Business Angel Blog

So once again, I find myself apologising for not having posted a blog for so long – although this is the longest period I have gone without and sadly, I received no complaints at all about no blogs!

I always enjoy the festive break as it is a great time to reflect and take stock of what you have done and what has yet to be achieved. It is also one of the few times of the year where you can take a break without worrying about the calls going unanswered.

The other interesting thing about personal ‘stock takes is that it is one of few activities that really reveal gender differences; men tend to overestimate what they have achieved and women tend to underestimate what they have achieved.

Everyone has been saying how they expect 2012 to be a difficult year. For once, I would say there is merit in the consensus view. The Euro drama has not played itself out and I just think the European leaders have not acknowledged the full scale of the situation or how powerless they are.

I am a very proud and staunch European but the Eurozone simply does not make economic senses. Along with a single currency you have to have single points of control. There are (and have always been) two Europes; a Northern Europe and a Southern Europe. What does make sense is to have two ‘Euros’ one for the North and one for the South.

There is no hope for Southern Italy (which I love) and Greece to compete with the super efficient Germany and Scandinavian economies. Normally, free floating currencies will compensate for these inherent differences, but they haven’t. Germany is benefiting from a massively undervalued currency (for them) really helping them to boost their exports (last month they overtook China as the largest net exporter!) and Greece and Ireland are seriously being hampered by a very expensive currency (for them) not allowing them to find the right level for their exports to be competitive.

The current economic management of Europe is a fantastic manifestation of Nietchzse’s maxim “principle is the enemy of the reason”. The leaders are so wedded to the idea of making the Euro work that they are prepared to let reason fly out of the window.

And for once, we in Europe all need to wake up to the idea that whilst the Germans are being asked to dole out more to support the Eurozone, they are by far the largest beneficiary’s of the Eurozone as well. There is something fair about them being asked to pay more towards the cost of keeping Europe solvent.

The hope for me is the USA. The economy seems to be moving again and I expect Unemployment to dip below 8% by November, ensuring Obama’s re-election. I do think Obama will win – and win convincingly. The main reasons being that the economy will improve, Romney will fail to ‘super-charge’ the Republican base (a strategy that Karl Rove deployed to terrifying effect in 2004) and I do not think in this year, Americans are willing to vote for a Private Equity guy (just see the anti-Romney video that his ‘colleagues’ in the Republican party have produced).

The UK will also benefit from the Olympics and I do not think we should underestimate the effect that will have on the UK economy. Along with the millions of visitors, it will bring lots of advertising dollars as brands will be desperate to communicate with that very attractive demographic.

And of course, inflation is showing signs of easing in the UK but I do expect things to be very tight here as companies continue to hoard cash and few investment projects get the go-ahead.

So…….

If you are an entrepreneur what does this all mean?

1) Now is a good or as a bad time as any other to start up
2) If you are seeking to work on Government financed projects – forget it
3) If you are looking to export – that would be a good strategy, go for markets are are in good health such as Northern Europe.
4) Export quality. It is going to become harder and harder to export on the basis of price alone.
5) Shop around in terms of the ideal location for you to be based as an entrepreneur. I did a lot of travel last year and I was amazed at the support available to attract and retain start ups. (I will be writing a blog about this soon) but be very flexible in your thinking.
6) There will be some great restructuring, management buy out opportunities. Get together the key skills needed to run an enterprise and you will be surprised at the opportunities available to you as companies continue to focus on their core activities.
7) Don’t give up.
If it’s really not working – learn when to give up.

And as always I wish you the best of luck for the New Year.

As any regular follower of my blog will know, I love Economics, and feel that an understanding of the subject can help business owners make better decisions. The Macro environment is very important in considering even what appear to be small business decisions.

However, a tweet (you can follow me on @permjotvalia) I read suggested that the very difficult pricing model of airlines could be solved by more competition. I disagreed with that and would hope to use this blog to demonstrate how in many cases, more competition can leave consumers worse off.

