoming shareholders in the company and being able to benefit from future returns the company may be able to provide to investors.
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The leading platform in equity crowdfunding is Crowdcube. It can be useful to explore crowdfunding platforms to see what types of companies are being created and get a feel for the entrepreneurial landscape. Here is an additional useful video on various sources of finance for entrepreneurs.
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4.2 Business Angel Investment As we already know, business angels are High Net Worth Individuals (HNWI) with significant business experience who invest their own money directly into promising entrepreneurial start up companies. HNWI is a relative term that varies from country to country. In the USA, Canada and UK most business angels have accredited status as defined by law, although this is usually self-certified. For example, in the UK, investors in unlisted companies are classified as HNWI or Sophisticated Investors. A HNWI is defined as a person who has £100,000 a year of more in income or £250,000 or more in relevant net assets. There are no stated requirements for Sophisticated Investors but individuals must be “a member of a network or syndicate of business angels” or “have made more than one investment in an unlisted company in the past two years”. Check your own county for more information on HNWI and accreditation. Business angels come from different backgrounds but mainly they are either successful entrepreneurs themselves or corporate leaders/business professionals. The vast majority of business angels invest in the early stage of a start up company. There are many online platforms which operate as bridges between an entrepreneur and angel investors such as Gust, AngelList and In4Capital. It is useful to look at these platforms to see what types of investment opportunities are available globally.
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Business angels are an ideal fit for young companies. Based on their own experiences of successes (and failures) in business they bring “smart money” to companies – cash complimented by hard-won experience and business contacts. This smart capital and mentoring is invaluable to entrepreneurs and the external scrutiny provides for better discipline and decision-making in the company due to diversity of thought and experience. Business angels are vitally important in filling the funding gap – the so-called Valley of Death - between friends and family funding and Venture Capital or Private Equity This video de-bunks some of the myths you may have heard about Angel Investors. https://youtu.be/1b8YLBFQy44 This video explains the key differences between Angel Investors and Venture Capitalists. https://youtu.be/Pnvg1Jgh_dk And these videos below are useful to see what other angel investors look for in investment opportunities. https://youtu.be/0ONPfJjEjhk https://youtu.be/41yPPkibJqo It can also be useful to consider angel investment from the entrepreneur’s perspective. If you have time, you may wish to also quickly look through our separate training program for female entrepreneurs. It can be found
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here and provides much more detail on entrepreneurship, business planning and pitching.
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4.3 Is Business Angel Investing for You?
Ask yourself again some key questions before you start investing:
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What are your overall investment goals?
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What is your attitude to risk and potential returns?
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How long do you want to invest for?
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How much money do you want to invest?
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Do you want capital growth or income, or both?
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How much time to do you want to commit to this investment?
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Are you confident enough to choose investments on your own, or do you want to work with others?
And with specific reference to business angel investment: •
Can you act as a mentor?
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Will your business experiences and skill set benefit companies you wish to get involved in?
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Can you accept new roles and incorporate them into your business life?
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Can you resist the temptation to micro-manage your portfolio of investments?
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How much are you willing to learn in order to become a capable Angel?
Answering these questions will help define what type of an angel investor you want to be and help you to develop your angel investment strategy. You may want to be a relatively passive investor – providing capital but not time. Or you may want to be an active investor, providing both time and capital. Or a combination of both, depending on your sectoral interests and experience: you may have a lot more relevant contacts and experience for Investment A, but not for Investment B, therefore you allocate more time to Investment A. When you are investing in a company as a Business Angel, investments are made at a very early stage in the company’s growth, therefore the risk is very high. As an investor you must be acutely aware of the key risks you
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are taking with your investment. Only by understanding the risks can you provide additional support to help mitigate them and ensure the company’s long term success. Be aware and remember:
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Most start-up companies fail – 9 out of 10 fail
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No-one knows which ones are going to fail
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What eventually wins was probably once failing
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Investing is a ‘Numbers Game”
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You only really need 1 out of 10 investments to succeed and yield 10x your investment
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All start-ups always need more money than planned
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Trust your own experience and instinct
4.4. Solo and Group Business Angel Investment Business angels are typically interested in more than just receiving a financial return. Personal interest, giving back, the thrill of being involved with innovative companies, meeting new people – all are powerful motivations and just a few of the reasons people become business angels. Whilst individual angels are very important, there is only so much one person can do alone. By pooling resources and knowledge, groups of angels can overcome the many limitations of solo investing and access a higher number of deals. Some benefits of group investing are as follows: •
Aggregating resources to secure staff and facilities to enhance the deal process
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More efficient deal screening process
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Making larger investments
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Making more investments to spread risk through diversification
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Syndicating with other groups to spread risk
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Sharing learning between established and new investors
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Enhancing negotiation terms of investment
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Influencing policy and regulatory issues with governments
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Camaraderie and friendships between investors
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For these reasons, although you can of course be a solo or “lone-wolf” investor, the vast majority of investors nowadays choose to join an established angel group or create a new one of their own. According to an EU 2015 study, only around one sixth of angels now follow a solitary investment approach. Do some research to see what angel groups are established in your local area and attend a few meetings to get a feel for them. If there are no groups in your area, or for some reason they don’t feel suitable for you, you may choose to start up a new angel group. This will however take considerable time and effort and needs a highly committed group to make it happen.
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4.5. Establishing an Angel Group
A summary of the key steps involved are as follows - use personal networks and entrepreneurial organisations to gather information: •
Angel Community Assessment o
Is there a champion to lead the group?
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Do you have sufficient wealthy individuals?
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Are there experienced investors who can help?
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Be aware you may face some challenges with finding the right people, low risk tolerance of other individuals, lack of trust and individuals not wanting to be visible. Ongoing education re investment process will be required for everyone and at all times, be careful to manage expectations for everyone. •
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Assess the Entrepreneurial Pool o
Are new companies starting up in your area?
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Do you have research centres and universities?
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Do you have accelerators and incubators?
Assess the Entrepreneurial Infrastructure o
Are there networking events?
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Are there trade associations?
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Are there experienced mentors for companies?
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Are there start up business support programmes?
Assess Service Providers o
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Is there a solid pool of accountants, lawyer and marketing professionals?
