Canada Rock..ies

Hello from London and apologies for the absence of posts for the last couple of days on business angel blog. I was at a conference in Halifax, Nova Scotia in Canada. It was an annual get together of the angel networks in Canada and many from the USA.

It was the first time I was at a formal gathering of angels and it reaffirmed my view that angels are a really nice bunch of people. We are driven by a desire to help entrepreneurs and generate wealth. The strange thing about conferences is that you do end up getting very close to people over a very short period of time.

I laid the foundations for what I hope are some long term great relationships with many people. The thing I enjoyed most about going to Prague for example was the opportunity to meet some Angels in the UK. If any of you are invited to go to a conference – my advice is to go as long as you realize the real thing you can do is forge relationships with people.

I learnt a great deal about angel networks and how angels tend to invest. As I mentioned in some other blogs as well is that angel networks tend to promote best practice and they want to contribute to the business venture being successful. Many entrepreneurs are understandably nervous about working with investors. I have seen too many good entrepreneurs being taken for a ride by so called angels. Worst of all are the advisers that get involved from time to time. Perhaps that should be the subject of another blog!

Most angels, who belong to a network, tend to be entrepreneurs who want to ‘recycle’ their money and their experience into new businesses. My advice to entrepreneurs is to feel confident enough to vet investors just as much as they want to vet you.

I will be writing a lot more about the lessons I picked up which I would like to pass on from my time in Canada. Please do have a look at their www.angelinvestor.ca/ - and in the future they may post the presentation I gave.

The presentation I gave was about my experience as an angel investor and the lessons I had learnt from my investments. I also learnt from the other speakers at the conference and look forward to sharing those lessons.

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Most businesses can be divided into two categories; lifestyle businesses or scalable businesses. Neither is better than the other, but only scalable businesses are investable propositions. So picking up on the theme of “It’s a pitch“, I thought I would write a business angel blog about what I consider as scalable.

Most self-employed people are engaged as consultants. When I started in ‘business’ I ran a training business (as I still do!) which trains staff in sales skills and now in raising money. The problem with this business was always that it relied primarily on me selling my time. What I sell can only be sold once. Of course, you can buy DVD’s of my training sessions, but that really is not the same thing and most people I know would not want to buy a training video like that (please email me with a payment for £30 if you disagree!)

The key thing here is that if I am on holiday I cannot be earning. If I employ someone to deliver the training on my behalf, and they are good, they can end up doing the business by themselves as there are no barriers to entry. If they are not good enough to run the business by themselves, I do not want to employ them!

I first realized the strength of being able to scale up when I won a contract to do some non client-facing work. I was able to outsource most of that work for a fraction of the price I was being paid. I remember the sheer joy I felt when I was sitting down enjoying a coffee in the knowledge that I was still earning money!

If you are going to pitch to an investor you have to show them that your business can grow beyond you working all the hours god sends. I do see business plans which try to take businesses that exist at the moment and add scale to them. There are a number of issues with these business proposals. Some businesses are simply not scalable or there is only room for one scalable business - in other words a natural monopoly exists. The taxi business in London is a great example - and something I learnt at my great personal cost - (see the business angel blog on Blueback). I also constantly see business plans which try to roll out and drive efficiencies from scaling up dry-cleaning businesses. They miss the point which is consumers demand convenience and quick turnaround. Johnson’s are the only large scale operator in this space - and they struggle as scaling up brings its own costs which you may not be able to recoup.

A classic example again is food service. If you wish to build up a scalable business you need to have more than one store (unless you are building a fine dining restaurant). Having more than one store requires a head office cost. It is unlikely that the business will be able to make profits until they have at least five or six sites. That is why each additional site will contribute a much higher amount towards profit.

The point here is that if you are seeking external investment from people other than friends or family, they will want to know how they can exit from their investment - which will be from building a business that is sellable. To be sellable, you have to be scalable. Make sure you are clear about this and your business plan reflects that.

