Rising number of business angels

19 min read

01 March 2013

They constitute an asset class that is three times bigger than UK venture capital. Chances are that you will know one. Or you might be one. Because right now, approximately 18,000 business angels are investing more than £800m each year.

“There has never been a better time to be an angel, and not for a long time has the need for them been so great,” says Sir Nigel Rudd, a doyen of the UK industrial scene and currently chairman of the UK Business Angels Association.

Business angels – private investors committing their own cash in return for equity stakes in early (and very early) stage companies – are nothing new. But after decades of playing what was regarded as a supporting role in the entrepreneurial economy, angels are now moving to front-stage.

“I feel that it is about to be recognised a market in its own right,” observes Kit Hunter Gordon, managing director of the Summit Group and one of the UK’s best-known angel investors. “The government has got the message that big companies are not where tomorrow’s growth will come from.”

“The next few years will show a dramatic change in the perception of angel investing,” agrees George Whitehead of Octopus Venture Partners.

What’s behind this?

The UK is part of a broader trend. Since the financial crisis, the number of angel investors funding start-ups has risen across the world.

The costs of starting a company (notably digital ones) has dropped like a stone, thanks to cloud computing and the ability to use the web and web-based enterprises such as Amazon as a global distribution channel. So it’s easier for individual investors to back a new business.

Bank lending volumes are down, so angel investors are taking up some of the slack.

Second, this government actually gets the concept of angel investing. The new Seed Enterprise Investment Scheme (SEIS), added to the already successful Enterprise Investment Scheme (EIS), provides massively favourable tax incentives for angel investors.

Other government initiatives, notably the Angel CoFund, are also beginning to make an impact.

“There has never been a Government – and I will go toe-to-toe with Margaret Thatcher and Nigel Lawson on this – that has placed more on angel investment than this one,” was the confident assertion of Rohan Silva, senior policy adviser to the Prime Minister at the UK Business Angels Association’s Winter Investment Forum last month.

The third factor is the growth in the number of entrepreneurial investors. There are more people prepared to plough cash back into small new companies. After all, it beats watching your money moulder in next-to-bugger-all-interest accounts.

Encouraged by this generous tax regime, new syndicates, groups and combinations of angel investors are emerging all the time.

And then there is the disruption of the web. Crowdfunding – the raising of money via small amounts from many people via the web – creates a new business model for equity finance. For £25, anybody can be an angel.

So let’s look at each of these in turn.

The considerable tax relief of the SEIS make angel investing in young companies a no-brainer.

Policy adviser Rohan Silva describes SEIS as “a brilliant demonstration of the government’s commitment to enterprise” and that “this is the world’s most generous government for tax breaks.”

For once, the hyperbole is justifiable.

The SEIS has been in operation since July 2012, so formal statistics won’t be available for a couple of years. To date, some 200 companies have had “statutory approval” ie HMRC has okayed investors to go ahead and claim the tax relief on their new, qualifying investments.

Now that may not sound much but compare it to the first year of the EIS in 1994. In its first full year, 77 companies got investment and tax approval.

“I hear of some reports of SEIS being the best kept government secret,” said HMRC’s Kathryn Robinson, speaking at the UKBAA Winter Investment Forum. “All I can say is that I wish they would come and man my phone.”

“SEIS does something really important,” says Doug Richard, the investor and entrepreneur who has been heroically pounding across Britain to drum up awareness of SEIS among entrepreneurs and investors. “It is democratic. Whether you invest £1,000 or £150,000, you have an opportunity to put a great deal of money to work. You can put a little bit of money to work in your friend’s son’s business; you can put a good deal of money to work. But everyone can put something to work.”

For angel investors it is “a beautiful scheme,” says angel investor Dale Murray (and who has been Richard’s ally in the promotional campaign). “Not only does it mean that more companies can be funded but it allows you to leverage your portfolio.”

It’s hard to find detractors. Some seasoned investors do grumble that the SEIS is so constrained that many companies don’t qualify. “It’s certainly an attractive scheme,” says one veteran angel investor, “but it’s been narrowed down so far that it cuts out lots of opportunities. It’s so limited. It’s just for companies at the bedroom stage.”

And it is possible that company founders will adjust their business plans just to make them SEIS-friendly – only raising the qualifying £150,000 even though the original plan was to raise twice that amount. The tax incentive tail really ought not to wag the entrepreneurial dog.

But these really are quibbles. The SEIS should be seen as one of the bravest and most innovative tax measures taken by any government since the financial crisis to encourage entrepreneurial growth. And it has been taken in the UK.

Equally adventurous and innovative has been the Angel CoFund.

It’s not as visible as EIS and SEIS but the Angel CoFund should also be recognised as a significant creation of this government.

The idea is simple: take a pot of government cash and to co-invest alongside business angels in a private sector-led fund.

Here’s how it works.

An angel decides to invest £50,000 in a company. He (sorry, ladies, at present it is almost invariably a man) gets a syndicate of angels together to invest another £250,000. But the company needs more. (Under-funding companies on a first angel round has been a problem over the years).

As the lead investor, the angel applies to the Angel CoFund to become a co-investor. The investment is scrutinised by Capital for Enterprise, the government body that holds the cash. CfEL checks that it meets the qualifying criteria (such as the company’s location) and who work with the lead investor to put together draft legal documentation and an investment paper for the CoFund’s investment committee to review.

A conference call between the investment committee and the lead investor discusses the deal.

Crucially, the Angel CoFund does not perform any due diligence of its own. Investment committee members (and they comprise an impressively grizzled set of investors and entrepreneurs) don’t visit a prospective investee company to kick the tyres and personally quiz the management. That’s all down to the angels.

