Business Angel Blog

“The problem is the world is too pessimistic, and I cant see it getting any better”

Optimism is the lifeblood of entrepreneurialism. It is where our ideas and our energy come from. It is the source of great endeavours from Landing on the moon (40 years ago) to the building of the Channel Tunnel. Optimism is what leads angel investors to invest in start ups knowing that in all likelihood they will, on any one deal, lose all of their money.

When I was in Halifax, I was reminded of a great story that I was told about optimism – and I hope you do not mind me retelling the story.

A businessman owned a great shoe making business. He had two sons and sent them out to an island to examine the possibility of selling shoes to the local population.

After one week of being there, both sons were able to submit their reports. One reported back that there were no opportunities out there “as the population simply does not wear shoes” The other son reported back “the opportunities are enormous as the locals do not wear shoes. There is no other competitor here and we have the whole market to ourselves”.

This is a great story and when ever you go to any foreign market you will always spot great opportunities but you also have to be cautious and ask yourself why the opportunity is not satisfied at the moment.

I remember a famous English based jewelry retailer going into the Dutch market. A bright graduate they had sent out there reported back that the opportunities were enormous. The company set up shop and then in the run up to Christmas, put lots of stock in the Dutch retailer. In January, the company was shocked to discover it had such high levels of stock in its Dutch subsidiary. The reason was simple; the Dutch do not have a tradition of buying jewelry at Christmas! Yet, no one had bothered to check this vital assumption.

Another real example is that of The Sock Shop. The founders had built up a great and fast expanding business in the UK by placing Sock shops in concessions along the London Underground and other busy locations but with cheap rents. The business model worked because they had such low overheads and customers knew they would get good quality and varied socks from this shop. In the move that killed the company, they decided to expand into the USA. They decided that New York was the ideal location (it was) and they decided to rent lots of concessions in the Metro system.

This was in the late 1980s and the company made a fatal flaw in its property policy. No one traded in the Metro system other than drug dealers and no one wanted to be in those shops! The company had to employ security guards in the stores and had to have strict opening hours; the business failed.

The lesson here is that whilst I was in Canada, I spotted many great opportunities and I think it is a great place for any aspiring entrepreneur to be right now (I really do). But you simply must ask yourself the question, “ why has no one else satisfied the need that you have spotted?”

When it comes to foreign markets this becomes more apparent but I am still amazed at how few companies do basic testing in their home market.

Optimism is great – but temper it with some evidence!

There has been much talk about the nightmare of negative equity returning to haunt the UK property market in the press over the last few months in the press. What does this all mean and what is the impact it is likely to have on entrepreneurs looking to raise money?

There was an interesting statistic published last week. 39% of start ups require just £10,000 or less to take them through to profitability. I appreciate that business angel blog is aimed at businesses looking to raise slightly more than this amount but it is an interesting statistic.

An overwhelming number of businesses get funded from family and friends. The ability of most people to help start ups is linked to the value of their property and hence negative equity will have a strong and negative effect on the number of start ups that are able to access this vital line of funding.

Most people when buying a property will borrow money to make that purchase. Let’s say someone buys a property for £150,000 (more or less the average price of a home in England). They borrow 85% of the value and make a 15% deposit. I bought my first place with a 95% mortgage! This means that the equity they have in the property is £22,500. If the price rises by 10% to £165,000, and the debt remains the same so the increase feeds straight through into the equity element. The equity is now worth £37,500 – this is an increase of almost 90% (this is known as the leverage effect).

As the homeowner feels wealthier – they may be inclined to re-mortgage and use that extra wealth to fund a start up. (You should never as a rule use borrowed money to invest in a start up – but people do).

All very well so far. But what if the property price instead of going up 10%, falls in value by 20% – as it has in the last year in England? Suddenly your property is only worth £120,000. Your debt is £127,500 and hence you have £7,500 of negative equity. This leads to financial insecurity and hence an inability to help friends and family who need some money to start a business.

The irony is that when in a recession, more people lose their jobs and hence would like to give entrepreneurship a go – but find the lack of funds available a real barrier to start

I was talking to a few of the start ups I had invested in recently and some themes started emerging for me in terms of the ones that were successful and the ones that were not.

One of the striking characteristics of the successful ones was the planning that went into the launch. I know that you have probably all heard about the six P’s (proper precise planning prevents poor performance) or ‘failing to plan is planning to fail’ etc but what struck me was the quality of the plans that went into the planning for the first 100 days in particular.

By definition, if you have raised monies through a business plan – you have a plan! However, what I noticed was a depth to the plans that many of the successful businesses I had invested in shared. Here the entrepreneurs could see what they would be doing and were living the plan.

If you are in business and facing a difficult time or if you are starting a business, I think writing down a 100 day action plan would be a great start out of your problems or to see you through an effective start.

Writing down a 100 day detailed plan – hand in hand with a cashflow projection is a great way for you to start seeing the links between your actions today and your cash balance tomorrow.

Once you have written the plan, have it checked and ‘sanitised’ by a friend or spouse (in my experience the terms are mutually exclusive!) preferably someone who is not too close to the situation as they may always be able to add a common sense check to your plans.