Assess Follow-on Funding o
Can you support entrepreneurs’ investment needs?
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Are there others you can work with?
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Are there other grants and support available?
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Are there any VC or PE funds locally?
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Assess Regulatory Environment o
Is there an appropriate legal environment?
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Do investment laws provide shareholder protection?
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Are there any tax incentives?
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Are Intellectual Property laws consistent with international law?
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Are there any immigration issues?
Reviewing the above will give you a good idea if a business angel group is sustainable locally. Be aware that for an angel group to be successful, all members must be personally interested in giving back to the local community as financial returns will not be immediate. The most common reasons that angel groups fail are: •
No committed champion
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Lack of deal flow
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Lack of successful exits
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Personality clashes
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Unsustainable business model
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Burn out of volunteers
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External factors (recession, political instability)
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If you do decide that your community is ready for a business angel group, whilst you do not need a large group to get started – two or four people can be ideal - you do need patience and persistence to stay the course and for all to understand the risks involved. You will need to define your group culture, determine the geographic location of members, size of group, member expertise, meeting requirements, fees, legal structure, individual/group investments, pooled/pledged funds, etc. Some groups will be member-led, other groups will fund an appoint an experienced person to manage their deals – often referred to as a gatekeeper. If you do decide to start up a new business angel group, the infoDev and Kauffman Foundation Guide to Creating Your Own Angel Group is a highly comprehensive and very clear guide. If you only have time to read one additional resource from this development programme, please read this one!
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4.6 Female Business Angels
With regard to encouraging more females to become business angels, diversity of expertise and perspectives can reduce risk and generate better returns for angel groups. Research from EBAN shows that female angel investors help widen a group’s focus beyond technology and tap into new sources of deal flow. Females also approach diligence differently to males, often asking more questions and digging deeper into financial projections.
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And as mentors, women bring a different set of experiences and contacts for the entrepreneur, all of which help to minimise risk in the investment. Ensure that your group structure and requirements are compatible with a woman’s schedule – many women have family duties and require flexible options to attend meetings. Think about having meetings at different times (e.g. lunch), allow virtual participation and record pitches so that women can watch them later at a time more suitable for them. Now you are ready to think about making investments, let’s move on now to reviewing the business angel investment process in more detail. For ease we will assume that you are investing as part of a group of angels, but of course the same principles apply to solo investors as well as group investors.
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4.7.Section Summary
In this section we covered the different stages of a start up company and the different type of funding available to these companies. We covered the benefits of being a group investor as opposed to a solo investor, how to establish an angel group, and looked at some issues facing female angel investors. Note your comments and queries in the section below. Consider if you would like to be a business angel and how you will do that. Who do you
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need to contact locally and what information do you need to find out next? Create a plan of next steps
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5.0 Business Angel Investment Process 5.1 Finding Deal Flow and Initial Screening In this module we will investigate how to find deals for you to invest in, how to manage deal flow and how to undertake initial screening of investment proposals.
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5.1.1 Finding Deal Flow A deal is accomplished when both the buyer and the seller agree to the terms of a transaction. As we indicated earlier, lack of deal flow is one of the main reason that investor groups fail, so finding a good source of deals is critical part of the investment process. So, where do deals come from? Where can you find them in your area? What are your deal sources? 80% of business angel investments come from the following sources and in the early days you may need to be quite proactive in seeking deal flow until your reputation as an investor is established. Consider the following options and establish a strong deal sourcing strategy to ensure good and consistent deal-flow:
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Members – from the individual members of angel groups (yours and other groups). The more active you are in the general business investment community, the more deals will flow to you.
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Word-of-mouth - a large percentage of deals come via word-tomouth from reliable personal connections
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Professional Advisers – lawyers, accountants and other service providers
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Direct Application - through your angel group website
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Incubators and Accelerators - good source of high growth opportunities
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Universities and Colleges – good source of high growth, high-tech scalable opportunities
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Investment Forums, Start-up Conferences, Launch - at these events you will be able to see deals pitched directly to an audience and be able to discuss deals and network with other investors and entrepreneurs. These events are every useful for expanding your contacts and experience
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Meetings – various other business meetings, conferences and events
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Social Media – e.g. LinkedIn. You can create a profile and search for business matches
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Internet Platform Offerings – These platform offerings operate as a bridge between the entrepreneur and the investor. Have a look at platforms such as Gust, AngelList and Crunchbase. There are many others – investigate these in your own country. They facilitate global deal discovery and networking and can also offer useful deal flow management tools and e-mentoring capability.
It is best to try and use one uniform method for receiving applications – that is usually an investor group website. This helps to maintain consistency and allows you to share information with entrepreneurs about your information requirements and types/sizes of investments you will consider. If you have a group website, think carefully about what personal information about members you want to share online – many angels want to keep their investments quiet and have a low public profile.
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Whether you are a solo investor or a group investor, you may also want to raise your public profile in the field of investment in order to gain more deals (equally, you may want to stay private – this is a very personal decision). If you do want to raise your public profile and enhance your investor reputation, consider undertaking some of the following activities: •
Create and keep relevant current profiles on online business networking platforms.
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Participate as a judge in business plan and pitch competitions.
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Become a mentor. Working with entrepreneurs from an early stage puts you in a preferred position when they are ready to raise money.
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Attend start-up events and provide helpful advice.
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Write blogs and newspaper articles about areas of investment you are interested.
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Speak at events and share your experience.
Here are some more tips on finding deal flow.
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5.1.2 Deal Flow Management
You do however have to consider how many deals you actively want to encourage, factoring in how many deals you can realistically afford to invest in and your time available. Active angel investment groups will typically receive dozens of business plans monthly and only tend to fund 1-2% of all deal proposals received‌but that still means substantial initial research has to be undertaken before deciding which deals to invest in. VCs can receive hundreds of business plans a month, and many established angel groups receive hundreds of plans a year. Start slowly.
