Banks, Angels, VC, savings, unsecured loans - a growing business has the choice of whose door to knock on for financial help.
Government initiatives such as the National Loan Guarantee scheme and the StartUp Loans Scheme are designed to boost business confidence by providing loans to small businesses. We hope this will encourage SMEs to visit the banks to finance their expansion plans and kickstart the UK economy once more. But with the familiar rhetoric that ‘the banks aren’t open for business’ ringing in our ears, other forms of raising finance – such as the use of Business Angels – remain appealing.
Following the precedent in Dragons’ Den, Business Angles are wealthy individuals who invest in the early stage and expansion of a company in return for equity in the business. They have become more comfortable with the idea of clubbing together and pooling their resources so that an SME gets double or triple the business expertise and the angels lower their exposure to risk by stumping up a smaller portion of the equity needed.
After the Angels say ‘I’m in’, how does an SME tie a contractual bow around the agreement, in a way that protects their interests and ensures they still get a fair deal? Do SMEs run the risk of becoming a minority stakeholder in their own business as too many Angels muscle in on the act – and in that case, is it better to go back to the traditional method of knocking on your bank manager’s door?
Why choose an Angel investor?
The majority of Business Angels make an investment for financial reasons. But other motives include taking an active role in an entrepreneurial process and just giving something back. Business Angels rarely have a connection with a business before they invest in it, but often have experience of the particular industry or sector and tend to favour sector-specific investments.
Besides capital, Business Angels usually make their skills, experience and contacts available to the business and frequently follow up a first investment with later rounds of financing for the same firm. Although most prefer to become a “sleeping” partner, some Business Angels may get actively involved in the company. This may be seen as both a benefit and a burden by the business owner. However, the significance of the Business Angel’s knowledge and experience must not be overlooked.
As many investments fail, a Business Angel investor will only be tempted if there is the opportunity for a sizeable return and will expect to take a stake in the ownership of the business, but normally leave the founders in control. They will also want to know how they will get their money back, so you must be prepared to justify your business plan and they will, by and large, also expect to see a financial commitment from you.
What to look for in a Business Angel
Raising finance can be difficult for any new or growing business. To get a fair deal from a potential investor, such as a Business Angel, you must be prepared to really do your homework to make sure the investor is right for your business.
Once a prospective Business Angel has been identified it’s very important to research their portfolio, check websites of companies they have been involved with and determine what you have in common to firmly establish what you might be able to do together to grow and develop your business.
It's not always easy to get right, but a business must do what it can to make sure that the Business Angel willing to invest in them is right for them. Before making any kind of legally binding commitment, you must ensure that the management team and the Business Angel are compatible. The upshot of this is that you'll likely be more able to work together and that the Business Angel’s skills will match the needs of the business to gain the most benefit. Ultimately it’s a matter of synergy to get the most out of your Business Angel.
Other methods of investment
Secured loans. They're a standard form of financing but there can be a number of disadvantages. For example, banks and similar loans will normally be secured against a capital item, such as your home; the bank or lender will want to see your business plan; you will have to methodically explain your processes and projected outlook for the business; there may be hefty fees which are payable up front; and in the current climate, most banks are only willing to fund what they consider to be very low-risk ventures.
Unsecured loans. Unsecured loans, including credit cards, are often easier to get a hold of than secured loans. There is no need to show your business plan or justify it. However, they typically have very high rates of interest and normally have to be paid back by a monthly capital payment over a short term.
Savings. Effectively you can be your own Business Angel. There is no need to explain your business, but you must be prepared to lose the amount of money you are investing. It may be sensible to use some savings on a small scale before approaching Business Angels. This will display your commitment, decrease risk and increase the valuation of the business, meaning that you may have to give away a smaller share in the company.
Venture Capitalists. Similar to Business Angels, venture capitalists invest in businesses, taking a share in the firm. They will expect a major say in how the business is run, which may include compulsory board and/or management team appointments and rigorous expenditure plans. Venture capitalists generally tend to invest in businesses with a turnover in excess of £1 million per year and look for an early exit, normally by means of a trade sale or listing. Investment from venture capitalists is likely to come in stages following milestones of achievement and offers an opportunity for fast growth. The downside is that you may end up losing overall control of the business and reporting to someone else.
In the end
Traditional forms of financing have many benefits, but Business Angels are an often unexploited resource that can offer significant advantages for growing business. All forms of financing will impose burdens on you and the business itself. It's important that you adequately evaluate what will work best for you to enable your business to grow and develop without making too many compromises.
Stuart Sproule is a commercial solicitor at SA Law based in St Albans. Stuart can be contacted via firstname.lastname@example.org.