Business Angel Blog

I’ve written a blog before called In Defence of the Banks and one of the most common areas I am asked to help start ups with is in the meeting with the bank to try and obtain Loan Finance.

Firstly, despite all the concerns about the Credit Crunch (credit crunch explained) there is still a healthy appetite amongst both investors and banks to finance, lend and support small businesses. Many Entrepreneurs simply do not help themselves when making an application for a loan.

I hope this blog helps in your preparation to see a bank – please do let me know if it does – case studies are always welcome!

The first thing I should say which is a bit obvious is that banks want to lend money! People do forget that so when you go in asking for a commercial loan – expect the answer to be yes. If it is a no – try and get feedback in terms of what you need to do to get a yes – and then try elsewhere! In my experience trying to get a bank to change its mind is very hard. Better to start afresh.

Here are my top tips!

1) Have a presentation prepared. Banks want to see if you are a credit risk. Although it is unfair, they may judge you negatively if you come across as unprepared and without evidence of clear thinking. It does not have to be a PowerPoint – but it does have to clearly laid out and flow. (Would you like me to post a template?)

2) Make it clear you have costed out what you are spending the money on. Showing quotes can really help

3) You need to demonstrate that you or other shareholders are putting in some money as equity. It is fair enough for the bank to say “why should I risk my money – when you are not prepared to risk yours?”

4) Have complete mastery over the numbers. You really must. You must be prepared to justify every single assumption

5) Present a range of scenarios. You need to demonstrate that even in the worst case; the bank will get its money back.

6) If possible have an accountant or a competent finance person with you. I realise it is not always possible, but it really will make the bank feel comfortable.

7) Have a clear vision for the business which extends beyond the life of the loan or overdraft. Banks are more likely to lend to you if you can demonstrate you can have a good commercial relationship with them over a long period of time.

Listen and ask lots of questions. I am amazed at how many people in sales scenarios don’t listen to the person they are selling to! (this is perhaps for another blog)

9) Make sure you are not asking them for equity funding. It must be debt funding. For clarity on this read in defence of the banks. In a nutshell, you must be able to provide them with a high level of comfort that they are not taking a risk

10) Be positive! Very glib to say but desperation really does not work with a bank. I went through a horrendous period recently where it was like a house of cards and was very close to all collapsing. In the midst of all of this, I went to see a bank to get a business refinanced. Had I failed, the consequences for the business and for me would have been… (lets just say this blog would be called something other than www.businessangelblog.com I can honestly say that meeting was one of the hardest of my career in terms of emotions. I just had to keep it together and stay calm and resist the temptation to fall on my knees and say “Please just lend me the bloody money and rescue me!”

I hope this helps. If you have other tips or golden nuggets to pass on, please do let me know

When I was at Mr. Kipling cakes I was employed as a sales manager looking after a team of van sales people who were paid a basic and a commission. One of the key targets for managers was to ensure that the commission never got to more than 30% of a salary package! 

Years later when I was at a start up company as an Account Director I was actually fired essentially as I was earning too much money as a sales person (this came out later in the wash – the business has since gone into administration). I was at a meeting last week with an Entrepreneur who wants to get rid of his sales director – because he is earning a huge amount of money!

It occurred to me that this seems to be a silly way to go round things. Many managers are obsessed with controlling the pay structure so that the hierarchy is maintained. Again, when I was at Pricewaterhouse Coopers as a sales manager, some partners did have a problem with the fact that I was earning more than them (they omitted the fact that I was generating over £2m in new sales!) Companies seem to create pay structures that incentivise sales people – but then when they hit targets they begrudge paying the commission.

The top earner in a start up (first three years) should always be a sales person. Actually a good indicator for me as an investor on how well a company is doing is to simply ask how much the sales team (if there is one) is earning – and what percentage of the earnings is commission. As readers of this blog will have noted, I am not obsessed with a company making a profit in its first couple of years – but do need to see a strong ability to generate cash.

If you are obsessed with being the top earner, you will not make a good entrepreneur. You need to be obsessed with generating wealth, which is very different from generating an income for yourself.

My lesson from this blog to company managers is simple; set up a commission structure for your sales team that is realistic for them to hit and is profitable for the company even after paying the bonus. Once this is in place, do not begrudge them earning the commission – support them in making your business worth more!

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I apologise to those of you who hate Finance, but in my humble opinion it is important for business owners and investors to understand the concept behind WACC.

WACC stands for the Weighted Average Cost of Capital. Every company has their own WACC. A company is a good investment if their return on the amount invested is higher than their WACC.

So what is WACC?

A company has two sources of funding; debt and equity. Up to a certain point, equity is far more expensive than debt. This was a massive revelation to me as it seemed to defy logic. But it is true!