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Deal flow is the rate at which you receive business proposals and/or investment offers. Strong, vibrant economies will usually generate healthy deal flow: a recession and sluggish equity markets will generate fewer deals. You can manage deal flow and information with simple Excel spreadsheets or CRM systems, but there are also tools such as DropBox, Slack, Podio, Zapflow and Pitchbook. Have a look at them and see what option suits you best. You are looking for a tool which will help you:
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Organise a flood of deal information to help save time and reduce errors
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Enhance investor collaboration
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Maintain a history of deals considered (be aware of data protection laws and GDPR requirements)
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Help with reporting on trends, deal flow, investment progress, etc.
5.1.3 Initial Deal Screening Often referred to as Pre Screening, this is the first part of the screening process of deciding proposals to invest in. An efficiently designed prescreening process allows investors to cut through a large number of deals, saving time and money and selecting those which meet their investment criteria and warrant closer consideration. A uniform matrix should be used for analysis – the infoDev/Kaufmann Guidebook provides a sample tool. It is not an intensive or exhaustive due diligence process at this stage.
According to the Angel Capital Association, only one in four deals that enter the first (pre-screening) phase make it to the second (screening) phase and one in three deals that made it to the screening phase go on to the final (due diligence) phase.
It is important to try to signpost to alternative sources of help and guidance for businesses that are not selected for further investigation. Please remember you have an entrepreneur’s dreams in your hands – even if you cannot support them financially, try to help them in another way. Research shows that one negative early interaction can put off an entrepreneur from starting their company for up to 10 years.
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Confidentiality agreements usually pop up at this stage. Most investors do not sign them this early, they do not need to have any proprietary information for pre-screening. If an entrepreneur insists, they are perhaps not right for this stage of investment.
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5.2Detailed Screening Coaching and Presentations 5.2.1Detailed Screening Once you and your other investors - or the investment group manager (often referred to as a gatekeeper) - have selected companies for detailed screening you are ready to move onto the next stage. This is often a screening group, made up of a small group of business angels. Its main purpose is to analyse the business plan provided by the entrepreneur. Again, this is not detailed due diligence, but you can refer to due diligence checklists for guidance on what to look for just now. Some groups distribute Executive Summaries of business plans to all investors for review at this stage. These Summaries are usually one or two pages maximum, prepared by the entrepreneur and which succinctly summarise their business proposal (hence the need to reinforce to all entrepreneurs the importance of a concise and well-constructed Executive Summary at the start of their business plan). If the group reacts positively to the business plan or executive summary, then a meeting is usually scheduled with the entrepreneurial management team to get to know them a little better and ask more questions about the proposal. This is one of the most important steps of the screening process - fundamentally you are making a decision on whether or not the entrepreneur and her team have the relevant skills, attributes and entrepreneurial mindset to execute their business plan. Listen carefully, look out for passion, commitment and determination as opposed to
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simply looking at the technology, product and financial forecasts. Focus more on the market opportunity and the management team. After the meeting, if there is again a positive impression, the proposals will either be sent to a screening committee for final filtering and review, or companies may be directly selected for a coaching process before they finally make an investment pitch and presentation to the wider group of business angels.
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5.2.2 Coaching
Selected entrepreneurs should present to the angel group as effectively and efficiently as possible. Coaching businesses can make a significant difference in ensuring that companies present the right information, in the right way, in order to maximise their chances of securing investment. Some groups give presenting companies exact instructions on what to include in their presentation and meeting handouts. Sponsors (such as law or accounting firms) are often keenly interested in providing these
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coaching services at no cost and, in fact, as a benefit of angel group sponsorship. These service providers see the opportunity to coach presenters as an opportunity to promote their services and possibly obtain new clients. Most entrepreneurial companies also see coaching as a benefit. You may find that the entrepreneur needs help with their business plan. If so, have a look at these useful resources for a business model canvas and for a business plan. And here is a useful video on business model fundamentals. You can also have a look at our separate training package on pitching for investment for entrepreneurs and direct them to it here. As with other steps in the investment process, the manager of a managerled angel group may take on the responsibility of coaching companies along with other aspects of deal screening and investment. The allocation of these various responsibilities will depend on member preferences, interest in participating in various steps of the process, legal structure, time availability, etc. But to sum up, the coaching process has one principal purpose - helping entrepreneurs to present a confident and clear proposal in an efficient and effective way and ensure investors have the right information upon which to base their investment decisions. During the coaching phase the gatekeep/manager of business angels will help the entrepreneur to develop their presentation and/or challenge some assumptions that have already been made, as well as giving guidance as to some questions that may be asked of them. The presentation (pitch) is an overview of the business plan and usually consists of 10-15 slides which include certain key pieces of information. A common structure would be as follows:
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The mission - who is the company and why they are here?
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The problem or pain - what problem are they trying to solve?
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The solution - how their product or service will solve the problem?
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The target market - how big is the target market?
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The business model - how are they planning to make money?
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The traction - have they already some revenues?
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The marketing and sales strategy - how will they market and position their product and what will their sales process look like?
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The management team - who are the key people and what skills do they have? What gaps are there?
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The financial projections - what are their sales forecast, profit and loss statement for the next three years?
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The competition - what are the alternative solutions to the problem you are trying to solve?
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The investment - how much money are they looking for and how will they use it?
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The exit strategy - what and when is their exit plan?
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The contact details - the company’s phone numbers, e-mails, etc.
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5.2.3 Presentations to Investors It can often take many months to get from receipt of initial application to the presentation stage. Do your best to keep entrepreneurs updated as to progress and indicative timelines for next stages and, again, provide contacts and signposting for those who do not make it through to the next round. Once the coaching phase is complete, it is time to proceed to the company presentations phase. Many angel groups have company presentations at regular group meetings. Typically, two to four companies present for a limited period (ten to fifteen minutes) with support of a presentation, followed by a short question-and-answer session (five to ten minutes). After the presentations, companies leave the room to discuss investment interest. This investor-only discussion serves a greater purpose than just making a “go” or “no-go” decision. Members have the opportunity to share additional information they may possess about the market, product innovation, and management, and to develop an effective message to communicate to the entrepreneur, particularly if that business is not selected for funding. This investor discussion should center around the following key questions:
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Is this a good deal for our Angel group?
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Does it fit with our investment strategy?
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Is this the right team to execute this business?
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What gaps are there in the management team?
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Does this business have superior proprietary products?
