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Richard Hargreaves. How To Become A Business Angel
Publishing details
About the Author
Preface
Introduction
Chapter 1: The Basics. Introduction
The importance of angels. Angels
The scale of angel financing
Angels and innovation
Where angels fit within the financing spectrum
Friends and family
Banks
Venture capital
Government-sponsored funds
The angel investor
Government stimulus for angel investing
Why angels are attractive investors. How entrepreneurs compare angels and VCs
How angels and VCs differ
1. Angels invest their own money whereas VCs invest other people’s money structured into a fund
2. Angels are quick decision makers. They don’t need to consult others when they invest – in contrast to VCs
3. Angel syndicates can be difficult to pull together because they make decisions independently of each other whereas a VC writes one cheque once he and his colleagues have agreed to invest
4. Angels will usually opt for a simple investment structure (the EIS requires it) and ask for simpler controls on decision making as the venture develops
5. Angels can add value from their own experiences and contacts. All VCs say they can but it is not always true
6. Angels are less punitive in their approach to further investment when things don’t go well
Case Study
Learning point
Summary
Chapter 2: Deciding Whether to be an Angel. Introduction
Are angel investments for you? Published research on UK angels
1. Investment outcomes
Enhancing the returns using EIS
A model to illustrate the effect of EIS reliefs on angel investing
2. Characteristics of UK angel investors
3. Strategies which improve investment outcomes
Requirements to be an angel
1. Accept the risks
2. Spread the risks
3. Invest systematically
4. Take advantage of available tax reliefs
5. Invest mostly in things you understand
6. Do some due diligence
7. Only invest when you like and respect the management
8. Plan to offer your experience when and where it may be of value to a venture but don’t impose it
9. Avoid investing good money after bad when things don’t go to plan
10. Enjoy being an angel
Portfolio considerations
Modern portfolio theory
The relevance of the theory to the angel investor
How big should a portfolio be? How many investments?
How much to invest in each?
Whether to invest more
Other portfolio issues
Other approaches to investing in unquoted companies
Funds
Venture Capital Trusts (VCTs)
Enterprise Investment Scheme (EIS) funds
Approved and Unapproved funds
Pros and cons of EIS funds and VCTs
Prospectus EIS deals
Loans to companies
Case studies. 1. Cautionary tales
Learning point
2. An example of an angel portfolio
Portfolio
Progress to date
Involvement
Learning point
3. An example of an excellent EIS prospectus offer
Learning point
4. A rogue EIS operator
Learning point
Summary
Chapter 3: Finding Investment Opportunities. Introduction
Matching entrepreneurs and angels
The importance of deal flow
How to find opportunities. Contacts
The unsolicited deal
The internet
Cautionary note
Crowd funding
Angels dating companies
LinkedIn
Angel networks and syndicates
Fees
FSA rules
Self-certifying
The Angel CoFund
Summary
Chapter 4: Assessing an Opportunity. Introduction
The balance between risk and reward
Initial screening checklist
1. Use clear personal parameters
2. Read the executive summary first
3. Check the length of the business plan
4. Financial projections
5. Cash requirement
6. Legacy issues
7. Market share fallacy
8. Entrepreneur’s investment terms
9. The management
Management team and its vision
Previous success and failure
Vision
Focus
Commitment
Referencing
Business model
Product and market
Market need
Is the product a must have?
Intellectual property
Patents
The benefit of patents
The cost of patents
Exit value
Development risks
Financial planning
Cash requirement
Cash flow
Legacy issues
Pricing model
Scalability
Exit
Case studies. 1. An illustration of the entrepreneur’s challenge
Learning point
2. Backing unproven young people
Learning point
3. The vision of Steve Jobs
Learning point
4. Establishing a must-have product
Learning point
5. IP opportunities
Learning point
6. Scalability in the internet world
Learning point
Summary
Chapter 5: Investment Terms. Introduction
When do you write your cheque?
The benefit of a shareholders’ agreement
The risks with no legal agreement
Structural matters and investment instruments
Investors with different terms
Shares. A cautionary note
Ordinary shares
The benefits of ordinary shares
Premium protection
Preference shares
Deferred shares
Employee options
The Enterprise Management Incentive scheme
Other options and warrants
An alternative incentive approach for senior management
Debt linked to equity
Bank lending
Overdraft facilities
Term lending
EFGs
R&D tax credits
Grants
Entry valuation
Investment valuation. Internal rate of return (IRR)
What is a good IRR?
