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.

We are without a doubt living in a time of volatility and business planning departments everywhere are frantically busy trying to create scenarios and the impacts that they have on cashflows.

Sadly, small businesses do not have that luxury (or curse). Many companies do suffer from paralysis through analysis. The other danger is of course that you read to widely and therefore get confused by what each different economist says.

It has widely been evidenced that past performance is actually very poorly correlated with future performance in numerous fields. So as a small business you have the ability to sometimes just plough your own field. But to add to your confusion, what do I think is going to happen.

The British and US economy is heavily dependent on consumption (it makes up some 70% of the GDP). Consumer demand depends heavily on disposable income. In turn on an aggregate basis, this depends on

1. Employment levels. Unemployment seems to have stabilised around the current level of around 2.3m and in the US seems to have peaked

2. Taxation. Disposable income is obviously dependent on this. Tax levels will have to rise significantly. There is no other option.

Much is made of public spending cuts. However, most public spending is related to the state of the economy and is mandatory, with an increasingly elderly population, it becomes difficult to contain let alone cut spending on health, pensions and other welfare. So no matter what governments say, cutting public spending remains a very hard thing to do.

I also expect the next government to be a weak government (in terms of the majority it will enjoy), and in that situation it is easier to raise taxes than cut spending. (Ironically, the lobbying power of a department is stronger than all taxpayers!)

Therefore taxes will be raised with VAT going up to 20% (if the conservatives win) and Income tax and Capital Gains tax going up if Labour hold on to power.

3. Disposable income is also heavily related to the level of interest rates (this is not true so much for North America where most mortgages are fixed for a period of 15 years plus). In the UK most mortgage holders are on variable mortgages.

So if you have a £100,000 mortgage a 1% cut in interest saves you £1,000 a year. Interest rates have come down by about 3% from their recent peak (if you have a £300,000 mortgage which is common in London, this is a massive saving of £9,000 per annum)

Interest rates in turn are dependent now to a large extent on the level of expected inflation. Inflation is set to soar. This is for a variety of reasons including the silent rise in the price of oil (it is back to $80 a barrel). And a weak pound will lead to inflation as it means the cost of imports becomes more expensive. Finally, if VAT does go up to 20% that will add about a full percentage point to inflation.

For these reasons and because of the huge government borrowing levels, interest rates will have to rise.

The impact of rising interest rates and taxation will dampen consumption. Our best chance of avoiding a ‘W’ shaped recession is to hope for a growth in exports. The chances of this do look good actually. Our largest markets, the US and Europe, are recovering and a weak pound makes our exports more competitive. I am doing my best through increasing my sales in Canada!

So , what does this all mean?

In my opinion, consumer demand is going to soften and possibly lead to another downturn. So if you are starting a business you will need to be aware of this scenario. So look for something that allows businesses and consumers to cut costs or to have a cheap treat. Or, really look to overseas markets. You would be surprised to learn how much help is available to UK based companies to help them export.

Or the best advice may be to simply ignore yet another prediction!

Between 2004 and 2007 I made about 16 Angel investments. Between 2007 and last year I made three more. Since June last year I have not made a single investment. My decision not to invest was driven by two factors. Firstly, I did not have any money (which is a pretty big bar to investing when you think of it) and secondly, I think the outlook has been lousy.

A lot of the businesses I have invested in have really struggled (I have only six still alive). I have written recent blogs about the dire state of the economy. I note that almost a year ago I argued that what the economy really needed was a dose of inflation – and that seems to have been the right call.

Well, I am pleased to make another call. I believe we have reached the bottom of the market in terms of asset prices. I have just concluded my first deal in almost a year and am therefore putting my money where my mouth is. Although it is the bottom of the market in my view (and I admit that I have been heavily influenced by Anthony Bolton – President of Fidelity Investments and the closest British version of Warren Buffet, calling the end of the bear market last week), the symptoms will still lag on.

I do expect unemployment to rise further in the UK and for house prices to simply stabilize before they start to rise again next year. Nonetheless, it is pleasing to know that we are probably at the beginning of the end of what has been a terrible period.

Many people have seen their fortunes wiped away and savings eroded. The meltdown has particularly affected people about to retire as the stockmarket had simply given up all the gains made over the last ten years or so.