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Do the products address a clear need in a large market?
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Is the requested investment sufficient for the company to achieve key milestones?
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Has this company made a compelling case for the overall attractiveness of the business opportunity?
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Is this an attractive investment opportunity?
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Really focus on the management team – do you believe in them and their entrepreneurial vision and mindset?
These group discussions also provide an excellent learning experience for new angel investors. The actual angel group structure will then dictate the follow-up activities. For instance, if a group is member-led and members make their own investment decisions, the group may have a process in which those members expressing an interest in continuing discussions with a company form a due diligence committee to thoroughly evaluate the company. That group could then divide up the duties, depending on expertise, with investments still being made on an individual basis.
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At the other end of the spectrum, if the group is an angel fund and/or has a manager/gatekeeper, the group may vote on whether to proceed with due diligence and members may volunteer to support the diligence process based on their background and expertise, often led by a manager. It is not unusual to have dozens of opportunities come to a group, many pass the screening stage, but only two or three are invited to actually present to the group members, and only one or two proceed through to due diligence and term sheet negotiations
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5.3 Due Diligence, Term Sheets and Valuation
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5.3.1 Due Diligence Due diligence is a process that verifies and confirms statements and views about a business and its prospects. Its main purpose is to reduce the risk as much as possible. It can be the most complicated and time-consuming part of the business angel process, but it is important take the time and care to do it properly. Very few proposals reach this stage, but good due diligence can make all the difference in achieving a positive return on investment. The approach to due diligence conducted by individual angels and angel groups varies widely. Individual angels tend to have less stringent screening criteria, rely on deal flow from known referrals and invest on their instinct. Active angels who are formally affiliated with a group tend to take a more proactive role in the company and typically have a wellstructured due diligence process. Whilst every angel group has variations on the nature of the due diligence process, doing nothing or very little in this area is not an option if you wish to avoid costly mistakes. Some groups recruit local university or MBA students to support due diligence through an internship programme. Other groups retain outside experts to evaluate a company or give a briefing on cutting-edge technology related to the potential investment (although most groups do not have budgets to pay for outside consultants.) After due diligence is complete, those who have undertaken the due diligence process present their findings to the angel group, and members decide whether to fund the company or not.
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There are numerous samples of due diligence documents available. The best places to find them are at business angel association websites such as The Angel Capital Association (ACA), the European Business Angel Network (EBAN) and the Angel Resource Institute (ARI). Through this due diligence process you are looking to get comfort in the following areas: •
Corporate structure and governance
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Financial assumptions and revenue source
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Market assessment
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Competitive landscape
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Management team (especially gaps)
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Technology assessment
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Operations
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Comparable companies (for exits)
Above all you need to have confidence and belief in the entrepreneur and her team. Not every skill will be in place, but if you feel that they are coachable, willing to learn and have an entrepreneurial spirit with drive, purpose and passion, you are a big step forward in minimising risk. It cannot be emphasised enough that the key to angel investment is believing in and having a good relationship with the entrepreneur and her team. Consider too that the way an entrepreneur responds to the due diligence process is in itself due diligence on the entrepreneur: do they answer questions in appropriate timescales, do they respond to questions positively (i.e. they are not overly defensive), are their answers clear and well-constructed, do they clearly state when they don’t know the answers? A due diligence checklist may include the following elements (not all will be applicable to start-ups but they should be at least considered): General Background • A simple declarative statement outlining the pain or problem in the market and the company’s solution that addresses the need •
The company’s unique advantage
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A brief history of the company
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An outline of the company’s financial needs 0
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People •
Organisational chart
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Resume of each member of the management team
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Significant gaps in the senior management team
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Professional advisors – lawyers, accountants, bankers, etc.
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References
• Disclosures (any legal issues, conflict of interest, etc. that might hinder the company) •
Compensation for all key personnel, including options
• Employment contracts, partnership agreements, non-competes and IP assignments Market • Market Opportunity - size of market, addressable market niche, expected market penetration •
Market geography and industry trends
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Barriers to entry
• Market maturity and where the product fits into the business maturity cycle
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Product •
Product description (focusing on what it does, not how it does it)
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Stage of development
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Pricing structure and unit sales forecast per year
• Unique features/USP. What is the product advantage over the competition? Sales and Marketing •
Sales and marketing strategy
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Sales pipeline
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Direct and channel sales model and distribution plans
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Price and price history
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Product description
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Brand positioning
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Sales force required
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Target market
Competition •
Details on the major competitors
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Competition’s strengths and weaknesses
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How are the major competitors growing?
• Plan and strategies to deal with direct, indirect, and alternative competitors • up 0
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Assessment of how competitors will react to the entry of the start-
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List of major customers who are buying from the competition
Financials •
Historic financial performance
• Cash flow projections to the next round of financing, breakeven timing, and profitability forecast •
Current financial position
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Financial model and projections
• Tax: all taxes (corporation tax, VAT, employment taxes, rates, stamp duty, import duties, etc.) •
Pensions: adequate provision in balance sheet
IP (Intellectual Property) ownership •
Chain of title – legal documents that prove ownership
• Copies of all patents and status of filings, especially patents pending, trademarks and copyrights • Clearance to operate – releases from prior agreements, past employee contract, non-competes etc. •
Regulatory issues identified
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Licensing agreements for IP and their financial impact
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Other IP activity
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Copies of material contracts (including license agreements, if any)
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•
Employee Agreements
Here is a short video on due diligence and a more comprehensive due diligence webinar. And here is a video on analysing financial statements.
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5.3.2 Term Sheet An essential part of angel investing is setting and agreeing to the terms of the deal. Many angels recognise the importance of deal terms, but often wonder which components of the term sheet to prioritise. The term sheet outlines the terms and conditions of the investment deal. The term sheet is a letter of intent, created by the Angel or the Angel Group and presented to the company. It spells out the proposed terms under which an investment will be made. The term sheet is not a legally binding document, but rather a mechanism that summarises the key financial and legal conditions under which a deal could be done. Most importantly, it serves as the base document for negotiations and focuses both parties on the major items that must be resolved before a deal is finalised. Most conditions (conditions precedent) will require to be resolved before an investment, but some conditions (conditions subsequent) may be satisfied after the investment. The following topics usually need to be covered in the term sheet. Keep it short – the purpose is simply to lay out a framework that helps agree and protect the angel investment. Angel Associations can provide templates for term sheets. • Financial structure of the investment: debt or equity; common shares, preferred shares, convertible debentures, etc.
