Return of the angel investors

As the economy recovery gains pace, growing companies are hunting for sources of finance to support their expansion plans – and finding very different appetites for investment. The banks hesitant to lend and the venture capital sector seems to be shrinking following the GFC.

But there is one source of hope for SMEs searching for cash – angel investors are investors are returning to the market, hungry for opportunities.

Doron Ben-Meir, Prescient Venture Capital’s chief executive officer, puts it bluntly.

“There’s less venture capital around, and fewer funds to deploy. But angel investing is an active space.”

Angel investors, usually wealthy individuals who have a successful entrepreneurial track record and who invest their own money, occupy a different universe to venture capital firms.

Usually, these investors have found or run strong companies in the same or related field. And unlike venture capital firms, angel investors put money into start up companies at the seed stage, often where the only tangible product is an idea in someone’s mind.

The other big difference from venture capital is that it’s not purely financial. In exchange for cash and equity, the angel investor seeks to add value to the business.

It can be done by providing contacts, sitting on the board, introducing the entrepreneur to networks, helping with their governance, mentoring or creating an advisory board.

A recent survey from the Australian Association of Angel Investors reveals that in the 2009 calendar year – in the midst of the global financial crisis - angels invested a staggering $1.4 billion in more than 5000 companies, creating 26,500 jobs.

Most of these investments were in seed and start up companies with a heavy focus on biotechnology and IT. Angel investors were also bullish about communications, manufacturing and web-based software.

Angels were either investing as individuals or in syndicates using unit trusts. They spent over 40 hours a month on their investment activities, with half that time spent advising the entrepreneurs.

According to the survey, the number of angel groups in Australia is increasing. Four years ago, there were three angel groups. At the end of 2009, there were 12.

The association’s web site lists several angel groups and their email addresses: BioAngels, Brisbane Angels, Capital Angels, Gold Coast Angels, Hunters Founders Forum, Melbourne Angels, SA Angels and Sydney Angels.

Typically, each of these groups would see 50 to 100 deals a year.

The return of the angels is great news for SMEs, but experts says it wasn’t that long ago when angel investors were watching their money carefully and not backing start ups.

Ivan Kaye, chief executive officer of BSI, which acts as a matchmaker for angel investors and entrepreneurs, says funds dried up during the crisis.

“Every three months, we have a BSI investor forum where we showcase eight innovative companies to pretty much 100 to 200 high net worth individuals and funds. During the GFC, there was no one buying, it was dead for a year and half.

“Now suddenly, there is a lot of interest. There is a lot more deal flow and there is a lot more money around.”

“They are looking for businesses that have got the potential to be cash flow positive or are already cash flow positive, that have got a product and are making sales and the valuations are a lot more in line with reality. These guys looking for money – the entrepreneurs – are actually more realistic about their valuations. It’s closer to reality than it was during the boom.”

Entrepreneurs seeking investors approach BSI might pay a success fee, or a retainer, for helping them to access finance. Alternatively, BSI might take a stake in the company. It has already done that with 25 companies over the last four years.

Before introducing them to the investors, BSI works with them on their vision, their product, whether they have the right people in place, all done to get them investor-ready.

In a sense, BSI operates as a marriage broker but as Kaye, it is not always that easy. “You have to make the bride look very pretty because otherwise she will die lonely.”

He says there is one lesson to be gleaned from the financial crisis: businesses that survived were the ones that had good management teams committed to achieving the original vision.

Deputy chair of the Australian Association of Angel Investors, Jordan Green, says the downturn did not stop angel investors. Indeed, angel investors come into their own during tough times, he says.

“Early stage investing is a counter cyclical investment activity so whenever there is a downturn it’s actually a good time for early-stage investors,’’ Green says.

“We certainly saw that here in Australia. Two important things happened in the downturn that made it attractive to early stage investors. One was that valuations went down. The hype went out of the market and valuations became much more practical. Number two was that the entrepreneurs who tend to be in the market at that time tend to be entrepreneurs who are very serious about their business and committed to the long term of their business and not just chasing a quick buck.”

Still, he acknowledged there had been a pick up in activity.

“Our impression is that the quality of the deal flow that that angel groups have seen has certainly gone up.’’

He says that typically, angel groups would invest anywhere from $50,000 to hundreds of thousands in a company. They could take equity anywhere between 20-45%, although that varies according to the type of investment. There have been some cases where investors have taken as much as 70%.

Entrepreneur and author Tom McKaskill, a member of the Gold Coast Angels and Melbourne Angels, says the size of the equity depends on the valuation and what the investors, either as individuals or as a consortium can offer.

If there is a low valuation and the investor tips in a quarter of a million dollars, they will have a fair chunk of the business. But if it was a high growth company with a large valuation, the same money would buy less equity. There is no set number.

Similarly, he says angel investors come in all shapes and sizes.

“Some are more sophisticated than others,’’ McKaskill says. “Some have better processes than others, some invest on gut feel, some invest on recommendation, some invest after getting their accountants and lawyers to do the due diligence.

“I have not seen any standardized pattern across the people we have worked with. They are all over the shop. Some are very sophisticated, some I would say are very naïve.”

As a rule, he says, angel investors tend to invest in sectors they are familiar with.

“If they come out of manufacturing, they are likely to invest in manufacturing, if they come out of IT, they are likely to invest in IT,’’ he says.

“What we have found is that when we put propositions up to groups of angels, if there is no one that has come from that particular sector, not matter how good the proposal is, it’s unlikely to be invested in.”

He says angels were less forthcoming during the downturn because the size of their liquid assets had declined. And now, even with the recovery, the angel consortiums are tipping in less than they would have during the boom.

How do entrepreneurs get in touch with angel investors? Apart from contacting the Australian Association of Angel Investors, they are likely to run into angel investors at networking events. Others turn to their lawyers and accountants to put them in touch with them.

And what are the rules of engagement? How does one conduct due diligence on a proposed start up that still has to start trading?

When there is no revenue coming in, investors look at such issues as patent and intellectual property protection, the size of the proposed market, employment contracts and shareholder agreements. They are more likely to be attracted to businesses that can scale up quickly and can be sold later for a big profit. The exit price is critical for attracting investors. And for some investors, all these can be as important as the financials.

David Gold, founder of LookSmart says: “I don’t place a large amount of credence on the financials. I will look at the market size and its potential. If there are other credible investors involved, I will look at it more closely.”

That in itself is the mark of angel investors. In the absence of hard numbers, it usually comes down to gut feel – and that can make it tough for SMEs to win an investor over.

But at a time when venture capital is declining and it’s harder to get money out of banks, the angel investors might be the only choice entrepreneurs have.