The role of business angels in the development of European start-up companies is likely to be important than ever as the global economy worsens. Venture capitalists, increasingly risk adverse even before the credit crunch, will now be even less inclined to invest in seed or early-stage companies, and into this breach the angels can tread.
At a little over 25 years old, London Business Angels is the UK’s oldest angel network. Predominantly technology-focused, it invests in the perennially unpopular sub-£1m area – most recently the network invested £200,000 in Wheelright, a company which has developed a method monitor the pressure of tyres across entire fleets of vehicles.
Chris Padfield, investment manager at London Business Angels, talks through the organizations methodology, and the challenges young companies face as the economy nosedives.
What is London Business Angels and how do you work?
London Business Angels (LBA) is the UK’s oldest formal angel network, celebrating its 25th anniversary last year. The network comprises approximately 130 paying members who actively invest in early stage, high growth companies. The network works on a presentation basis, running 7 events a year in the city of London at which 6 companies will present to the investors.
As well as presentation events the network runs investor readiness events, social events for members and extensive training as part of the presentation process for the companies selected to present. As part of GLE Growth Capital, London Business Angels is supported by a range of projects and funds within the angel investment ecosystem including EIS co-investment funds, an Early Growth Fund and an Enterprise Capital Fund.
What type of companies do you target?
The network is generalist by name – by nature the companies are heavily tech based – 5 out of 6 companies in any one event are likely to be centered on a core technology. Our key areas are med-tech, clean-tech and ITC but with 42 companies presenting a year there are a wide spread of opportunities for investors.
Recent companies to raise money through the network include a cancer imaging company and a solar array technology. Non tech companies that have presented include Cobra Beer and Innocent Smoothies. Companies presenting are seeking to raise between £100,000 and £750,000. We funded a £2m round last year into Bac2, a fuel cell company, however this is the exception rather than the rule. Each company is selected on its ability to provide a 10x return for investors.
What is your due diligence process? How do you decide on which companies to invest in?
The process for a company to present to the network is an evaluation of a business plan followed by an extended two to three hour interview with the company by the London Business Angels gatekeeper. The team will then select the best opportunities for the network and begin the training process. Each individual investor of the network will then make their own investment decision on the company.
Generally the company (and interested angel group) will aim to identify a lead angel investor who will drive the deal forward, organise the angel syndicate and manage the due diligence process. The due diligence process will depend upon the type of investment and may include customer validations, site visits, patent and intellectual property reviews, financial reviews, team evaluations etc.
What is the background of the typical angel investor and how do you go about attracting angels to the LBA?
There is no typical background of an angel investor, although we see the break down of our investors as approximately 50% cashed out entrepreneurs, 25% FTSE 350 board directors and 25% city professionals with a few professional angel investors.
We are certainly seeing a younger generation of angels who have sold IT/software companies and are looking to recycle the money they made from exiting that investment; this is certainly key to a creating the ecosystem to support early stage companies.
A lot of our angels are attracted via word of mouth, met by the team at various networking sessions or introduced by our existing members. We have a number of network sponsors including RBS, Kingston Smith, NESTA, Harbottle & Lewis, IGF and McDermot Will & Emery who have introduced us to new members.
We get enquiries via our website, the BBAA introduces angels to relevant networks in their area and we often find angels whom have previously invested seed money into companies that go through the network.
How do you think your business will be affected by the economic downturn?
The economic downturn has clear negatives regarding the ability for investors to exit the current investments or liquidate capital gain in other investments used to fund their investment activity. Despite this, for those with capital to invest a down turn provides an excellent opportunity for investment. Some of the best and most well known investments were developed and funded during previous down turns and recessions.
The profile of a lot of the companies that have previously raised money is providing a new or improved product, service or technology at a lower cost than available today. A recession will sometimes encourage the uptake of these new technologies as companies look to cut costs; we particularly expect to see this in our clean-tech and medtech investments as well as efficient ITC products.
More generally, how do you think the venture capital industry will be affected by the current economic climate?
In a similar way to angels. It will be harder to sell portfolio companies with acquirers less willing to invest into acquisitions or be able to fund acquisitions with debt and clearly the IPO market is essentially closed. It is likely that it will be harder for venture capital funds to raise new capital for investments. For those funds with capital ready to invest they will be able to dictate stronger terms to both new investments and existing portfolio companies.
Naturally some portfolio companies will be directly affected by a recession and this may challenge the funds with those investments but in general a downturn should be considered an opportunity for venture capitalists to invest in the next generation of technologies that will deliver goods and services for which there is high demand independent of the economy growing or not.
Venture capital has been a much maligned asset class in Europe for years now. Why do you think this is and what can be done about it?
I think recently European Venture capital has a far different image; high profile European exits including Bebo, MySQL and Skype have shown the potential returns venture capital can generate.