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• Pricing/parties investing: what is the size of the deal; what is the price per share; and who will participate in the Angel round? Will the Angels invest individually or in a voting trust or group? • Use of funds: what will the investment be used for? Without this provision an entrepreneur could use the proceeds inappropriately. • Downside protection: terms and conditions under which a measure of protection is provided to the angel if he/she is willing to participate in future rounds of financing or in the case of the liquidation or sale of the start-up. • Expenses: what are the acceptable expenses in negotiating and closing a deal and who will absorb these expenses? • Exclusivity/no shop/closing date: Angels may need assurance that this deal is not being shopped around to other investors, and that the start-up is not trying to create a bidding war. A firm end date for the deal needs to be set early. • Milestone and tranches: Angels are advised not to invest in one lump sum. Rather, milestones are created up front, usually tied to such things as completion of software development; signing customers; gaining significant revenues; or achieving some form of positive cash flow. The funds are tranched out upon the completion of each milestone at a predetermined percentage of the deal. These milestones should be stretching but achievable for entrepreneurs. •
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Exit Priority: It is also worth asking for some form of priority on exit, such that you receive back your investment before the founders receive any proceeds. This covers the negative scenario where the company fails or has to be sold for less than you paid at the time of investment.
• Redemption rights: These rights can help angels to achieve liquidity by selling their shares back to the company, if management wants to continue running the company but investors want out. Here is a short video introduction to term sheets.
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5.3.3 Valuation The final - and often most contentious part – to be included in the term sheet is the valuation. You should deal with valuation during term-sheet negotiation rather than postponing it to some later date and leaving the decision in the hands of subsequent investors. Postponing the valuation only leaves the you vulnerable to the decisions of others. The valuation of a company is a critical component as to whether the deal occurs or not. How the entrepreneur approaches the valuation is very revealing about the management and can make or break the deal. The tone of the relationship between the angel investors and the entrepreneurs is frequently established early on and if there is no mutual consent to the valuation then there is a good likelihood that a deal will not proceed. Be fair. Leave enough equity so the entrepreneur and her current and future team are suitably incentivised but ensure sufficient equity to support a good return on investment for all angels. There are no rules of thumb for valuation at such an early stage. It basically comes down to what you are prepared to pay and what the entrepreneur is willing to accept. Negotiating investment term sheets is a bit like negotiating a pre-nuptial agreement prior to marriage. You want to protect the long-term relationship, but you want to clearly document certain details related to ownership, governance and exit payouts. If either party negotiates in bad faith or demands unrealistic terms, then the marriage never takes place or breaks down soon after the agreement is signed.
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If properly executed, the negotiations can help build mutual respect, understanding and the lasting foundation for a successful long-term relationship. It can be a very emotive process, so do your best to keep everything calm and focused on the long term result. Here is a short video on valuations.
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5.4 Legal Agreements Once the term sheet is complete, it is essential that the terms of the investment are outlined in appropriate legal agreements. The principal legal agreements are as follows and will be prepared by lawyers in the country of investment: •
Investment agreement (sometimes called a shareholder’s agreement)
•
Articles of association
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Directors’ service agreement
Angel financing can range from a couple of thousand pounds to several million. Complicated deal structures and legal agreements make no sense for small financings, but larger financings with multiple syndicate partners can be more complex. Prepare what is appropriate for the stage and size of the investment but do take the time to ensure appropriate warranties are in place. Always take appropriate legal and professional advice. Angel investors are often first outside money in a company so you need to be aware of follow-on funding needs and possible sources for this additional capital. Do not make deal terms so complicated or onerous as to effectively prevent attracting follow-on financing, which is as undesirable for the company as it is for the angel investor. If angel group members make independent investment decisions, there should also be a strong disclaimer of organisational liability. This disclaimer should indicate specifically that each member makes his/her own investment decision and that the organisation is not recommending any particular company for investment. 0
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It is all a negotiation process and important that both parties treat the other with mutual respect. Some of the most important fundamentals for a successful negotiation are as follows: •
Separate the People from the Deal Terms. It is vital to ensure that the negotiations do not damage the long-term relationship.
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Focus on Interests, Not Positions. Position-based negotiators often find themselves locked into their positions.
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Create Options for Mutual Gain. The ability to uncover interests and discover which issues are most important to each party is key to achieving win-win outcomes where both sides feel they have negotiated a good deal.
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Use Objective Criteria and Fair Procedures. There are currently few objective standards for angel investments so it is particularly important to engage in fair and reasonable procedures.
The purpose of this module is not to delve into the intricacies of investment terms and negotiations. The Angel Capital Association provides free, detailed operating documents on its website as do various angel networks such as the European Business Angel Network and the UK Business Angel Association.
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This article from Hyde Park Angels provides a list of terminologies used in negotiating an investment.
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5.5 Section Summary
In this section we covered ways to find and manage deal flow and whether or not and how to create a personal public profile for investment. We also covered how to screen and select deals and how to coach companies for presentations. Then we considered how to undertake due diligence, prepare term sheets, agree valuations and finalise legal agreements. Note your comments and queries in the box below. Think about how you will find your first investment and the first steps you will take to meet with
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an entrepreneur. Also consider who to contact locally to create the legal documents you will need.