Limitations of IRR
When you might see IRR used
Early-stage valuation guidelines
Deal benchmark
1. The valuation has to be sensible
2. The whole of the investment should be in ordinary shares
3. The investment must qualify for EIS tax reliefs
4. The articles should have certain standard clauses
5. The founders should have made a sensible financial commitment
6. There should be an option scheme of at least 10% of issued share capital to incentivise members of the team who are not shareholders
7. The salaries of founders must be agreed with service agreements in place
8. There should be appropriate good leaver/bad leaver provisions
9. Investors should have a majority of the voting shares
10. There must be non-executive directors on the board, one of whom should be chairman
11. There must be a shareholders’ agreement
12. Directors should fill in a legal questionnaire
13. Keyman insurance should be in place
14. Trust
Common issues when negotiating terms
1. Control
2. EIS
3. Equity percentage and ratchets
4. Money on the table
5. High salaries and bonus arrangements
6. Good leaver, bad leaver
Case studies. 1. A staged investment
Learning point
2. Traps with convertible loans
Learning point
3. The use of IRR in an exit calculation
Learning point
4. An exit ratchet
Learning point
5. A discretionary bonus
Learning point
Summary
Chapter 6: The Enterprise Investment Scheme (EIS) Introduction
Historical note
The EIS tax benefits
Income tax relief
Exemption from CGT
CGT deferral
Loss Relief
Inheritance tax
EIS carry back relief
How EIS can enhance your returns
Table 6.1 – example investment in company shares with and without EIS reliefs
Table 6.2 – sale of shares for five times amount paid after three years
Table 6.3 – company goes bust and investment is lost
Table 6.4 – example investment in company shares with and without EIS relief
Table 6.5 – sale of shares for five times amount paid after three years
Table 6.6 – company goes bust and investment is lost
Qualifying for EIS benefits
1. Qualifying investors
Connected investors who don’t qualify
Financial interest
Employment
2. Qualifying investments
3. Qualifying companies
1. Must be unquoted
2. Must not be controlled by another company
3. May have subsidiaries
4. Must be a small company
5. Must have fewer than 250 full-time employees. 6. Must carry on a qualifying trade
7. Does not have to carry on the trade in the UK. 8. Does not have to be resident in the UK
Qualifying trades
How the money must be used
How to claim EIS relief
How to lose EIS relief
Cautionary notes
1. You may be concerned that all the money raised might not seem to be invested within the required timescale
2. It is not hard for a company to lose its qualifying status
3. An easy way to cease to be qualifying is the formation of a new subsidiary which is not more than 50% owned
4. It is quite common to wish to form a holding company for commercial reasons
5. It is important to make sure no arrangements are created allowing another company to either take control, or to have the right to take control, at any time in the future
6. At first sight the takeover for shares of one EIS qualifying company by another might seem to be acceptable
7. The 30% rule needs to be watched if there is a large investor
8. As an angel you will be investing for capital gain and so you are interested in the company being sold at a profit
9. The company has several financing rounds before the exit
The Seed Enterprise Investment Scheme (SEIS)
Points of difference between EIS and SEIS
Comment
Summary
Chapter 7: Legal Documentation. Introduction
Changed rules for private companies
The legal framework
1. Terms sheet
2. Articles of association
Share capital
New issues of shares and pre-emption
Share transfers
Compulsory transfers
Drag-along
Tag-along
General meetings
Resolutions
Borrowing powers
Directors
Duties and responsibilities
Appointment and removal
Number
Alternates
Proceedings
Conflicts of interest
3. Shareholder agreements
Subscription
Completion
Warranties
When warranties arise
Standard investment warranties
A typical set of warranty headings
An example warranty clause
A short form example of warranties
Disclosure letter
What warranties achieve
Common issues with agreeing warranties
Employee share options
Investor directors
Information rights
Investor consents
Restrictive covenants
Deed of adherence
Variations
4. Service agreements
Dismissal
IP and inventions
Restrictive covenants
1. Non-Competition
2. Non-Solicitation
Case studies. 1. Traps for the unwary. A private example
A public example
Learning point
2: The value of drag-along clauses. Example 1
Example 2
Learning point
3. An investment warranty claim
Learning point
Summary
Part C: Managing Investments
Chapter 8: Active investment management. Introduction
Initial formalities
What you should expect from the company – and they from you
Mentoring
The board
The non-executive director (NXD)
Personal risks
The size and make-up of the board
Building a board
Board meetings
Board papers
Procedural issues
Arranging meetings
Meeting formats
Conduct of meetings
Voting
Removal of NXDs
Areas of influence of NXDs
Strategy
Budgets
Accounting
Income recognition
The importance of full accounts
Funding needs
Overseas development
The need for management evolution
Introductions
Salesmen
Try and try again
Exit
Case studies. 1. Structuring the board when there are many senior executives
Learning point
2. A public example of management change
Learning points
3. A private example of getting management wrong
Learning point
4. A story of progress from start-up to established business
The company
Building the board
What the NXDs brought to the table
Board contribution
Strategic ecosystems
US sales and move
Sales hiring
Accounting
Pricing
Evolution of management roles
Discipline
And so what next?