The new VC funds are a different breed, often taking US principles – the need to nurture and develop portfolio companies as early stage investments into new technologies as opposed to treating venture capital as a private equity deal with just a smaller price tag; venture capital investments into technology requires a different skill set than a debt leveraged private equity investment into a retail chain and specialisation by funds into different areas should be considered positive.
There is a new breed of venture capitalists entering the market; entrepreneurs who have built and sold their own businesses and this can only add to the success for the asset class moving forward.
How difficult is it for you to attract new angels in light of the historically poor returns European venture capital has generated?
The presumption here is that angel investment has low returns, something we do not believe to be the case. Unfortunately there is a lack of data on the £1bn a year of angel investment activity. A recent report in the US, run by the Kauffman foundation, showed an angel investment IRR of 27%, a far higher return than a range of asset classes. The BBAA (British Business Angels Association) is currently organizing a similar study of angel investment returns to be run on the same principles as the US study. We expect this survey to give a far clearer picture on the returns angels can make.
In general, the growth of angel networks and the presence of (albeit small) number of early stage VC angel co-investment funds have professionalized angel investment. There is risk in the public believing in the haphazard approach to investing as portrayed by entertainment shows such as Dragon’s Den and funding business in this way; however we find that new angels rapidly learn the correct process to angel investment once they are introduced to a network.
What is you view on, and how have you been affected by, the introduction of entrepreneurs’ relief back in April?
The biggest problem with entrepreneurs’ relief is the lifetime limit of £1m. The creation of a vibrant entrepreneurial ecosystem is based around serial entrepreneurs; this is what has made the US so successful in the creation of companies. Once an entrepreneur has realized their first exit, the lack of any tax relief (due to the now abolished taper relief) acts as a big disincentive for that person to invest their gains into a new startup.
The EIS investment scheme is a big motivator for angel investors; it is disappointing that the tax regime is less generous for entrepreneurs. Despite this, the best entrepreneurs will create good businesses and returns whatever the tax implications so while the change is a disappointment – we do not expect it to affect us fundamentally.
How important in your view is the public sector in the venture capital space?
For angel investors the most important public sector initiative is EIS tax relief. This is a considerable motivator to angel investors providing a 20% income tax relief, 40% (on the 80% remaining) loss relief and no capital gains or inheritance tax. More work could certainly be done by the public sector on investor readiness and training, something London Business Angels is continually trying to expand. For early stage venture capital there is a clear equity gap. The public sector, through BERR, has important initiatives in this space – Early Growth Funds and Enterprise Capital Funds in particular – however there is a limited budget the government have to fund early stage venture capital and there is the potential for the government to crowd out private investment. The problem raising an early stage, private fund is the lack of tax incentives to do so.
While EIS funds can exist they are limited in their investment period to a year making it extremely hard to run a fund while needing to fundraise every year. One of the biggest mechanisms the public sector could do to improve early stage venture capital would be the creation of tax efficient early stage venture funds with a typical 10 year lifespan which provide the tax incentives to individual investors to invest into an early stage fund in a similar way to doing an individual EIS investment.
The BBAA has requested an extension for the period to three years, a positive step but only a step and the increase on the initial income tax relief to 30%. My personal opinion would be to change EIS tax relief to a simple top rate income tax relief (40%) but remove the capital gains and loss relief benefits. There are however a range of opinions on this subject!
How have things changed in the angel investing world over the last few years, particularly in regards to the number of VCs that have abandoned seed and early-stage investing to go later-stage, not to mention the likes of Apax and 3i leaving the asset class altogether?
Angels have professionalised to take the place of some of the VCs that have moved from the market. Angel networks have certainly been part of this professionalization – allowing for rounds like our £2m investment into Bac2 last year. Early stage VC funds are also seeing the huge benefits that motivated angel investors can provide early stage funds apart from their cash investment – something the more tradition private equity houses did not appreciate. The public sector has also made important contributions in providing investment into venture capital funds filling the equity gap; but there is certainly more than can be done in this regard.
What does the future hold for LBA?
The future is bright for the network, every year we are seeing an increasing quality of deal flow, lean and mean entrepreneurs looking to build the next google or x-ray technology and an increasing number of high net worths looking to invest into exciting, extremely high growth potential companies. There are a lot of initiatives we will be taking over the next year particularly regarding investor readiness, increasing the social element of angel investing, which a key component of how syndicates form and deals complete and looking to continue to work closely with the early stage VC funds active in the ecosystem.
Biography: Chris Padfield
An investment manager for London Business Angels, Chris Padfield acts as the ‘gatekeeper’ to the oldest UK angel network. The network comprises of 130 high net worth individuals, around half of whom are cashed out entrepreneurs, looking to invest into early stage high growth companies. The network receives over 800 business plans a year, of which he selects the best 42 to present across seven company presentation events. The network raises approximately £5m in new capital per year for companies seeking between £100k and £750k.
Prior to this he formed Headstart Solutions whilst still at university, a business software company which has developed a customer relationship management products for a wide-range of organisations, from multi-nationals to schools.