It will still be sometime before the greenshoots filter through to the high street. A lot of spending is psychological and people have been left spooked by the turn of events. Low mortgage rates will be used as an opportunity to repair badly damaged household finances rather than being used as an opportunity to go out spending. I think only once unemployment has peaked and shows signs of recovery, along with house prices, will the Great British shopper return with force.

And no doubt, we will end up where we are again in ten years time! The difference with the next boom will be that the US and UK governments will have to use the tax receipts to pay down the simply gigantic levels of debts they have left us saddled with.

These are worries for another day – lets just enjoy the hope that this is the end. It does feel great to be back doing deals!

One of the factors for rapidly rising inflation in the earlier part of the year was the rise in the price of oil. As a large component of fertilizers is oil, this also then fed through into increases in the price of food. It is amazing to recall how much circumstances have changed in the last six months. We were really worried about stagflation rather than deflation as we face now. Given the importance of the price of oil, where next?

Oil peaked at $147 a barrel in July. It is now around the $45 a barrel range. This is a drop of two thirds. This will ensure substantially lower inflation over the next few months. There is no doubt that the ‘correction’ in the price of oil has been vey sharp, if indeed you could describe it as a correction.

Many would argue, including Tim Guinness (an energy fund manager, who is a bit of an expert in these matters) that at $147 the price of oil had risen too far and too fast. He thought it would correct itself to trade at the $70 to $80 range and then move upwards gradually. In the long term, I remain convinced that the price of oil has to rise substantially. Oil is running out and demand is increasing.

In the short term though, I would expect the price of oil to remain below $50. Politics plays a big role in this. These thoughts are based on my own analysis – and no doubt experts who are more knowledgeable than me will have better informed views.

As one of the major oil producers, Saudi Arabia has a major influence on the volume of oil produced and hence the price. It is of course easy to assume that the Saudi interests are best served by having as high an oil price as possible. That I think misses the wider point. The marginal cost of a barrel of Saudi oil is around $17. For Canada at the other extreme, it is around $62 a barrel.

The Saudi budget balances when the price of oil is around the $30 range. Saudi Arabia is overwhelming Sunni and they have long been worried by the Iranian Shiite regime. The Iranian sphere of influence has gradually been spreading. The Saudis are worried about the influence Iran is having in Iraq and the success of their proxy Hizbollah in the Lebanon. The Iranian populist (bad use of the phrase – I would have preferred the word demonic) president is popular with the poorer classes in Iran.

The Iranian budget needs the price of oil to be around $70 for all of the planned social spending to be carried out. It is now more important to them to have a high oil price to combat the effects on sanctions brought on by their pursuit of nuclear weapons.

Elections are coming up in Iran early next year and there is every chance that the reformers could win under the former President Khameni who is being nudged out of retirement. A low oil price would hinder the chances of President Ahmedinijad of being re-elected. It is my view that the Saudis would be pleased to see a regime change in Iran. A low (ish) oil price may help them achieve that objective.

I would expect the price of oil to stay low until after the Iranian elections and then rise if Khameni (he has not yet declared himself as a candidate) or another reformer was to win the Presidency.

I also fear that if Nethanyu wins the election in Israel and the current regime is re-elected in Iran, Israel will order pre-emptive strikes against Iranian nuclear sites (as they did against Iraq in the 1980s).

As investors or entrepreneurs, you need to prepare for these scenarios and realize how these events may have an impact on your business.

Let us hope that the second scenario does not come to pass.

Most of the world has recently moved from taxing income and wealth to taxing consumption and expenditure. Last week, the UK government temporarily (for the next 18 months) decided to bring the rate down from 17.5% to 15%. Many critics have attacked the move as not being bold enough and wanted direct tax cuts (on income) instead. I feel this criticism misses the point and in this business angel blog I want to defend the action taken by the UK treasury.

VAT (Value added tax) is a tax which countries within the European have to apply on a range of products. The standard band is between15% to 25%. Your standard VAT rate cannot go below or higher than those limits.

So, the most the UK government could do is reduce the VAT rate down to 15%. This point has been sorely missed from many of the commentators criticizing the move.

A point I have made in my previous blogs is that what we really need to see is consumers spending again. During a recession or any period of economic uncertainty, the savings ratio tends to rise. In the UK and the US, the ratio has recently been as low as 2% to 3% (By contrast in Germany it has been around the 10% mark). If consumers were given direct tax cuts, the likelihood is that they will use this extra cash to pay off debt. Again, as I mentioned in a previous blog, whilst that may be good for an individual (managing my debt down is certainly my priority for next year!), for the economy it is a bad thing.