The problem with long term plans is that I think they can be lazy and can make you just ‘wish’ a better future and hope that all is OK. As we have seen from the last few weeks, we do live in very volatile times. If you were working in the strategy team of a bank – I doubt if any of your plans which are more than a month old are still meaningful.

If you have a tight focused plan – it can be great to see the impact of variances to the plan immediately and therefore what you need to do to address that situation.

The danger with making plans which last longer than 100 days (you may feel that this is too long and you go for fifty days) is that it will lose focus and you add too many unknowns into the plan. You are also in danger of merely writing about the business rather than running it!

Happy running!

One of my favourite modules on my MBA course was Financial Engineering. A more accurate name for this module would have been ‘making profits from thin air’. I am convinced that employees from Enron were required to excel on this course! One of the great techniques I learnt about was boot strapping!

For a variety of reasons, different businesses often get rated on different multiples. A mature business with good management which is listed may for example be trading on a multiple of ten of annual profits. A new entrant which is up and coming on the other hand may have a multiple of twenty (as the growth prospects are better). Bootstrapping occurs when a company with a higher multiple takes over a company with a lower multiple and benefits from the entire new company getting re-rated with the higher multiple.

Company A makes profits of £1m and is rated at 10x profits and therefore has a valuation of £10m.

Company B makes a profit of £0.5m but has a multiple of 20x profits and therefore also has a valuation of £10m.

Both companies are worth £10m each and you would therefore think that if they were merged (ignoring any cost savings and other synergies etc) the new company would be worth £20m.

But if company B was to buy company A, the new company may get rated on the same multiple as company B before the merger. Therefore the new company B will be rated at 20x profits of £1.5m which is £30m.

Bootstrapping has thus ‘created’ £10m of additional value simply through re-rating the prospects. Some of you will no doubt argue that I have simplified this very complicated area. Of course, it is a bit more complicated than this, but the end result is the same.

In the 1980s companies like Hanson trust were able to build themselves into huge empires by acquiring companies which had lowly rated earnings, but then apply a higher multiple. This made Hanson shares expensive – which allowed them to continue to buy other companies. Tomkins also did the same thing before it suffered a severe bout of indigestion having bought RHM (incidentally, my first employer). RHM was simply too big for them to manage effectively.

Start ups are often valued at a multiple of turnover. Hence many start ups do try to buy other companies with turnover. This is especially true in cases where you can buy a company for cheap because it has run into trouble.

This is a brave strategy. The key thing to bear in mind is management ‘bandwidth’ Many companies, especially start ups simply do not have the room to manage another business.

Given the climate we are in though. I would not be surprised if someone did come along to buy many businesses on the cheap with a view to bolting them all on to get a higher multiple.

You heard it here first!

Here we go again – and welcome!

The first business pitching last night was a company from North London with a business which provided instant paper blinds which required no tools for assembly. The pitch was simply great (Elevator pitch 10/10). They knew their market brilliantly and were able to convince me within the first two minutes that their was a demand for this (and it is large). The question is always about the detail and profitability.

The first issue was one on the patent on the product. It is always dangerous for an investor to go into a business which cannot be protected. Barriers to entry are a key requirement for ensuring a business is able to generate good products. As a result of the lack of protection they lost many of the potential investors. (This is a good topic for a future blog!)

The second issue was that the business team (three people) had only achieved one sales meeting with a major retailer in five months. This meant that they got crucified on valuation (they were offered £40,000 for 50% of the business). I felt for them. Had they just spent a bit more time selling the idea, they would have achieved a far higher valuation. I cannot stress this enough – you need to demonstrate to an investor that people want your product. (Incidentally, that is how I got into angel investing. I helped a few start ups get their first sales and then realized what had happened to their valuation as a result of my help! I then started investing.)

The second presentation was a low calorie and zero cholesterol curry sauce. It was a good presentation but because of my earlier experience of selling low calorie cakes I was very skeptical. The great thing is that she had actually sold the product. She sold a lot of jars after appearing on QVC. Brilliant, but you only make money out of selling food lots of times – the repeat purchase is very important and this has not yet been proven.

It was all going well but then she dropped a bombshell….

She was trying to transfer assets from one company to another whilst leaving the debts in the original business. This is too sharp for me as a practice. However, the Dragon’s all came out one by one. I disagreed with the reasons the Dragon’s gave for not investing but would not have invested in her because of my skepticism about the appeal of fat free food!

We then had a presentation from an investor looking for £150,000 for 10% of an energy efficiency business. I am sorry to appear slow but after the presentation; I still did not understand what the business actually was. The entrepreneur was honest, hardworking and passed that critical test of putting his own money (substantial) into the business. Having lost money on investing in businesses I haven’t understood – I was never going to invest in this one and nor did any of the dragons.

The final business pitching tonight was a ‘green’ business which made packaging from recycling materials. They had great customers and it is a business in the moment. I would have invested in this business as unlike the dragon’s I liked the fact that the entrepreneurs had a bigger vision. My only concern would have been that it seemed that the entrepreneurs needed a lot of help on the business. I was delighted to see that at the very end they managed to secure the investment and got one dragon to change his mind!