As has been mentioned on this blog before, investors require a higher rate of return on equity for the risk they take than if they were to deposit their money in a bank. I explained this from the point of view of the banks as well (please see In defence of the banks) So therefore the cost of equity will be higher than the cost of debt, especially if the business is successful!

Let’s work on a simple example. We assume a business has £50,000 of debt at 10% per annum and £50,000 of equity at 20% (there is a specific formula for working out what the cost of equity is – that is perhaps for another day!)

The WACC for this business will therefore be 15%. Imagine I decide to buy this business and I have an excellent credit rating so I acquire the business and am able to borrow 80% debt to buy the business. I do nothing else to the business.

What I have done though is bring the WACC down from 15% to

£8,000 (10% of £80,000) + £4,000 (20% of £20,000) = £12,000 or 12%

That is a huge drop in WACC – and this is exactly how private equity works. A company which can access huge amount of cheap debt will buy a publicly listed business (and therefore a large proportion of their capital will be equity) and take it private.

Please allow me to make a further point on the issue of private equity and on reducing the level of equity. If the business in the example above makes a profit of £20,000 when it was 50% equity and 50% debt (And assume they have 50,000 shares of £1 each). This means that after paying off the interest charge of £5,000 – the 50,000 shares get 0.30p each.

If the profit after the company has been taken private go up to £22,000 (up 10%) – what happens to the shareholders earnings?

The profit after the interest charge is down to £14,000 (£22,000 – £8,000) but this profit will be shared amongst only 20,000 shares (equity is now only 20%) so therefore each share gets 0.70p each. Despite profits going up 10%, the profit to shareholders goes up 133%!

You can see why private equity has been so attractive in recent times. However, if profits go down, it can have a disastrous effect as profits may not be enough to cover the interest!

We are in for some interesting times – make sure you control your WACC

Post Script – Thought I would mix it up a bit so this is the first time I have written something so technical on this blog so feedback welcome.

Agreeing to invest in a business is relatively easy. Agreeing to accept an investment is not as easy as it involves giving away part of what many entrepreneurs feel is their baby.

The first thing I should say to entrepreneurs is that they should think long and hard about whether or not to accept going down the investment road. Control is a big issue for many of you. But recognise that 51% ownership is meaningless. I have a very simple view, the moment you accept just £1 of external money, you have a legal and moral obligation to run your business in the best interests of all shareholders. I will typically not invest in a company where the management team have more than 70% of a company. No specific reason for that number, but I have found in the past that the business ‘owner’ does not recognise that no matter how small another investor is – they have the same duty of care and attention to them as they do to themselves.

So this is a short post – but I hope an important one. If you accept external investment please remember this means

1) You cannot use the company as a personal bank account

2) Every penny spent has to be to further the interests of the business

3) You have to produce meaningful financial information on a regular basis

4) You have legal obligations to always act in the best interests of shareholders. Especially if someone offers to buy the business!

5) The shareholders have the right to ask you lots of questions and expect answers!

6) You need to have at least one non-executive director on the board and recognise what that means

Having said all of this, most businesses find that external investors can add real value to a business and help it grow rapidly.

Let me ask you, would you rather own 100% of a corner shop or 1% of Tesco?

If your answer is the corner shop – because you want control and the lifestyle – external investment is not for you!

If you believe in the theory of efficient markets you would accept that it is not possible to consistently beat the market. And yet many people consistently do that – including my hero Warren Buffet. How do they do that?

Many successful investors take a very long term view and are prepared to take a contrarian view to the rest of the market. Buffet is perhaps the best example of that. Most of us realise that when cab drivers start telling you to buy shares, property or gold – it is time to get out of that market. Buffet seems to have a sense of picking up on this before it gets to the ‘cab level’. Having said that, many of us can get the timing wrong. The current UK property market is a good example. I along with many others (including The Economist!) thought that the market had peaked four years ago. In the last four years, prices have gone up at least 40%. Even allowing for the worst predictions of prices falling 25%, most people who stayed in the market will still be better off than having sold off when clear signs were available that the market was overheating.

As with all things, it is never as easy as following ‘six easy steps’ to investment success. Nonetheless, my advice to investors in start ups would be

1) Always take a very long term view – with start ups you should be looking at a five year time span at least.

2) Follow your own judgment. You may be wrong (and you are more likely to be wrong more times than right!) But you will be able to live with that. Trust me, the investments I have hated are the ones that have gone wrong when I trusted someone else

3) Do your own research. A day visiting a business and talking to managers and customers is a brilliant start – don’t outsource this to someone else.

