Moneyfacts Article: Business Angel Investing to Ride out the Recession

Jenny Tooth Business Development Director, British Business Angels Association, the UK Trade Body for Angel and Early stage investing, gives an overview of the current challenges and opportunities concerning Angel investing in the economic downturn.

With many small businesses struggling to survive and grow in this challenging economic climate, and with bank lending still very difficult to access, despite the new Government measures, Business Angels can offer a vital injection of investment capital at this time.  Angels bring not only their own money, but experience and management skills to enable the company to remain competitive.  Many Business Angels have been through at least one or more economic downturns, although this one may be the worst so far, and are able bring strong experience of how to steer the business forward and identify priorities for growth.  Angels in entrepreneurial companies have always represented themselves as patient investors. Good angels are often referred to as “mentor capitalists.”
However, it should be remembered that Angels invest in the business in return for shares in the company and this should always be compared with other forms of finance. The process is not a quick one and can take several months to complete all the legal aspects and due diligence and so this would not be suitable for many small businesses who require funds to meet their immediate cash needs or to pay their suppliers. Angel investment is generally focused on early stage companies with high growth potential and a scalable business model, with a strong chance of good returns, Generally Angels would seek 10x return on the investment over a period of around 3-5 years.
Business Angel investment does not need to be seen as a straight choice between equity or debt. Angels frequently do invest alongside bank loans and other forms of debt finance as part of a balanced finance package to meet SME’s funding needs. Indeed companies accessing Angel investment have often found this as important leverage for obtaining Loan Guarantee funds (or now the new Enterprise Finance Guarantee Scheme).   Angels are also regularly investing alongside early stage VC funds as part of a structured funding plan for business growth. One useful approach has been through the provision of specific co-investment funds such as The Early Growth Fund initiative which was supported by the Government in a number of regions to stimulate Angel investing. These Co-investment funds have been seen as an important means to leverage Angel investment as well as attracting a considerable level of VC funds, although many are now fully invested.

However, at BBAA, the UK Trade body for business angel and early stage investing,  we are aware that across the country, existing Business Angels are in a challenging position. Angel investors need to nurture and maintain their existing portfolio companies through these times. At the same time many are less liquid than previously due to the downturn through the stock markets and property markets and options to achieve exits for their existing investee companies are currently very limited limited.   Thus there are fewer angels available to invest the much-needed early stage capital at this time, resulting in a 20-50% fall off in investing across the angel networks.  Whilst at the same time the number of business plans from entrepreneurs seeking finance received through BBAA’s Business Angel Networks has been reported to have increased by between 30-50%.  Thus there is an urgent need to increase the pool of Angel investors available in the UK to meet the demand for equity finance. 

There is also evidence that an increased number of individuals may be seriously looking at Angel Investing as an alternative area of investment other than stocks and shares or property, as a potentially more effective area of investment in the current economic climate. There are clear opportunities for highly skilled people with entrepreneurial or managerial experience who may have been recently made redundant or cashed out their businesses.  With an increased number of entrepreneurs seeking equity investment at this time , there are opportunities to pick up some great deals at good valuations and by bringing both investment and real skills to take these businesses , there are opportunities to take them forward to become the stellar companies of the future. 

The tax breaks for Angel Investing in early stage businesses can be attractive compared with other forms of investing. Under the Enterprise Investment Scheme 20% tax relief is offered on investments in small businesses, including CGT relief and IHT deferral.  There are however certain rules about companies that can be invested in and some specific excluded sectors and must be an SME with under 250 employees. It is also important to gain greater understanding of the investment process before commencing Angel investing and Business Angel Networks also provide an important source of information and advice as well as ongoing support in identifying suitable deals for new potential angels.

To respond to this increased investment demand among entrepreneurs and to build on this potential new interest and capacity for angel investing, BBAA is planning a major national awareness campaign which is due to kick off in April this year around the regions. This will be designed to bring forward a new pool of individuals who have the spare investment capacity and relevant business or professional skills and who have the potential to become angel investors. The actions would provide initial support and guidance to ensure that these individuals are able to understand the risks and rewards and to become competent in the investment process so that they can become can rapidly become effective investors.  The campaign will operate nationally and will also have a focus in each UK region, supported by the local Business Angel networks. The campaign will be designed to complement and link with relevant activities being taken by Government, including through the Regional Development Agencies, both in relation to the implementation of new funding measures and economic recovery programmes and by individual business support agencies and intermediaries around the UK.  

Yet information on angel investors has always been rather patchy due to the fact that this is carried out by private individuals. Our understanding from such sources as the UK Enterprise Investment Scheme is that private investors currently claim circa £600m p.a. of EIS tax breaks. Indeed the amount invested currently exceeds the level of the UK’s VC investment into SMEs at the same stage.   Yet unlike the formal VC market, we have had little information to date about  Business Angel investing. However if we are going to be able to significantly expand and promote this important source of investment for early stage entrepreneurs, especially during the current economic challenges, it is important that we know what kind of people are involved in Angel investing- what is their investment approach and experience, what outcomes do individuals have from investing in SMEs and what factors affect successful investment?.

With this in mind, the BBAA as the UK trade body for angel investment and early stage investing with the direct support of NESTA, has been carrying out a major piece of research during the latter part of 2008 with a view to addressing these questions. The Survey has specifically focused on identifying the behaviour and investment outcomes of investors who operate within Business Angel networks. The aim was to identify both the  current investment they had made, but also their exits ( whether positive or negative) and also  focused on  what factors influenced their  investing  and their outcomes.  This research which will be published in early April 2009 will provide important information to enable us to identify key areas where both policy and practical actions can be taken to support further development and stimulation of the Business Angel investment market.

So what else could be done to stimulate the Business Angel market a this time? One key issue which we would want to consider is whether increased EIS tax relief for investing in early stage micro businesses would be useful to encourage more individual to get involved in investing in early stage businesses at this time. A further area worth considering will be whether the existing Enterprise Management Investment Scheme EMI could be changed to provide further incentivises to individuals to invest in businesses and take an active role on the Boards of their investee companies. 

The RDAs are now launching new Regional Funds with the support of EU finance under the European Regional Development Funds and in some cases this will also include opportunities to offer new co-investment funds. However, these initiatives will be geographically very patchy with the level of finance available through RDAs to stimulate co-investing with angels remaining very variable across the UK. Further national and regional support for more co-investment Funds to encourage angel investors is therefore needed.

At BBAA we have also identified the need to build further alliances with all key players in relation SMEs and the early stage investment market place, building on each others’ strengths to create a connected early stage funding environment and support of angel investing.  BBAA would welcome the opportunity to work alongside all those involved in advising SMEs and would welcome contacts with Moneyfacts readers on this subject. For further information on BBAA see www.bbaa.org.uk