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6.0 Follow-on Finance, Monitoring and Mentoring
Post
Investment
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6.1 Follow On Finance Most start-up companies have a continuous need for funds to help grow the business. A common refrain among angels is that “it takes twice as long and twice as much money as you think it will to be successful”. The vast majority of companies require multiple rounds of finance over many years – anything from three rounds upwards. So, when you initially invest in a company, also think ahead about its future funding requirements. For example, you invest £20,000 in two agreed tranches of £10,000, and the company meets most of its milestones e.g. prototype created. It is growing well, but in order to grow faster and bigger, it needs more money to fund e.g. customer acquisition. Another round of £20,000 is required. The company again achieves its key milestones but needs yet another round to fund further expansion. You invest again for more equity. In total you have now invested £60,000 in one company over three years. This happens in the vast majority of investments – it is rare for start ups to achieve their forecasted projections early on and there are always problems to overcome. In reality, when you first think about investing £20,000, you should think about whether you would be willing and able to invest £60,000. (This is an example – it could be a lot more money or a lot less.) You will often hear one investor say to another “are you planning on following-on in this round”? Simply put, the investor is asking if you will invest additional funds in the company. If you believe in the entrepreneur and the business potential, you will most likely follow-on. If not, you won’t, but if others do provide follow-on investment, your equity stake will be reduced. Plan ahead for the provision of follow-on funding. 0
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A major aspect of angel relationships with start-ups is securing follow-on financing and planning for eventual exit by investors. Even when angels plan to bring in new funding from other sources, such as venture capital funds, it is a good idea for angels to allocate funds to invest alongside new investors. This allows angels to secure better deal terms and encourages new investors to participate as they can see that existing investors believe in the company and are willing to “follow their money.�
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Honest dialogue amongst all stakeholders about timing and amount of both tranched investments against milestones and subsequent follow-on financing is therefore key. It is the collective responsibility of both angels and the company to work together on future funding options (such as other angels, banks and VCs), whether funding should be equity, debt or a combination of debt/equity, until the company reaches cash break-even. The range of experience and contacts within the angel group should facilitate the best available financing options. Venture Capital firms (VC’s) are the major players in later funding rounds of a potentially successful scalable high growth businesses. Some angel group managers speak with VC contacts weekly, staying up to date with the VC funds’ investments and available capital. An angel group should have several VC firms to choose from when looking for follow-on funds for portfolio companies and match the company with the most appropriate VC. Be aware that dilution of rights, stakes and board seats will occur with VC investment. Every investee company should update its business plan and spell out future funding needs. Monthly meetings between investors and entrepreneurs should include updates on funding and eventual exit options…which leads us into the importance of Post Investment Monitoring. Here is a video on follow on finance.
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6.2 Post Investment Monitoring 6.2.1 Purpose Once the initial investment has been made, the work has really only just begun! This is when the “smart money” invested - i.e. money and experience and contacts – really starts to benefit the company. But in order to achieve this, there needs to be a close relationship with the company: this is achieved through Post Investment Monitoring. It is the way by which you can quickly move and work together to capitalise on successes and breakthroughs…and equally get early warning signs when things are not going so well. It is important to stress to all, especially the entrepreneur, that monitoring is not about control, but finding a way to work together in mutual trust and respect to maximise the success of the company for everyone. Trust is a key element here – it is human nature for people to want to hide bad news – and you need to build a strong relationship so that the entrepreneurs will share news openly with you in good times and bad. Things can and will go wrong. How much time should be devoted to post-investment monitoring? One study from Germany shows that angels spend an average of 6.2 days per month working with investees, which comes out to 1.34 days per month on each investment. The answer really depends to a great extent on the size of the investment, specifically the percentage of the round or the
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percentage of the company acquired by the investors. The more at stake, the more support is likely required. Firstly, determine who is responsible for the monitoring process and ensure a key focus is maintained on monitoring achievements against milestones, especially if these are linked to timings and amounts of a tranched investment round.
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6.2.2 Board Seats The key way in which to assist with monitoring is by having a seat on the board, or board observer rights. Sometimes angels will appoint experienced individuals as their representative on the board. Ensure that the board member has the necessary skills to help the company and remember that a board member has a duty to promote the best interests of all shareholders of the company, not just one shareholder. Board members need to complement other board members and they should be aware of the increased time commitment, fiduciary responsibilities and possible increased exposure and liability to them before taking on the role. Ensure an appropriately diverse board of age, gender and experience and a strong but not dominant chair. Keep the board focus on strategy, managing risk and ensure good governance and adherence to any compliance, GDPR and cybersecurity requirements. There is also a certain amount of hands-on work and support required from board members in start-ups, so members need to be prepared to “muck-in�. Monthly board meetings should be held with board pack of minutes, financials and reports. Board packs are not legal documents (although they can be used in legal proceedings) and are important documents for current and future investors – future investors may ask to see past board packs to get a handle on how the company is progressing.
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The board is really all about guiding the investment and the company through this next stage of growth and sharing and communicating the good, the bad and the ugly information. Be aware that one of the first signs a company is struggling is when their board packs start to be late and not arrive on time‌or at all. Keep your eyes out for this happening. Ensure that you feedback information to fellow investors and invite the entrepreneur in to give updates as appropriate e.g. every 3 or 6 months. Here is a useful guide to board packs and board meetings.
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6.2.3 Information All investors should have access to information rights (achieved through the shareholder’s agreement). These include access to financial statements and annual reports, business plans, quarterly updates, visitation rights, etc. The amount and type of information required depends on your involvement with the company and what the company is prepared to share with a minority investor. Again, if you focus on building trust and strong relationships to help build the company together, the company will be more open and honest with you. Try not to overburden the company with reporting requirements though. A small entrepreneurial team has a lot of work to do in so many areas. Make requests appropriate and relevant for the size and stage of the investment but have an eye on building a governance and reporting structure that can evolve to meet future growth requirements.
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6.2.4 Danger signs As indicated earlier, things can and will go wrong. That is the nature of the entrepreneurial journey and nine out of ten investments will fail (but you only really need one to succeed!). However, be alert and you will get early indicators of when things are going wrong in a company. Some danger signs to look out for are:
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Lack of communication
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Late board packs
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Late accounts
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Cancelled meetings
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Individuals putting personal needs ahead of company needs
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6.3 Mentoring Mentoring is crucial for helping guide and grow the entrepreneur that you have invested in. It is one of the key ways to make a difference to a business and in many ways can be even more valuable than the financial investment. Sharing your contacts and experience (there are not that many mistakes in business that haven’t already been made by someone else) and guiding investees through the ups and downs of their business journey will reduce overall risk and improve the chances of generating a return on your investment. However, many entrepreneurs “do not know what they need to know� and pride/mistrust may prevent them from seeking help. It is key for you to ensure that an entrepreneur is coachable from the outset and willing to be mentored and act on advice given. Mentorship can take many forms, but all angels should ensure they address mentorship requirements in parallel with capital investment. Mentoring can be formal or informal, and can be focused on strategic connections, sponsorship, technical knowledge, local knowledge, general business acumen, or a combination of all. Ensure that entrepreneurs clearly articulate the gaps in their skillsets and that they know how wiling you are to help. Some business angels start of their angel investment journey by simply mentoring and getting involved
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with companies – it can be a good way to understand how you can help a young business.