If anything, airlines are one of the best examples of learning from economic principles. They are great at explaining the issue of marginal revenue. (Even if ALL costs are not covered, it is always worth doing something providing marginal cost + $1 is earned). So even if a flight is making a loss, it is worth flying providing the costs of actually flying (petrol, food etc) are covered. That is because the fixed costs are going to be huge; that is wages (fixed), landing fees (fixed) and aircraft costs (fixed).

Travel is also one of the few markets that allows producers to practice perfect price discrimination. They are able to price each seat differently depending on how much the traveller needs that ticket. So if you buy a ticket for tomorrow that will be more expensive than in a months time. Just before Christmas will be more expensive than January. And my pet hate, if you do not stay over on a Saturday night, the return flight can be very expensive (as they can use this to discriminate between business travellers and leisure travellers).

But the airline industry is also very odd in that it is very heavy regulated. You would have to get rid of some these regulations to ensure that there could be more competition. One of the reasons Ryanair prefers pilots to hold Irish licences rather than UK ones is that they can fly an extra couple of hours a week because of that. How would we as consumers feel if the UK upped the limit from around 32 hours a week to say 60? It may lead to lower prices but is that what we would want.

And what about the fixed landing slots regime. In a truly competitive market each and every slot could be up for negotiation. If it got to the stage where all the fixed costs were made flexible, flights could literally decide 24 hours before they were due to take off if it was worth making the flight or not. Although its opaque pricing structure is very annoying, it is also the best guarantee we have that these flights will indeed take place.
So, more competition and flexibility is not always the answer.

Another great example is Premier League Football. Until recently, Sky had a monopoly on live matches. Because of EU intervention, other operators have had to have matches offered to them. This sounds great, but the consumer is a lot worse off as they now have to subscribe to multiple pay for view TV operators.

Anyone who has been subjected to sit through one of my lectures, will know that I love Economics. I am so grateful to Mr. Shellard at my college for encouraging me to pursue this subject.

Economic concepts are so highly relevant to understanding business models and profits and I think more entrepreneurs need to understand concepts such as marginal cost and marginal revenue. But I think an important piece in this equation often gets missed which I hope to illustrate in this blog; the cost of acquiring and keeping a customer.

Marginal cost is simply the cost of producing the last unit. Some businesses have zero or very little marginal cost. So a cinema for example will have a zero marginal cost (the cost of allowing one more person to ‘consume’ a film). Equally, the transport industry has zero or virtually zero marginal costs. How much extra would it cost to sit one more person on an otherwise full flight from London to New York? Perhaps $50?

Economic theory states that providing you can cover the marginal cost (and do not confuse marginal cost with average cost) you are always better off making that trade. Profit is maximised where Marginal Cost is equal to Marginal Revenue. This is very much the pricing model that airlines and hotels adopt.

But, you can still be making big losses as a business even if you are covering marginal costs (because you may not be covering average costs). Again an airline may have a very expensive average cost of a flight – and the breakeven may be to get the flight 70% full. But given that most of the costs are going to be incurred anyway, providing they can get marginal costs covered, it is always a better decision to accept that additional ‘contribution’ to the average cost.

Digital businesses often assume that they have zero marginal costs. This is true to a certain extent. But what is often missed by a lot of businesses I deal with is the cost of selling to a customer and then keeping that customer.

It is easy to think of your cost of production – and thats it. But what about the time, effort and SEO cost that goes into acquiring that customer?
And many people will want customer service – that can be thought of as a marginal cost (if x% of people will phone and take up y% of time, you can add that to the cost). Often businesses fail to make a profit because they confuse this element as a fixed rather than a variable cost. The business plan assumes that this overhead is fixed and not related to sales volume. This is not true.

One of the companies I spent some time with recently, wanted to employ some account managers and I had to show them that there simply was not enough margin in their pricing for them to afford to do this (even though it would grow revenue).

Entrepreneurs have to remember the old adage from Economics “Sales is vanity, profit is sanity, but only cash is reality”.
Have you worked out the true cost of each sale?