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One of the very first blogs I ever wrote was about the scanning the environmental landscape. I wrote about how using STEEPL can help you validate an idea.

The first process I go through when I look at investing in a business is to validate an idea. I simply use the STEEPL framework to see if the forces shaping the environment are in favour of the business proposal in front of me.

This week I made an investment in a fund (something I rarely do) and I thought it might be helpful to explain the process I went through in making the decision. I have to emphasize that this business angel blog should not be considered as investment advice. And to avoid any hint of bias, I will not name the fund I have decided to invest in as that would be wrong.

For the last few months, there has been one story which has been dominating the business agenda; the rising price of oil. The long term trends suggest that the demand for energy is increasing. The International Energy Agency has suggested that by 2030, the rise in demand will be around 50% of current levels. At the same time, the supply of oil, coal and gas is finite. Long term prices are going to rise.

However, there are other concerns on the energy agenda. It struck me when candidate Obama said that he would work to make the USA independent of foreign oil within 10 years. The recent trouble in Georgia has again highlighted the issue of energy security in terms of the reliability of dealing with a newly resurgent Russia.

All of the above (STEEPL) analysis got me to look at alternative energy as an area for investment. The issue then was would I invest in individual businesses in this space or in a fund? The concern for me was that although I have a good feeling for the long term trend, when it came to which sector (wind, solar, geothermal, biofuels, efficiency etc) I had no idea. The area is a very technical one and I felt that I do need expertise in making the right decisions.

So I then looked at funds in this area and assessed the different fund managers who operate in this space and then finally made my choice and decided to invest in a fund.

The reason for outlining this process was to demonstrate that as an investor you go through a funneling process. You start out looking at wide angles and then successively narrow your selection criteria. If you are pitching to an investor, you need to show that you understand this process and make them feel comfortable that they are backing the right skills within the right sector within the right long term growth area.

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There are easier places to find funds

So you have done market research which makes you realize your solution is wanted. You have written a great business plan. You have put together a great management team. You also know exactly how much money you need. What next?

The first place to start is the bank. This is only if you have got customers who will commit to purchasing your solution. Retail banks will not finance equity (please see In Defence of Banks) but if you need a certain amount of trade finance, they will see you through. Or it may be that you have certain assets that the bank may lend against. (Also see when talking to a bank).

If a bank is not an option what next?

It depends how much money you are looking to raise. If it is over £1m, there are a number of financial institutions which may be able to help. Typically, they will not invest amounts of less than £1/2m because the amount of work they will have to do to make the investment makes it uneconomical. If it costs them £100,000 to make the investment and £20,000 a year to monitor the investment at the end of five years the investment has cost them the amount invested plus £200,000. A £100,000 investment will therefore need to treble just to break even for them!

You may approach the funds directly yourself of course, but it tends to help if you employ the services of a corporate financier. A good financier will check your business plan for you and help target the right institutions. They will typically charge around 3% of all funds raised (for amounts over £1m) and they may charge a monthly retainer. You may find yourself paying £10,000 a month for three months with no guarantee of success whatsoever.

If you are looking to raise less than £500,000 you should consider the angel market. You will see that through Google Ads (at the top of this blog) there are lots of adverts for Angel groups such as British Business Angels Association and Envestors. Click on those links to see if they may be right for you.

You can of course also use corporate financiers to approach angels. CONFLICT ALERT – This is what I do! Typically for this they will charge 5% for funds raised. I don’t want to do myself out of a job here, but with a little bit of research and application, this is something you can do yourself.

As a start, find companies that are similar to your proposition without being a competitor. Find out who the shareholders of that business are (through Companies House) and approach them directly. Anyone involved in marketing will tell you that the most powerful predictor for consumers is past purchasing behaviour. If someone has already invested in a sector (and done well from it) they are likely to do the same again.

Your pitch to them needs to understand what they are motivated by. You will be surprised; it is rarely about money. If you pitch to them at the right level you will succeed.

