Experienced angel investors share hard-earned lessons
By Chantelle Arneaud, Envestors
To help new investors take the plunge and avoid saying ‘if only I’d known that when I started!’ we sat down with expert angels with years of experience to compile our top five lessons. We changed the names to spare blushes.
Lesson 1: Ensure the company, not the director, owns all the Intellectual Property (IP)
John shared with us the nitty gritty details of one of his first investments that went bust. ‘I invested into a young business that had developed an interactive app for tourists. It was clear to me early on that a lot of research, branding and grit had gone into making a stellar product and so I confidently invested. Not long after I parted with my cash, the company got into financial trouble and folded. That hurt, but what hurt a lot more was when the CEO created another suspiciously similar business a few months later.’
John later came to learn that it was the CEO and not the business who owned the IP. This tiny little detail meant that when the business folded, the CEO could walk away with its greatest asset, the IP.
A key takeaway from this situation is to ensure that all IP is owned by the company, not the CEO or any other party.
Lesson 2: Expanding too fast can be detrimental
After getting friendly with the founders and seeing a real business opportunity within the food industry, Tom invested £50k into a bakery business eager to capitalise on the global craze for their signature product. He was so enamoured, he even set up a franchise of the business at Heathrow airport.
Yet, he explained, ‘Cracks started to show as the CEO was overly relaxed about the financial affairs of the company. He was keen to show growth to investors and so expanded quickly to around twenty sites.’
This rapid expansion caused issues as around half of these new sites were what Tom kindly described as not good. Soon, the failure to realise the revenue expected from the expansion led founders to go back to shareholders with their hands out, looking for more capital to keep the business afloat. ‘It was not a good situation,’ continued Tom, ‘Not only had the revenue not come in, but the customer experience had suffered as a result of the business trying to do too much too quickly – which impacted the brand.’
Quick expansion and high standards not being able to remain consistent led to the critical mass never being reached. ‘It was inevitable that the company was going to go into administration once the overheads outweighed the revenues by a ridiculous amount’.
Interestingly, the company was bought by someone in the industry with more experience and it is now a thriving business with stalls across London train stations.
The lesson here is about speed and experience. Of course, as a minority shareholder, you can’t dictate the company’s plan, but you can counsel them. And if you see them trying to go too fast in an industry in which they are new, put up a red flag and introduce them to that contact you have who has done it all before, so they have the guidance and the support they need to make it work.
Lesson 3: Scrutinise the balance sheet; ensure the data source is credible
This lesson came six months after an initial investment into a flower distribution company when it was discovered that the business owed £350k in VAT. Caroline explains, ‘I have a thorough approach to everything, and my due diligence on this investment, like all my investments, was done with a fine-toothed comb. The problem, I later learned, was there was missing information.’
The Business Plan that was sent to Caroline didn’t disclose this financial information. If it had, she would have quickly seen the company was insolvent.
The lesson here is a nuanced one. Of course, Caroline did her due diligence, so how could she have avoided this situation? At Envestors, we always recommend our companies work with accredited advisors to show investors information has been reviewed by a qualified third party. This could be an accountant or corporate finance advisor or, failing that, we recommend investors work with an investment network that is regulated by the Financial Conduct Authority to protect themselves from situations like this. A regulated business will ensure all information is clear, fair and not misleading.
Lesson 4: Be constantly vigilant
After a colleague gave her a tip off about the ‘coolest new business to disrupt the fitness industry’, Julie was excited to make her second angel investment. The timing was a bit tight, but she managed to conduct her due diligence in time to get the benefit from the Enterprise Incentive Scheme (EIS) in the year, which meant her £10k investment would be subject to 30% tax relief and if things went badly a further £2,800 in relief, so the total amount she stood to lose was £4,200 and not the full £10k.
‘Sadly,’ says Julie, ‘while they had a stellar brand, the business was absolutely not the next big disrupter. I could tell from the outside things weren’t going well and getting information out of them, despite being a shareholder, was like trying to interrogate an MI5 agent.’
Then the inevitable happened, the business folded. ‘I was upset when I found out, but I exploded when I learned my tax relief wasn’t coming.’
While Julie believed the business was eligible for EIS, she later learned the paperwork had been incorrectly filed and there was no tax relief to be had.
The lesson here is to ensure that the EIS paperwork, and all paperwork related to your investment, is being handled by a qualified individual such as a lawyer or company secretary. S/EIS is notoriously complicated and it is easy for non-specialists to make little, but expensive mistakes.
Lesson 5: Sometimes s$!t happens
As the current COVID-19 situation has proved, external factors can’t always be controlled. Tanith learned this lesson after investing £20k into a boating business as she knew that ‘boats don’t deplete in value over time as they just get repaired’.
‘The company was doing really well and decided to expand. We were all onboard with it. To purchase more boats, the company took a loan from an international bank. But soon after, the financial crisis descended like a perfect storm and sank us.’
Once the financial crisis took hold in 2008, the bank pulled in the loans. While this decision had nothing to do with the business, it left the founders scrambling to find new backers in the worst financial crisis in recent memory. Unable to do so, the boats were sold off.
This shows how external events, such as recessions, can impact businesses hugely and uncontrollably. Overnight the business went bust and Tanith and the rest of the investors lost their investments, just like that.
A key lesson to take away here is that stuff happens. The only way to protect yourself against the uncontrollable is to build a diverse portfolio. Experienced angels know that a good portion of their investments will go bust, while others will circle the drain slowly before sinking and some won’t do much at all. Then, there will be one or two that will exceed their potential. Accept that some will fail – no matter how clever you are – and ensure you’ve got enough in your portfolio to balance the risk.
One of the greatest appeals of angel investing is that it is a lot more than just providing financial resources to early-stage companies and waiting for a return: a key role of angel investors is to help the business grow by sharing contacts, advice and mentoring the founding team. Therefore, angels are referred to as smart capital as they deliver both finance and expert knowledge. Remember the lessons learned by our five angels and hopefully you can avoid feeling less than smart.
ABOUT THE AUTHOR
Chantelle Arneaud is from Envestors. Envestors’ digital investment platform brings together entrepreneurs and investors across geographies, communities and sectors – creating the single marketplace for early-stage investment in the UK.
Envestors partners with accelerators, incubators and angel networks to provide a white-label platform empowering them to promote deals, engage investors and connect to other networks.
Founded in 2004, Envestors has helped more than 200 high growth businesses raise more than £100m through its own private investment club.
Envestors is authorised and regulated by the Financial Conduct Authority.