My political career ended today at around 10am. My career in politics lasted around two weeks and it was great fun and I met some completely new people whom I was deeply impressed by.

Regular readers of my Blog will know that although I was never a big fan of Gordon Brown, I have been less than impressed by the actions of the new coalition government. They are shrinking the size of the state for ideological reasons; and I do not philosophically have a problem with that. But they are doing so at exactly the wrong time. I believe the UK will enter another recession because of the actions of the government.

When people say that this is the best thing for the UK in the long run, I remember what Keynes said “In the Long run we are all dead”. Someone losing their job is a massive tragedy for them and their family; they will not be comforted by the idea that their lost job is in the best interests of the UK economy.

So rather than complain about what is happening I decided to contact one of the contenders for the leadership of the Opposition Labour Party; Ed Balls. Two weeks I got involved in his campaign. It has been a strange experience but an inspiring one. My advice to everyone would be to get involved in a political campaign (whichever colour or views you subscribe to). You will meet some great determined and talented people and you should get inspired.

I met Ed Balls last night for the first time although I have been working on his campaign for two weeks. I really enjoyed meeting him and in a classic case of being in the right place at the right time, I was asked if I would introduce him and chair a major speech he was delivering today in the City of London. It was strangely nerve wracking!

Get me in front of hundreds of people to talk about business strategy or investing as a business angel and I will not have a problem. I realise I know enough to not embarrass myself; but talking to a room full of journalists and TV crews (live coverage on BBC news!) about something I know little about and you can imagine my fear. So at the end of talk, I decided any involvement I have in politics will be strictly behind the scenes! Hence my political career is over!

I do have to say though that I really enjoyed the talk that Ed gave and I felt inspired. He has bravely broken away from the consensus that we need drastic cuts to public expenditure. www.labourlist.org/the-growth-deniers—ed-balls-full-speech I also found him to be very keen to listen and learn what I thought were the key ways to support start ups and entrepreneurs. I wish him well and I will continue to support him.

As for advice from this blog; stick to what you know and are good at!

Contrary to popular imagination the vast majority of Business Angels are not ultra wealthy. I do not know the statistics, but anecdotally, I would say that the most active angels are just over the threshold (in the UK, £250,000 of assets excluding your home). The very wealthy tend to either invest with VC firms or set up their own investment offices.

As such, angel investment levels are highly sensitive to stock market valuations and house prices; the bulk of angels’ wealth will be in these assets so that when these prices are high, angels feel wealthier.

But angels do have to be very careful about how they invest and it is a discipline that I have had to adopt in the same way that the UK is learning to cut its debt. There are effectively two bank accounts that I have to use; a capital account and a current account. Angels need expenses to live off and you get into a dangerous situation if you start dipping into your investment monies for your day to day expenses. It is far more dangerous though when you start using monies meant for your day to day expenses for angel investing purposes (as I did two years ago!).

I have now decided to stick to some golden rules around investing. I have now invested in over 27 deals and I will not be investing any ‘fresh money’ now until some of these deals start to pay out. (I am still active in 11 companies at the moment). Only monies from these deals will be re-invested. Otherwise you are trapped in the illusion of good money chasing bad. (Be interested in other angels opinions though).

The other area where I think people can sometimes get confused about business angels is that the angels do need to still earn some money (well most of us do). And the discipline you need in making others value your time.

These two things are related. I don’t want to sound negative, but if you have some business experience and you have invested in companies, you will tend to get requests from lots of people who wish to meet you and tap into your experience. It is a good thing and I do try to make some time for this. The problem is when you spend too much time on this – and your business activities do suffer. Sadly, I am still at the stage where I do need to earn an income to meet my expenses and therefore I need to ration the time I can make available for ‘free’. I have also realized that companies tend to benefit more from my advice and time when I charge for it!

It is true that giving something away for free tends to be poorly valued and therefore I hope this blog is of real value.