4) Look at who else has invested. Even if I think something is brilliant – I need to know that at least one other person has also been persuaded (this does not conflict with point 2!)

5) Develop a set of criteria that works for you (readers familiar with my blog will know what mine are).

6) Above all, make sure you understand what the business does, how they make money and make sure you trust the management team

Happy Investing!

You will be amazed how many times [tag]Business Angels[/tag] see [tag]business plans[/tag] with very limited or meaningless market knowledge. As a potential [tag]investor[/tag], I really want to know what the sales opportunities are for the business – but I also want to know how realistic the chances are of winning sales for the business.

One of the things I should say to would be a presenter is please understand the difference between a Market and an Industry. For example, if someone is pitching a business which provides software for travel agents based in the UK – please do not quote me the size of the Travel Industry in the UK. That is not the size of the market you are going for! It would be more meaningful to tell me how much travel agents in the UK alone spend on software. Better still how much they spend on your particular application area each year. And then you can tell me about why they will switch and how easy it is for them to switch (are most of the agents tied in for 3 years etc?) Is there a pain in switching?

I hate being told that there is a £7bn ‘market’ when they mean Industry. (For me, a market size is the measure of the buyers spend, whilst an Industry is the size of the buyers and sellers in an area) Therefore for this business to be successful we only need to capture 1% of that market – which is growing at 3% a year. That statement is simply wrong and yet it is probably one of the most frequent mistakes I see in business plans.

To illustrate, someone recently pitched the idea of a dictionary for dyslexics. They gave me the figures of the dictionary ‘industry’ and they told me what % of the population suffered from this condition. But the figures did not add up. When I went through the numbers properly – it took me 10 minutes using Google, I was able to demonstrate that the size of the market was too small to justify an investment from a business angel looking for 10x their money back. That business is now talking to some charities and I expect will do very well as a social enterprise. But the point here was, the entrepreneur in this instance could have saved himself a lot of time if he had really understood the size of the opportunity as that would not have led him to abandon his mission – but just made him realise a lot quicker the best route to market.

The one ‘golden’ bit of advice I would also give to would be entrepreneurs is when you are selling something,

really understand what the customer/ client is buying – not what you are selling.

As someone who has been in [tag]sales[/tag] all his life, I try to train people to never sell – but to always help their customers buy. A lot of entrepreneurs get so passionate about their product or invention that they forget why someone might consider buying it.

The reason I chose [tag]sales as a career[/tag] is – you get more done by doing less. It is the ideal career for someone who does not want to work all the hours!

A business I invested in last year (2007) needed additional finance so I decided to put the company in touch with an investor whom I knew very well and respected.

The investor invited the CEO of the company desperate for cash to his house for a meeting.

The house is more like a castle and very impressive. It is obvious the moment you get there that this is a very successful person and you therefore assume very busy and you feel like ‘Wow – I have made it into the big league. This is who I should be dealing with’.

My CEO was then made to wait whilst the potential investor was on the phone doing deals which involved ‘millions’. The CEO is struggling for cash and is really hoping that this new [tag]investor[/tag] will do a deal and he is obviously successful and a nice guy (he spoke very well on the phone) and really knows his stuff.

The Investor was then charm personified and made the CEO feel very special. He also made it clear that he has no need to invest in this business – that whilst he liked the CEO he is very busy and how could he possibly add value. (Eerily – it looks like the scene in Goodfellas when the Boss is begged to become a business partner in a restaurant). The CEO then made the pitch to the Investor – saying that he really wants his expertise rather than his money. The Investor was persuaded but then makes it clear that he will only come in if he is a major shareholder (it is a lot easier to negotiate over a larger stake). The CEO at this point was practically wetting himself with excitement.

So they left on a handshake with the Investor suggesting that one of his team will get in touch with the CEO. I got a phone call from the CEO thanking me for the introduction and telling me how impressed he was with this Investor, and how with this person’s contacts and knowledge, the business could not fail with this person on board. I then heard the words that were truly scary “It doesn’t matter what he offers – I just want to work with him”.

When the offer came through – it was truly awful. The investor wanted a 1/3 of the business, to appoint an FD and in exchange for this, he would give cash ‘guarantees’. In reality this meant nothing as he would be in charge of the Finance Department. Despite it being such a bad offer, the CEO still wanted to think about it. Eventually we did say no to the deal.

The point of this little anecdote is that in business we are all to some extent showmen. What the Investor did brilliantly was sell himself and his brand. It was not the CEO who sold the business – but the other way around. I then learnt from some of my friends that they had very similar experiences when they were [tag]fundraising[/tag] – it seems the whole ‘look how big I am’ is an often used ploy by Investors.

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