You can also ask business directors to recommend angels to you. As a whole, entrepreneurs are a good bunch and we do tend to do what we can to help people.

All of my corporate finance work comes from recommendations (both ways) and I tend to only raise money for companies I have invested in or intend to invest in. I will only take on about one project a quarter. It does take a long time to raise money and if you are not careful as a financier you can spend a lot of time with scant or no reward.

If you are going to use a financier please do ask the following questions

1) Who have they raised money for in the last 12 months?
2) How much have they raised?
3) How many people/ organizations have they raised it from?
4) Are there any projects that they have not succeeded on?
5) What were the lessons from those failures?
6) What do they think of your business?
7) Would they invest? Would they invest some of their fees back into the business (Apart from two cases, I always invest my corporate finance fees back into the business. I think this shows confidence and tells other investors that you really do believe in the business)
Can they give you two references? (Please do take up the references. You will be amazed at how much people will tell you!)

Finally – just be wary of financiers with lots of time on their hands (for example if they have time to write a daily blog……) In my experience all of the best financiers I have worked with tend to be too busy to take on new projects.

I hope this is helpful and best of luck

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j-curve

One of the lessons I learnt about investing early on from my mentor Sir Rodney was to watch the J curve. I hope I can pass this lesson on today to Entrepreneurs and would be investors.

Most start ups plan follow a J curve type profit profile. If you draw the letter J at a slant you will see what I mean. With the J being made of a U and a I. The ‘U’ phase represents the start up phase when you make losses and the I phase is the profit phase!

As Sir Rodney says

“companies tend to be very good at sticking to the U phase of the plan, but not so good at the I phase!”

These words have certainly been my conclusion from the investments I have made to date.

As an investor you must expect this in a start up situation. The valuation of a company will depend to a very large extent to where they are on this J curve. What annoys me are investors who want to invest at a valuation which places the business at a different place to where they are. Recently I had two would be investors waste a lot of time by suggesting they would be investing in a business and then they backed away because they felt it was still at the risky phase - yes it was and the valuation reflected that! You are not going to get a potential of ten times your money without a high level of risk!

As an investor, I expect the management of a business to act with real parsimony during the U phase. If things are going worse than expected and they need to raise more money (this does happen) I also expect them to show moral leadership. Are they offering to take pay cuts? (Temporarily at least) - are they increasing the amount of money they will put into the business? (Either themselves or from their friends and family) Are they coming up with some real cost cutting measures? (Without damaging the core of the business). These are important questions that need to be asked by the board and investors.

I think of the two stages in very stark terms.

• In the U phase you are spending my money.
• In the I phase you are spending the companies.

You need to keep investors informed whilst you are losing money (as will have been planned). We hate surprises (good and bad). A good surprise is of course good - but it still reflects badly on management!

This advice might sound obvious but get to the I phase as soon as you can.

U is not my friend, I is!

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Last week, inflation this side of the pond hit 3.8%, almost twice the target rate of 2%. What does this mean for investing?

I was at an excellent series of presentations by Citi bank last week and one of the statistics they demonstrated was that when inflation goes above the 3-4% range, stock markets fall significantly across the world. What drives this relationship?

The prevailing theory explaining inflation at the moment is monetarism (as opposed to Keynesian theories). Basically this says that inflation is caused by too much money chasing too few goods. The prices of goods are effectively being auctioned up.

With most things, if you want to cut the demand, you make it more expensive. The demand for money is dictated by the price of money which are interest rates. When interest rates are low, consumers will be tempted to borrow (thus increasing their demand for money).

The Bank of England will therefore have to either adopt higher interest rates or maintain them where they are at the moment. And although interest rates are historically low, they are very high in terms of our recent experience over the last 10 years.

Interest rates also represent the risk-free rate of holding money. If interest rates are high, investors may decide that they would rather invest their money in deposit accounts than risk the money on stocks and shares or unlisted companies. If interest rates are high, they will need a much higher rate of return from other potential investments.