After the teleconference, the investment proposal will either get the nod, a request for further review, or a polite refusal. To date, 80 per cent of the proposals that have come to the investment committee have been approved.

So a lot depends upon the lead angel investor. Taxpayers’ money is being invested in companies on the basis of an investment paper and a one-hour teleconference.

The Angel CoFund is just 12 months old. Its investment committee has already invested in 22 angel-backed companies – and seven more are in the pipeline, amounting to a further £1.8m.

Some £8m has been invested alongside £24m from angels and other investors.

The current rate and level of the Angel CoFund’s investment activity is on track. The average CoFund investment is £330,000 out of an average total investment round of £1.3m. (The average amount put in by the lead angel investor is £80,000.)

“It’s exactly where we wanted to end up,” says George Whitehead, a venture partner manager at Octopus Ventures who is also the chairman of the CoFund. “One-third is a really useful amount to give companies extra runway. It can really make a difference, whether it’s to get them to their next round of funding, or hit break-even, or hire better people.”

What is really interesting about the CoFund is that it’s a fund that follows the market. It is not a strategic fund designed to pick winners, or to build a balanced portfolio. Rather, it reflects the investment preferences of the angel community.

Of the deals that have been completed and/or approved by the Angel CoFund:

Whether the same trend will be seen in crowdfunding remains to be seen.

If that isn’t enough encouragement for angels, there is also crowdfunding. It adds a whole new dimension to the concept of angel investing. It is also stretching the definition: many of the start-ups using crowdfunding are not making equity stakes available. The much-touted Kickstarter enables companies to give away “rewards”, discounts, or their actual products in return for the money that helps get their project off the ground.

Selling equity through crowdfunding is much less common.

Seedrs is one of the most significant. Authorised by the FSA in July 2012 and run by ex-lawyer Jeff Lynn, it operates more like a marketplace. Investors become members of Seedrs for free and then review and, perhaps, invest in the start-ups on the Seedrs website. Seedrs will hold investors’ shares as a nominee, holding and managing the shares on behalf of the investors. It takes 7.5 per cent of any money raised and the same percentage cut from any profit made by an investor.

There’s an interesting blog by Matt Warren, founder of Veeqo, on how his company used Seedrs to raise £30,000.

Direct equity via crowfunding is the pitch of Crowdcube. Since launching in February 2011, Crowdcube has raised more than £4.8m in 34 deals and has 28,000 registered investors. The typical investment is £50. This is the collaboration of the web. Crowdcube has also recently been authorised by the FSA.

There are as many opinions about crowdfunding as there are crowdfunding sites.

Serious business angels are not wholly averse, but they are cautious.

Some are concerned that crowdfunded companies will not have as much access to the same networks and connections than if they had used “normal” angels. The mentoring that comes with angels should not be lightly ignored. “If that was absent in a crowdfunded model, I would worry a little,” says one well-placed angel investor. “If I could not sit on the board, then I would want to know who was monitoring it from an investor’s point of view.”

And it’s not as though the entrepreneur is short of experienced business angels to pitch to.

A favourable tax regime, allied to new institutions such as the Angel CoFund, is creating an angel-friendly climate.

And there are more people with the financial resources to become an angel.

According to a Barclays Wealth/Ledbury Research study in 2011, there were 619,000 millionaires in the UK and 86,000 had more than £5m. The number was set to grow by one-third by 2020. One in 86 households is technically a millionaire household, according to Core Data Research.

Small wonder, then, that the number of angel networks and entrepreneurial investors is increasing. And their groupings and combinations are multiplying.

The long-standing business angel networks such as xenos, London Business Angels, Minerva, Halo remain a crucial part of the ecosystem. These networks vet and review business proposals and then frequently use investment forums as a way for companies to present themselves to the network members. By being careful in its selection of companies, and by matching them to the preferences and know-how of their members, the networks can deliver results. For example, over the last three years, nearly 40 per cent of the companies selected to pitch to London Business Angels’ investors have secured funding.

But even in this crowded island there is room for growth. Take Silicon Beach Business Angels, one of the new angel networks of 2012. with a focus on the Bournemouth/Poole/Christchurch conurbation in Dorset. According to its co-founder Steve Berry, the network has the potential to grow to more than 100 members in 2013.

There’s a spawning variety of angel groups and networks. In the past, business angels tended to act alone – hence the model of the networks of bringing them together.

Now, there is a greater willingness to co-invest, either with each other or alongside venture capital firms (as well as to use the Angel CoFund).

Some, such as north-east based Hotspur Capital Partners act rather like a mini-fund. Set up by Colin Willis in 2007, it is an investor group of high net worth individuals. It is based in the north-east but will do deals nationwide.

Firms such as Octopus Venture Partners have assembled groups of successful entrepreneurs and high net worth individuals who co-invest alongside an Octopus fund.

Others, such as PROFounders, established by high-profile business figures such as Brent Hoberman, describe themselves as venture capital funds, “run by entrepreneurs for entrepreneurs.” Or there’s Jos White’s Notion Capital. Passion Capital is another.

Add into the mix Angel List, which currently lists 2,606 investors across Europe (and rising) as another resource for entrepreneurs to identify potential backers.

From City high-fliers to Mums and Dads; from cashed-out entrepreneurs to inheritors of wealth – a virtuous circle is being created. More angels means more angels with experience, leading to more angels who can lead investments. It also means more angels enjoying the experience of giving back, loving being mentors, and making tax-efficient returns. And that breeds scale, diversity and momentum.

So there are fabulous opportunities and incentives to become an angel. The pool of potential investments is wide and deep. Of course, right now the challenge for many angels is finding an exit for some of their existing investments…and that is a topic that I’ll come to that in my next article.

But to learn more about business angels and where they fit into the funding ecosystem, come to Real Business Funding on March 15.