Learning points
Summary
Chapter 9: Resolving Corporate Issues. Introduction
Failure to develop to plan
Morale
Sales slippage
1. There is demonstrable demand but sales are not developing to plan
2. Significant sales haven’t started despite market interest
3. There is little interest from potential customers
Predicting cash needs
Overtrading
Retail cash flow
Financing cash needs
Further rounds
Down rounds
Setting the price
Insolvency
People problems
Dismissal. Unfair dismissal
Employment contracts
Legal advice
The formal three-step process
Step 1
Step 2
Step 3
My own experience
Compromise agreements
Payments
Shares and options
Litigation
1. Patent infringement
2. Wrongful dismissal
3. Product and public liability
4. Directors and officers liability
Case studies. 1. Sales failing to develop. The vision
Consumer response
Alternative ways forward
Learning points
2. Management evolution
The first step
The second step
The third step
The fourth step
Further steps
Learning points
3. Pricing model changes. Background
The pricing problem
The solution
Learning points
4. Trading whilst insolvent
Learning points
5. Down rounds
Example 1
Example 2
Learning points
6. Litigation
Example 1
Example 2
Learning points
Summary
Chapter 10: Resolving problems with other Investors. Introduction
Investor characteristics
Other angels
VCs
1. Funds which come entirely from private sources
2. Funds partly backed by public sector money
3. Tax advantaged funds
The VC process
Corporate investors
Banks and other lenders
Relationships between investors
Approaches to structure
1. Preferred shares
2. Ordinary shares and loan stock
Interaction between ordinary shares and VCs’ terms
Preferred shares
Loan stock or preference shares
Investor consents
Funding rounds
1. Pre-emption
2. Dilutive rounds
3. Highly favoured investment instruments
Time horizons and approaches to exit
Changes in investor manager
Case studies. 1. Bad bank behaviour
2. Balance sheet restructure and exit expectations
Investment
Performance
The first investor meeting
The second meeting
The third meeting
The solution
Learning points
3. New investors at a high valuation
The Series A offer
The legacy problem
The solution
Learning points
4. New investor and the protection of EIS relief
Learning point
5. Corporate investors with special needs
The challenges
Learning point
Summary
Part D: The Exit
Chapter 11: General Principles of Exits and IPOs. What is an exit?
1. Flotation or IPO
2. The sale to a trade buyer or private equity
3. A partial sale
4. A distressed sale
5. A complete failure of the business
Flotation or initial public offering
Benefits and drawbacks
AIM
Tax advantages
Scale of the AIM market
Movements to and from AIM
The downside of AIM
Costs and regulation
Shareholder liquidity
Restrictions on directors’ dealings
Case study. From IPO, via growth by acquisition, to sale to private equity
The flotation
The early period
New management
Shareholder liquidity
The sale
Choosing advisers
The legal process
Events after the sale
The postmortem
Learning points – a personal view
Summary
Chapter 12: Sale: Strategies and Process. Introduction
The trade sale. Why the trade sale is attractive
Strategies to achieve the best trade sale
1. The best exits are when companies are bought, not sold
2. Ensure investors’ views are aligned
3. Confirm whether exit ambitions relate to market reality
4. Try to speak to prospective buyers
The selling process
1. The direct approach
2. Appoint advisers to conduct a structured sale process
Choosing the adviser
A beauty parade
Cost concerns
The best choice
Appointing the adviser
The sale process
3. Be approached by a potential buyer
How a business is valued by a buyer
Ways to enhance value
1. A scalable business model
2. Customers
3. Market position
4. Product
5. Culture
6. Systems
Enterprise value
An example calculation
Case studies. 1. Unexpected investor alignment
Learning points
2. A structured bid process
Learning points
3. Sale triggered by an unsolicited approach
The unsolicited approaches
The approach to an alternative buyer
Process
Sale issues
1. The company had a large PAYE liability dating from an earlier period
2. There was a fierce technical argument as to whether the fees the company charged were VATable or VAT exempt
Shareholder issues
Legal matters
Learning points
Summary
Chapter 13: Sale: The Consequences of Different Structures. Introduction
The importance of tax
An overview of investors’ tax positions on exit
EIS
Entrepreneurs’ Relief
Retirement relief
Emigration
Overseas investors
Institutional investors
Structured sale proceeds
Cash
Cash and quoted shares
Cash and loan stock
The danger of qualifying corporate bonds (QCBs)
The effect of loan stock on Entrepreneurs’ Relief
Cash and deferred consideration or earnout
Known payments
Unknown payments
Earnouts
Shares
Sharing exit proceeds with premium protection
The split of proceeds
Table 13.1 – example of sharing sale proceeds with premium protection
After tax returns for EIS shareholders
Table 13.2 – after tax returns for EIS investors
Warranties and indemnities
The difference between a warranty and an indemnity. Warranties
Indemnities
Warranty negotiations
Problems with warranties
A warranty solution
Possible conflicts between management and investors
Misalignment of expectations
Earnouts
Service contracts
Longer term
The private equity sale
Partial sale
Case study. Partial sale by a VC fund nearing the end of its life
Expansion finance
Sale of the VC stake
Current status
Learning points
Summary
A Final Thought
Glossary