You can observe this relationship in the real world. When interest rates go up, the stock market tends to go down and vice versa. Sadly therefore, as entrepreneurs looking for investments you do need to realize you are in competition for the investor’s money with not only other businesses - but also with other potential investments they could make in other assets.

The point is you should be aware of the investors mind set and price your business accordingly.

Please don’t do the “you will get 10 times your money back within three years” unless you have some evidence to back it up!

Best of luck.

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Unless things have changed dramatically over the weekend, investors find themselves in a place they have not seen for a while; a bear market. The official definition of a bear market is when stocks and shares are 20% lower than their recent peak. We are in deep bear territory. What does that mean for companies looking to raise money?

There are many clichés out there in the financial market to tell you what you should and should not do. The cliché that I think is apt for these times is to “never catch a falling knife”. This simply means you should never buy shares whilst the price is still falling. Let it settle for a while and then buy. I am amazed at how many investors are obsessed with buying at the right price. As an angel investor, I have always been worried about the price I sell my investments at - never what I pay for them (within reason)

As an Entrepreneur looking for money, you will find it harder to raise money. I have witnessed this first hand. In my opinion (humble and with no qualification whatsoever) there are so many bargains to be had in terms of buying shares of the leading companies, that my own risk profile has changed in the last few months.

Firstly, I have decided to cut down on my angel investments this year (I will perhaps do just one more this year - I have only done two this year). I also realize that I will need a much better safety margin on my investments for the same level of return than I would have even a couple of months ago. You can no doubt appreciate the logic behind this.

I have a fixed amount of money I wish to invest over a range of assets. If the price of some of the assets is now cheaper, I will need all assets to change prices to invest in the same ratios as before. If angel investments remain at the same price, I will of course prefer to invest in the stock market where my returns are supposedly lower but my risk is lower as well.

There are still some great businesses out there that I see that I will back over the next few months. But the quality of these opportunities is great and investment valuations appear to be more realistic.

My advice in the current climate is not to give up - but to be realistic. Ask yourself about the risks involved in investing in your business and price your business accordingly.

If history is anything to go by, the next few years is the time for the next biggies to be born. I do not want to miss out!

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I guess that strictly speaking this is not a topic relevant to Entrepreneurs - but it might be of interest to potential investors. As such hedge funds represent competition to non-listed companies seeking investors. As such you should appreciate what they are.

I have only learned about hedge funds in the last six months or so and it has been interesting to learn about them!

I asked a fund manager what is a hedge fund and I got the following reply “Basically it is the same as any other fund, but we get to charge a lot more”

Given that helpful explanation, I hope that you find the information below helpful.

Most funds measure themselves in relative terms. That is to say that they will judge themselves against an index such as the FTSE 100. If the FTSE100 is down 20% in a year - and they are down say 10% - they will make the claim that they have done very well as they have outperformed the market by 10%. If you are the investor that has lost 10% and have to pay a fee, you may not feel so great about it!

Typically hedge funds, aim to deliver an absolute performance. That is they will seek to deliver a positive return on your monies irrespective of market conditions. Hence they are called hedge funds, because they will hedge their market positions so that they do not lose money. For example, they could find two assets that have an opposite relationship. Say the price of gold always goes up when the price of bonds goes down. It would therefore make sense for you to ‘hedge’ your position by buying both.

Most funds would be described as long only funds. This means they will buy shares or other assets and expect the price of the assets they have purchased to go up. Hedge funds can go short. They have the ability to sell assets they do not have in the expectation that the price of the asset will fall and then buy them in the future at a lower price and deliver the asset to the person they had sold it to at a higher price. (The mechanics are a bit more complicated that - but this is the principle).

There is also the ability to leverage. Most funds (especially if they are described as retail funds) will not be allowed to borrow money. If they are, the amount they can borrow will be strictly governed. Hedge funds are allowed to borrow and hence aim to magnify the return available to their investors. This makes them particularly prone to large movements and losses can be substantial if they place the wrong bet. A hedge fund can lose all of its money quickly.