Therefore the only thing the government can do is cut the main tax on expenditure which will result immediately and directly in lower prices. That is what they have done.

The flip side to this is though that of course it brings down inflation. That is an undesirable side effect. To play devils advocate for a bit, what if rather than reducing VAT the government announced that it was going to increase it to 20% from the 1st of March 2009?

I would have thought that this would not only help balance the government books, which look simply awful (Government debt will be 57% of GDP – up from around 40%) and it might actually induce people to spend a lot ahead of the VAT increase. Assuming people are rational, if you know that prices will be going up in a couple of months, you will no doubt try to save money by bringing forward your planned purchases. This is the exact opposite to where I fear we are heading which is the built in expectation of lower prices.

As I have argued over many blogs in the past, what we really need in the UK is a good dose of inflation!

I was having a coffee last week with one of my former managers at PwC and I reflected on why he was one of the best managers I had ever had. It came down to clarity.

These days it seems everything is being averaged. We are reluctant to say that a piece of work or a person’s skill set (we can’t call it ability) is not up to standard. I am a defender of political correctness (see in defence of political correctness) but this to me has nothing to do with the issue of respect. It is disrespectful to allow someone to carry on in a role with no knowledge of how they are doing. This lack of clarity is stifling for members of a team.

In the gulags during the Stalin era, the soviets used to break the spirit of their prisoners by making them dig a hole in the snow in the mornings and then fill it back up after a 5 minute lunch. They had worked out that nothing destroyed the soul quicker than being asked to break your back on work that was meaningless.

People often obtain their identity from work. One of the first questions we ask strangers is what they do for a living. You need to feel pretty good about your work to answer that question positively.

Many managers though fail in their duty to provide a sense of direction to staff that report to them. I am a big admirer of Gordon Ramsey. (He is a celebrity chef famous for his aggressive style in the kitchen and his demand for exacting standards as well as foul language). This may surprise you but why I see from his style of management is that his team is never under any doubt as to what is expected of them.

The manager I had at PwC was the same. He was seen as tough but you always knew exactly where you stood with him. He set clear targets which you knew you either had to meet or tell him why they could not be met (and hope that he accepted that). When he said “good job” to you it actually meant something. You knew that you had earned it.

The quantity theory of money holds that if there is too much money in an economy, you will get inflation. Money simply fails to hold its value if there is too much of it. I have the same belief about praise. You do get managers who get trapped in a praise inflation cycle. Because everyone in their team is great, when someone really does do very well, the praise that is heaped upon them becomes meaningless. These managers are responsible for creating a new industry called the ‘employee recognition industry’. If each manager did their job properly this industry would not need to exist.

What I like to do is manage people using just one overriding principle; clarity. Are members of your team clear about what is expected of them and why it is important? Are they aware of what will happen to the team if their role is not performed well? (if the answer is nothing – why are they being asked to do the job?) And avoid saying well done to people who I assume are adults simply for doing the job they are paid to do. Leave the praise to when they have done something noteworthy.

Well done for reading this!

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.

A couple of days ago I was talking to a good friend of mine who runs his own business (which I have invested in!) and he was lamenting the fact that M&S shares were down 25% although there was only a decline of 5% in sales. I then went on to explain how this actually made perfect sense so thought I would make it a business angel blog entry.

If a business has a fixed cost base of say £10m a year and makes sales of £30m a year with a margin of 50% it will make a profit of £5m a year. (50% margin on £30m means £15m of Gross profit, less the £10m of fixed costs and you end up with a profit of £5m)

Shares are typically traded on a multiple of profits. If a company has a P/E ratio of 10 that is the same as saying it trades at 10 times its annual profits. In the case of this company this would give the company a valuation of £50m (10×5).

Let’s say as in the M&S example that sales are down 5%, what should happen to the share price – if all else remains the same.

Fixed costs are still £10m (although in reality they will have gone up by inflation). But sales are now only £28.5m (£30m – 5%) and therefore the gross profit is £14.25m. Profits have gone from £5m to £4.25m which is a 15% drop. The shares will therefore drop by at least 15%. In the M&S case it was worse as the market had priced into the shares future growth not decline.

This brings me on to one of the key points I have learned in business over the last few years. It is really crucial that Entrepreneurs understand percentages. That is the relationship between numbers. You need to see how a 1% fall in sales will affect your profit and hence your valuation (in the above case the relationship is 3 – a 1% fall in sales led to a 3% fall in profits). It is never straightforward.