The most important part of a good mentor-mentee relationship is the matching process to ensure a good match between skills and experiences and of course a relationship fit. If it doesn’t feel right for either party, it won’t work, so respectfully part and develop a different mentoring relationship with someone else. There are no hard and fast rules re the amount of time to spend mentoring an individual, it will depend on your availability, and on the needs of the individual and the stage of company growth – it may be half a day a week or an hour a month. It can be done face-to-face or over the
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phone. Focus on quality over quantity and be sure to follow through on agreed actions. Sometimes investors will mentor or take a board seat on a company in return for a small equity stake (e.g. 0.5-3%). Template agreements for this approach are available from many angel associations – check your local country. Here is some information on mentoring. What exactly is the mentor’s role and what is the mentee’s? Everyone Needs a Mentor, by David Clutterbuck https://www.amazon.co.uk/Everyone-Needs-Mentor-DavidClutterbuck/dp/1843983664/ref=as_sl_pc_tf_til?tag=wescotland21&linkCode=w00&linkId=af41ab85bf07a7a19d34f544eb5d54bc&creative ASIN=1843983664
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6.4 Exit We know that most angel investments will fail (or be termed as the ‘living dead” – alive but delivering very little). The failures should be prepared for in contract negotiations, especially around who will shoulder responsibilities. However, a positive exit is the ultimate goal for any angel investment and again needs to be considered in all contract negotiations. You may receive a substantial return on capital invested and can recycle some of that gain for future investments. You may also receive dividends and royalties. The most common exits options are as follows:
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Trade sale/acquisition
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Acquisition by other funds
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Management buyback
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Initial Public Offering (IPO)
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6.5 To Invest…Or Not To Invest When angel investing, start small, keep terms as simple as possible, invest with others, tranche investments against milestones, be confident in the management team, provide mentorship, expect to follow on, expect failures…and be patient. Of course, there are reasons to invest…and reasons not be an investor… Why You Should Not Invest •
You will lose money
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Companies will fail
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You will require to provide follow on funding
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It will take up a lot of your time
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Entrepreneurs will not execute properly
Why You Should Invest •
You can make a LOT of money
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You will have fun
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You will learn about different areas and sectors
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You will be a visible female role model
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•
It will help your personal growth and development
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You will stay up to date with innovations
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You will create stronger personal networks
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You will make new friends and contacts
And above all, as a female investor you will play a major role in inspiring other females in business and angel investment, positively impacting the gender imbalance in society for current and future generations to come. We hope this course has inspired you to take action and support other females in business.
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6.6 Section Summary
In this section we covered the importance of follow-on finance and post investment monitoring through use of board seats and gathering information. We also talked about the danger signs to be aware of and the importance of mentoring, as well as the critical planning for exit. Note your comments and queries in the box below. Let us know if you now feel ready to become a business angel. If not, what else do you need to know or whom do you need to talk to. Let us know and we can help.
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7.0 Next Steps 7.1 Thank You Thank you for joining us on this programme. We hope it has provided you with sufficient guidance and information to help you decide if becoming a business angel is appropriate for you.
Create an action plan to keep track of the areas you would like to learn more about and who to contact locally and nationally for more information. Be patient and take time to understand your local investment community, the entrepreneurial investment opportunities available to you and your own risk appetite before you make your first business angel investment. 0
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6.2.3 Resources If you would like to explore further resources, we recommend the following: SEEWBAN Project Women’s Enterprise Scotland UK Business Angel Association European Business Angel Association Business Angels Europe Angel Capital Association Angel Resource Institute Useful Books: 1
Angel Investing: The Gust Guide to Making Money and Having Fun Investing in Start Ups, by David S Rose
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https://www.amazon.co.uk/Angel-Investing-Making-HavingStartups/dp/1118858255
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3
Angel: How to Invest in Technology Start Ups-Timeless Advice from an Angel Investor Who Turned $100,000 into $100,000,000, by Jason Calacanis
https://www.amazon.co.uk/Angel-Invest-Technology-Startups-TimelessInvestor/dp/0062560700/ref=sr_1_2?s=books&ie=UTF8&qid=1529946083 &sr=1-2&keywords=business+angel Fundamentals of Angel Investing, by Hambleton Lord and Christopher Mirabile https://www.amazon.co.uk/Fundamentals-Angel-Investing-HambletonLord/dp/1539346145/ref=sr_1_5?s=books&ie=UTF8&qid=1529946083&sr =1-5&keywords=business+angel Everyone Needs a Mentor, by David Clutterbuck https://www.amazon.co.uk/Everyone-Needs-Mentor-DavidClutterbuck/dp/1843983664/ref=as_sl_pc_tf_til?tag=wescotland21&linkCode=w00&linkId=af41ab85bf07a7a19d34f544eb5d54bc&creative ASIN=1843983664
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7.3 Keep in Touch Please keep in touch to hear about any local pitching event that you can attend to hear investment opportunities, as well as all the latest news from Women’s Enterprise Scotland. Register your interest here to find out about local pitching events. You can also subscribe to our newsletter here and please connect with us on social media too: Facebook Twitter LinkedIn
7.4 Evaluation We hope you have enjoyed this eLearning course and that you have found it useful. We would appreciate your feedback as it will help us improve the experience for others.