“You guys have been hurt,” the entrepreneur was telling me. “I get the sense most angels have a $2-3 million dollar net worth and this downturn in the market has hurt you.”These were astute insights from a frustrated entrepreneur who invested a lot of time pursuing angel investors. He was smart, articulate, funny and dedicated; he just had lousy timing. No one was writing checks as he came to the front of the line in late 2008.

We’ve had quite a scare in the US as Senator Dodd drafted a revision to the SEC’s standard for an accredited investor. A revision made sense on one level, it hadn’t been updated in decades, but concerns grew quickly that any change, even applying an inflation rate to the threshold, would wipe out as many as half the angel investors in the country. We’ve dodged that bullet for now, but it sizes the wallets of business angels: many of us are investing with finite resources.

Angels make up a precarious bridge in the early-stage investing ecosystem. Venture capital has moved upstream in many markets, leaving a gap in seed stage funding. Angels fit nicely in this range; many of us have the time to contribute more than just money to a worthy startup. But angels who have been at it for awhile are feeling quite pinched due to a liquidity crunch. Lisa Lambert, VP Intel Capital, recently quoted statistics on Stanford’s Entrepreneurship Corner, citing the time to liquidity has grown from 2.6 years to as long as 8.4 years today; that’s something Intel can withstand, but early-retired business angels are feeling “tired and tapped out” waiting to get to an exit on their investments.

For me, besides impacting my personal net worth, the turbulence in the market has pushed my exit opportunities further into the future. Yes, this is supposed to be patient capital, but more time to exit also carries great risk. For example, one of my most promising investments is finding itself impacted by the Gulf oil spill. Talk about a black swan! No one ever imagined such an outcome.

I predicted that many of my angel peers would be spending more time supplementing their incomes resulting in less time for looking at deals. So far this year in Los Angeles, angel investment in early-stage deals is at record low levels. But before I get totally depressed, don’t let me forget to mention that we have 2 IPOs planned for later this year; one is expected to be spectacular, the other less so. News of these exits will revitalize the early-stage market and attract more business angels to join groups. But two deals won’t make many of us whole, just a relative few. And for those angels that do reap large rewards, I predict that money is coming off the table, as they say in Las Vegas. They’ll have waited over 9 years for this return, and many weren’t spring chickens when they made the investment. Some will, but I imagine many will pocket the proceeds and concentrate on their retirements; few will contemplate another 9 year cycle.

Is it the lure of making big returns, or the fact that so many of us are unemployable after our own entrepreneurial successes? Whatever the case, we’re attracting new members at a surprising rate, so much so I’m conducting a half-day training class later on this month; I’ve titled it “Angel Investing 101”. My challenge? How do I balance a candid assessment of the current trends, the ever extending liquidity timeline, while educating and inspiring them? The need for seed and early-stage capital is as great as ever, but the sustainability of the business angels providing that capital is in jeopardy.

Frank Peters
Newport Beach, California
July 5, 2010

At University I read Economics and the courses that fascinated me were around managerial economics. One of the most exciting courses for me was looking at the relative industrial decline of Britain since the start of the twentieth century. The usual suspects include Trade Unions.

There was though a very interesting theory put forward though that the problem with trade unions in the UK is that they have always been too weak! The argument goes that in Germany where trade unions have management representation and see themselves on the board of companies, union leaders are able to help companies, because they have access to all the information and realise what must be done. It is also fair to say that along with most places outside of UK and North America, the German culture does not have the same obsession with maximising shareholder value.

The thought is that if companies find it hard to adopt hire and fire policies, they will have to take longer in the recruitment process, they will have greater incentive to train and to be very productive. It does seem that ‘left-leaning’ economies like the Nordic countries have much higher productivity than free-market economies.
What interests me though is the role that Trade Unions have played in recent innovations. Fax machines only really took off during a large scale postal strike in the UK in the mid 1980s. (By the way I would really like to meet the sales person who sold the first fax machine – that is a sales person!)
More recently in the US, the screenwriters in Hollywood went on strike for a long period of time. Of course television needs to carry on and the studios response set in motion an innovation we are all tragically living with now; reality TV. It is cheap to produce and needs no writers. Of course we had reality TV before the strike – but it was the strike that really got it to take off.
So lets see what innovations come out of the BA strike!