The best job I ever had was when I was elected to run the Student Union enterprises at Leeds University. It was when I first learned about the importance of percentages. I was amazed how a small price increase (on beer) had a huge impact on our profits.

Using the example above, if sales had not fallen but stayed the same but I was able to put my prices up 5% – what would happen to the profits of the company and hence its valuation?

£30m worth of sales are now £31.5m worth of sales but the gross profit has gone up from £15m to £16.5m (or 10%) and my profit for the year has gone from £5m to £6.5m or almost 30%! The lesson here for Entrepreneurs is to think very carefully about cutting prices and not be scared of putting up prices.

One of the reasons Sir Phillip Green has been so successful when taking over companies like Top Man has been his ability to shave huge costs out of suppliers. This ability to improve margins has a magnified effect on the bottom line.

From the above you may conclude that you should always be putting up prices. This brings me onto another very important concept in Economics called elasticity. In the next business angel blog, I will talk about this to see how far you can take the price rises.

I have now written two articles which seem to defend a position which most people like to attack. I have defended banks (with a heavy heart) and political correctness (with integrity and heart felt beliefs) and today I would just like to hear the case being made for a bit of [tag]inflation[/tag] (cheekily). So I accept that unchecked inflation is not a good thing – but I would like to just put forward the case that perhaps there are one or two positive aspects to come out of it. And in these current times, inflation may not be a bad thing.

Briefly, inflation is seen as a bad thing as it erodes peoples savings (high inflation means your savings become worth less than in a years time than in a time of low inflation), it causes goods in a country to become more expensive and therefore less competitive as exports to other countries which have perhaps had lower inflation. It also makes business planning harder as there is greater uncertainty.

It is interesting to look at the rapid rise in food prices around the world recently. Four main causes can be identified for the rise in [tag]grain prices[/tag].

• Firstly, because China and India are growing rapidly, they are eating more meat as incomes rise. Something like seven kilos of grain goes into producing 1 kilo of meat – hence demand for grain goes up significantly as demand for meat goes up.
• because of the madness of promoting [tag]bio-fuels[/tag], many farmers (especially in the US) are producing corn for fuel rather than food. Filling a tank of an average family car with biofuel uses as much grain as to feed a family of four for a year!
• the price of oil has shot up, the costs of fertilizers has gone up and hence the cost of producing crops.
• Finally (and this is not meant as a political point – it really is not) but the growth of the organic food movement will mean that yields will drop per acre as less intensive farm methods are used. (A study quoted in The Economist stated that if the whole world went organic we need four times as much farmland as we currently use – which would have to be rainforest. Interesting quandary – you can’t be green and organic!)

The beneficial effects of inflation are

1) It erodes the nominal value of debt. In the past debt has been easier to manage as inflation has helped erode the value of it. Let us take the example of you owing £10,000 today with your salary being £20,000 and you were paying interest only on the loan. After something like 10 years, if inflation was running at around 7% per annum (and your salary kept up with inflation) your debt would still be £10,000 but your salary would be £40,000. Your debt has gone from being half of your salary to a quarter. Many have argued recently (although their voices have not been heard much) that what we need in UK and the US is a period of inflation to erode debt. Even if house prices were to fall, if salaries went up with inflation – it means the % of debt to income would improve.

2) Zero or negative Inflation encourages consumers to save money rather than spend it. As we know consumption is the main driver of Western Economies. If prices are falling, and interest rates are positive, it makes more sense for me to defer my purchases and save money. If I have £100 in the bank and I have the choice of buying something now or saving it, I will probably save my money if I expect prices to be lower in a year and I know I will get interest on my money. In a year I may have to only pay £95 for the product instead of £100 and my money after a year in the bank may be £105.

3) Rising prices also act as a signal for entrepreneurs to enter markets and innovate. An example of this is Alternative Energy. Setting aside, the harmful effects of carbon emissions (and by the way the number one cause of carbon emission are termites and the number two cause are cows – and 2/3 of a cows methane emission comes from its mouth not it’s behind!) the rising price of oil has acted as a massive incentive for alternative energies as they now become economically viable.

Keynes, the great Economist of the 1930s through to the 1950s focused his attention on solving the world of the problem of Unemployment. When his ideas were criticised as in the long run they would lead to inflation, his reply was

“In the long run, we are all dead”