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7.5 References Here is a full list of references and links used in this programme: 2.0 Introduction to Business Angel Investing
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HNWI definition https://www.syndicateroom.com/learn/glossary/highnet-worth-individual-hnwi
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Impact of Angel Investing Across the UK https://www.ukbaa.org.uk/wpcontent/uploads/2015/09/ERC_Nation_of_Angels_Full_R eport.pdf
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European Early Stage Market Statistics https://www.ukbaa.org.uk/wpcontent/uploads/2015/09/ERC_Nation_of_Angels_Full_R eport.pdf
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Definition of NXD https://www.ukbaa.org.uk/wpcontent/uploads/2015/09/ERC_Nation_of_Angels_Full_R eport.pdf
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Early Stage Investing https://www.ukbaa.org.uk/wpcontent/uploads/2015/09/ERC_Nation_of_Angels_Full_R eport.pdf
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Introduction to Business Angel Investment https://www.ukbaa.org.uk/wpcontent/uploads/2015/09/ERC_Nation_of_Angels_Full_R eport.pdf
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What does an angel investor look for? https://www.ukbaa.org.uk/wpcontent/uploads/2015/09/ERC_Nation_of_Angels_Full_R eport.pdf
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Statistics on European Business Angel Market http://www.eban.org/wpcontent/uploads/2017/11/Statistics-Compendium-2016Final-Version.pdf
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Female Business Angels in Europe http://www.eban.org/wpcontent/uploads/2017/11/Statistics-Compendium-2016Final-Version.pdf
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Female Business Angels https://goldenseeds.com/who-we-are/
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What is an entrepreneur? https://www.youtube.com/watch?v=92ZmzD70sOU&fea ture=youtu.be
in
USA
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Female Entrepreneurship Report https://www.babson.edu/Academics/centers/blankcenter/global-research/gem/Documents/GEM%2020162017%20Womens%20Report.pdf
3.0 General Investing Overview •
Portfolio Definition https://www.investopedia.com/terms/p/portfolio.asp
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Asset Allocation Definition https://www.investopedia.com/terms/a/assetallocation.a sp
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Diversification Definition https://www.investopedia.com/terms/d/diversification.as p
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Asset Management Tools
https://www.personalcapital.com https://www.mint.com https://getticker.com https://www.morningstar.co •
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European Angel Statistics http://www.eban.org/wpcontent/uploads/2017/11/Statistics-Compendium-2016Final-Version.pdf
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Investment Principles https://www.youtube.com/watch?v=WEDIj9JBTC8
4.0 Start Ups and Business Angel Investing •
Stages of Companies https://www.investopedia.com/examguide/cfa-level-1/alternative-investments/venture-capitalinvesting-stages.asp
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Peer to Peer https://www.fundingcircle.com/uk/investors/
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Crowdfunding
Lending
https://www.kickstarter.com https://www.indiegogo.com https://www.crowdcube.com •
Angel Investment Platforms
https://gust.com https://angel.co https://in4capital.com
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Angel Investors https://go-beyond.biz/Rising-Tide-Sources-ofFinancing-20160122
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Difference between Angels and https://www.youtube.com/watch?v=aqRBN7qvyxs
VCs
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What do Angel Investors Look https://www.youtube.com/watch?v=ewTl4aRU--s
for?
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Definition of Mentoring https://www.investorsinpeople.com/resources/ideas-andinspiration/what-mentor-all-you-think-mentor-and-lot-more
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EU 2015 Statistics https://www.business-angels.de/wpcontent/uploads/2017/12/Final-Report_Understanding-theNature-and-Impact-of-the-business-angels-in-Funding-Researchand-Innovation_FV_Formatted_Revised1.12.2017.pdf
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infoDev/Kauffman Guide to Creating Your Own Angel Group http://www.infodev.org/publications/angel-investor-guide
5.0 Business Angel Investment Process
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Tips on Finding Deal Flow https://www.forbes.com/sites/mariannehudson/2015/12/16/hun ting-for-deals-where-top-angels-find-greatcompanies/#2795aeb968b4
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Definition of Deal https://www.investopedia.com/terms/d/dealflow.asp
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Flow
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Project Management Tools
https://www.dropbox.com/business/landingt61fl?_tk=sem_b_goog&_camp=sem-b-goog-uk-eng-topexact&_kw=dropbox%7Ce&_ad=249602021162%7C1t1%7Cc&gclid=EAIaI QobChMI1pL4q5nv2wIVbbftCh38NQhqEAAYASAAEgI0W_D_BwE https://slack.com https://podio.com https://www.zapflow.com https://pitchbook.com •
Definition of Executive https://en.wikipedia.org/wiki/Executive_summary
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Business Model Canvas https://strategyzer.com/canvas/businessmodel-canvas
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Business Plan Templates https://www.bgateway.com/businessguides/first-steps/business-plan-template/download-your-freebusiness-plan-template
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Business Model Fundamentals https://go-beyond.biz/Rising-TideVideo-Business-Model-160201
Summary
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Angel Capital Association https://www.angelcapitalassociation.org
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Angel Resource Institute https://angelresourceinstitute.org
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Due Diligence Video https://go-beyond.biz/video/Rising-Tide-DueDiligence-1601
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Due Diligence Webinar https://www.anymeeting.com/WebConference/RecordingDefault. aspx?c_psrid=E952DB8787473F
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How to Analyse Financial Statements https://gobeyond.biz/Rising-Tide-Intro-to-Financial-Statements-20160224
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Term Sheets https://go-beyond.biz/video/Rising-Tide-Intro-toTerm-Sheets-20160229
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Valuation https://go-beyond.biz/Rising-Tide-Intro-to-CompanyValuation-20160208
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Negotiation Terms https://medium.com/hyde-park-angels/howto-read-a-term-sheet-3c4204ab1c0f
6.0 Follow-on Finance, Post Investment Monitoring and Mentoring
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Follow On Finance https://go-beyond.biz/Rising-Tide-IntroManaging-Follow-on-Rounds-2016-08-02
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Board packs and Meetings https://www.sequoiacap.com/article/preparing-a-board-deck/
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•
Mentoring https://hbr.org/2017/02/what-the-best-mentors-do o
Everyone Needs a Mentor, by David Clutterbuck
https://www.amazon.co.uk/Everyone-Needs-Mentor-DavidClutterbuck/dp/1843983664/ref=as_sl_pc_tf_til?tag=wescotland21&linkCode=w00&linkId=af41ab85bf07a7a19d34f544eb5d54bc&creative ASIN=1843983664
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