Finally, there is the charge structure. Typically most funds will charge around 5% initial fees (although increasingly they are not) and a flat annual management fee of around 2%. A hedge fund will aim to charge around 5% management fee and 20% of any profit they deliver. They are able to charge this on the basis of past performance and with the argument that they will be very active in managing the money. If you do well as an investor in a hedge fund - the manager wins, if the fund does not perform well - you lose!

Because of the above, hedge funds are at this moment in time not deemed suitable for retail investors. It is punishable by a prison sentence to promote a hedge fund to someone who is not either a sophisticated investor or a financial institution. This is the same offence as selling an unlisted investment to someone not suitable (more in a later blog)

Basically, if someone is suitable to invest as a business angel, they will be suitable to invest in a hedge fund. As someone looking for funding, you need to be able to ensure that you understand the choices your investors face!

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The best pizzas in the world are made here

One of the curious concepts I came across in my MBA was the idea of trying to exploit economies of scope. Most people involved in commerce recognise the idea of economies of scale. Simply put, things get cheaper to make or sell as you make or sell more of them.

Economies of scope are simply the idea that you can exploit a resource more than once!

A great example of this is any business that has at its heart a database. A good database can be exploited (ie sold!) more than once without the resource itself being depleted in any way. Think of companies like www.wooshare.com or www.facebook.com These are companies that are dependent solely on this concept. They are essentially a fantastic database that can be used as many times as you like (in Wooshare’s case in as many ways as you can think possible) and in fact the more the core resource is used, the stronger the business becomes. [CONFLICT ALERT - I am an investor in Wooshare! But I invested purely on the basis that I understood this as its business rationale.]

I like businesses like this and would encourage Entrepreneurs to think this through and see if they can find any economies of scope in their own business. With times getting harder, if you can find resources within your company you can exploit more than once you will be doing well.

Let me give you an example of a business I have invested which does this brilliantly. In the UK we are unique in going to Starbucks for a coffee, Pret for a sandwich, a pub or wine bar for our alcoholic drink and then finally Pizza Express for a pizza in the evening.

In continental Europe you would expect to have all of these services provided under one roof. A company called Amano (www.amanocafe.com) was doing just this and I was impressed because they were taking the basic asset of a property with catering facilities and using it for multiple occasions. The challenge for them was to ensure that they were best in class in each of these offerings. I have to say (and of course I am biased!) that they do the best sandwiches and pizzas I have ever had. The place works because it modifies its operation slightly for each part of the day. (If you are ever in the London Bridge area do have a look - and if you are there on a Saturday morning - please feel free to buy me a Latte!)

Have a look at your business and the resources you use. How else could they be used? Could someone else use them whilst you are not using them? What other services could you sell to your existing customers provided by someone else? These are all ways of exploiting economies of scope.

Go exploit!

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Do you know what a Monopsonist is? No. Neither does Spell Check on Word!

Yet we all know what a monopoly is. A monopsonist is simply the reverse.

A monopoly is one producer and many consumers and a monopsonist is one customer but many producers. M&S used to have monopsonist arrangements with many of their suppliers - otherwise called ‘exclusivity’!

As an investor I am very nervous about investing in these types of companies and the only time I did invest in a business like this, I regretted it! The risk is simply too high as you are tied into the fortunes and fate of another business totally.

The definition of a monopoly from a trade point of view is actually 25% of all supplies to a market from one producer. So I use this same definition and reverse it for companies I tend to back. If a business that wants me to back them relies on one customer for more than 25% of its turnover, I tend to look at what will happen to the cashflow if they were to lose that customer (you could argue I should discount two or three of the largest customers, but I think that is just taking caution too far. No matter what you plan for, investing in a business will always be a risk!)

If the business cannot cope with the loss of that customer, I will be very cautious. As an investor you should never normally have more than about 15% invested in one asset class (other than cash) and I try to argue the same about businesses.

In a business your customers are really your only asset - but is there only one asset?

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