The economic environment we are in is a big determinant on entrepreneurial activity. I am a believer that start ups which start in a recession can often do better than companies starting up in a boom. I do think though that the UK economy is going to be heading into another recession/ slump very soon.

It is important that entrepreneurs recognise the circumstances that they will be trading in. Starting in a recession is very different from trading into a recession.

My views on why we will go into another recession are just mine – and better placed people than me, will no doubt disagree. Firstly, the recovery the UK is going through at the moment is very fragile and although inflation is higher than the target range, it is predicted to fall sharply.

Public expenditure is coming down sharply in the UK. Some cuts (£6bn) have already been announced and another set of cuts will be announced on the 22nd of June. This will of course negatively affect total demand in the economy. Taxes are also set to rise, and if VAT goes up as widely predicted to 20%, it will have the effect of adding 1% to the inflation rate.

Sterling being very low at the moment against the US$ and Euro also adds to pressure on inflation (by increasing the price of imports). The ‘problem’ with this type of inflationary pressure (as well as with VAT increases) is that they are shocks to the inflation rate and don’t represent excessive demand. Nonetheless, the Bank of England which is charged with maintaining a low inflation rate may need to raise interest rates.

I hope they do not raise rates as I think demand is going to be considerably lower in the economy without a rise in rates. An increase in the interest rate would precipitate a recession.

The point of this blog is that if you are looking at starting up – now is a time to be a bit more cautious than normal. You may be better off starting in a year or two. Equally, if you are trading already – just be careful, we are most certainly in for a bumpy ride

Every so often it is nice to be able to help out some of my companies with a quick plug.

This is a short film that was made for AngelsDen by one of the creatives on Wooshii, (a company I have invested in and of which I am currently Chairman) .

A few characters you may recognise within…

For more information on AngelsDen head to angelsden.co.uk Where entrepreneurs and investors meet

Video and Rich Media powered by Wooshii.com

Plug – If you want an online video, animation, presentation etc then head over to Wooshii where they will match you up with a ton of creatives, from all over the world, that can help you out. wooshii.com

I seem to be back in investing mode. In the first two months of 2010 I have done the same amount of deals than in all of 2009. I just think that the time is good for Angel investing at the moment. Here are my reasons

1. Interest rates are so low. Money in the bank will only earn around 1% at the moment. Inflation is around 3%. So in real terms, you lose money by putting money into a bank! Might as well invest in something

2. From April the top rate of Income tax will be 51% in the UK. Angel investing through EIS means you get 20% tax relief back immediately and after three years all of your gains are free of any tax. The high tax rate also means that your downside is now limited to just 30% of your investment. This risk reward ratio makes angel investing more attractive.

3. Valuations are realistic at the moment. In the past, many entrepreneurs think that you can just stick a pre-money valuation of £1m on any idea (and to be fair to them, have found idiots like me who have accepted those valuations).

4. Given the recession, many business plans do not make the assumption that growth is to be taken for granted now. Cash flow forecasts are much more realistic. And with money being so tight, businesses have to be clear with the value proposition that they are offering.

5. Any business that can survive and start to lay foundations during these times should do well when the upturn does eventually materialise. They will have lower cost bases and hence can quickly turn into profit when revenues appear

6. Most investors are very nervous about business plans that require several funding rounds. We know that it is very difficult to raise money at the moment. The flip side of this is that we are seeing businesses that realise they have to generate cash quickly. I am seeing fewer business plans where there is no expectation of profit in the first two years.

What has changed though is my approach to investing. Time will tell, but I think I am getting better at investing. In my next blog, I will look at the criteria I am using now compared to my approach in the past.

In the meantime though, I trust you have found this useful. If you are a business looking for funding, hopefully the above gives you a feel for where other businesses are at the moment.