All the best until the next one!

The first presenter (mobile shoes) did a great presentation despite being understandably nervous. She had enthusiasm, she knew her customers (very well) and she had built up a good business with 21 franchises. She knew her numbers as well (which was very impressive).

The problem she faced is the same that a lot of retail start ups face and is a real problem when your unique selling point is variety and choice. The issue here is that variety and choice means huge stock costs. I hate investing in stock. One of the great lessons I learnt at University was about the Japanese way of just-in-time production. It was all about managing stock costs. Having stock is very expensive. My advice to would be entrepreneurs (and I saw two this morning on this very subject) is to really focus on how you can reduce stock costs. It is a killer!

I am writing this as I watch – as I don’t want to follow the dragons. The glasses idea – wow! I got excited about that. I just know that there is a market for that. London house parties will never be the same again! As for the numbers – they seem to stack up. I get the environmental concerns but I also believe that the team with help and investment can solve that. I am glad he got the investment and it will be interesting to follow this one. In terms of the offer, my standing problem with the program remains, giving up 30% of his business for £40,000 seemed daylight (pardon the pun) robbery. I would have invested in this!

I liked the Barbeskew idea – I did. The solution he offered did solve a real problem. However, the price he was proposing to sell his solution for was way over the pain of the problem he was solving. And as it was not protected, it was too weak a business proposition. I see this type of business a lot sadly – ask yourself before you price your solution – how painful(in monetary terms) is the problem to your consumers your solution is solving!

The PC case – sorry just too boring for me to comment on. Ignoring the business – you cannot put a valuation of 50 times projected earnings – you just can’t!

As someone who did incur a very expensive bill because they filled a diesel car with petrol (back in 1998!) I was very interested in the business to do with the misfuel device. Companies who invent great technology often have a debate on whether to licence or to sell themselves. This is perhaps a blog I can return to at a later date? (Can I also say – a brilliant bit of negotiating by the Entrepreneur – well done!)

I recently wrote a blog about controlling your costs. I got a few emails pvalia@businessangelblog.com (thank you) asking me about salaries for the management team in a business plan. I hope you find my response below helpful.

There are two types of money you can earn; Income and Wealth. Entrepreneurship is about generating wealth for yourself and your investors in the business. If your primary objective in starting a business is to generate an income, there is nothing wrong with that. Please recognize though that this is what I would call a lifestyle business and it is not an investable proposition for external investors (friends and family may still wish to invest).

In business plans for start ups where the entrepreneur does not have a great track record, the salaries have to be very modest. I simply will not tolerate a situation where the investor is seen to carry all the risks and the so called entrepreneur carries on with a great lifestyle irrespective of the fate of the business.

I do see business plans, where the Entrepreneur puts himself down to earn over £60,000 per annum. I find this figure a tad high for a start up situation. They should recognize that till the business starts delivering a profit, they need to earn enough to just keep going. They should be motivated by generating a huge amount of wealth for themselves rather than income.

The defence they (owners seeking high salaries) often cite is that they are very talented and could earn a much higher salary in the market place. I hear that, but I think they have missed the central point about wealth v income. And if they value an income so highly – I would urge them against being an entrepreneur – as it really is probably not for them. They should stay in a highly paid job.

As an interesting aside, I looked at the businesses I have invested in over the last few years and found out that the average salary of the CEO’s I have backed is around £40,000. Interestingly (and not scientific at all), businesses that have failed for me tend to have much higher CEO salaries (average in this bunch has been £60,000)

I am working on a new start up at the moment, and I will not take a penny as a salary until the business generates revenue. I accept this happily as I have a 75% stake in the business. My attitude is simply – sod the income – think of the wealth if it succeeds!

I have had the pleasure of supporting an initiative based in Manchester called EnterPrize . The idea is to help companies raise ‘their game’ and grow.

It has been a very interesting experience for me and I have enjoyed spending the last two days providing one to one coaching to five different businesses who were all finalists (that is part of their prize readers – spending time with me!)

The reason I have loved working with these people is that they all come from different backgrounds and are engaged in various fields. Building signs to Arabic clothing to domestic services and a great one providing a fitness service for non-gym goers. This makes for such an interesting experience for me and I can say that I felt revived by it.

One of my business heroes, (and a good friend) is a guy called Chris Gorman. He has a very simple mantra which says “work hard, play hard and always give something back”. He remembers how he was supported by Sir Tom Farmer when he started in Business and in turn he now offers support to as many start ups as he can manage. I could not by any definition be considered a success yet, but I do feel that I have benefited enormously from certain people providing me with lots of support and encouragement from time to time.

If you are an entrepreneur with some experience (just one year will do it!) please get involved in a local initiative to support start ups. Even if you can only spare one hour every month – please do something. I can promise you will find it very rewarding and I can guarantee you will learn lots and become a better business person as a result of putting something back.

You will also benefit from an enormous amount of goodwill which will have a business benefit. One of my very first blogs was Being nice as a business strategy. It remains 100% true!

Happy Giving!