Angel investment and equity crowd-funding is booming, thanks to incredibly generous tax breaks, people struggling to find decent returns for their savings and, dare I say it, the ‘glamour’ of TV programmes like Dragon’s Den.
Take the Seed Enterprise Investment Scheme as an example. It offers income tax breaks of up to 50 per cent for investments in young companies and further capital gains or income tax relief if the investment goes wrong.
This growing demand has been met by a proliferation of crowd-funding platforms, incubators, accelerators, funds – in other words, an angel investor revolution.
But behind the excitement and exuberance one simple fact remains – one that even the most optimistic proponents of this new investment class don’t really dispute.
The chances are you will lose money.
There is no doubting if you make it big you can make it really big – but even so your chances of making a really good return and getting a decent exit are pretty slim. In other words, this is a high-risk game to play, with the odds stacked against you.
So how do you increase your chances of winning and avoiding investment disaster? Here some key things to consider. Lessons I have learnt the hard way – from making mistakes and losing money.
Heed these warnings and you have a better chance of angel heaven not turning into angel hell.
1. Total commitment and passion are a must
Never back entrepreneurs who are not full-time and working all hours god sends on the business. If they are not going to commit to the business, you shouldn’t either.
2. Perseverance matters more than the idea
Everything takes longer than you think. The product, the sales, growing the team… you name it. And the business will probably end up looking very different from the original idea. So always take the bright shiny business plan with a pinch of salt.
In my view, the key entrepreneurial quality that marks out the best from the rest is persistence and determination – to keep going whatever the ups and downs (and there will be plenty of those).
In other words, does that entrepreneur live and breathe the business and are they in it for the long haul? Will they move heaven and earth to be a success whatever it takes?
3. Teamwork is important – so does the team work?
No entrepreneur can go it alone, however great, credible and experienced he or she is. There needs to be a committed team covering the key skills the business needs. Just as importantly that team needs to click and get on well. If there are cracks at the start, they will quickly get bigger and bigger.
Top tip: Great talent is hard to find. So many entrepreneurs raise money to find the team. If they haven’t already got people lined up or involved, this adds hugely to the risks.
4. Selling is the entrepreneur’s biggest asset
Can the entrepreneur sell? This doesn’t mean they have to be a second-hand car salesmen. But can they inspire you, other investors, new team members, partners, suppliers…. Ask yourself a simple question. Do you like them and would you buy from them or work for them?
5. Is the opportunity really worth it?
Avoid inflated valuations. So many investors (normally those investing other people’s money) claim valuation doesn’t matter. But it is so important for angel investors who want to make any sort of return.
Given the chances of making money are slim, if you do get a winner, the returns you get will probably need to make up for losses elsewhere. But if the initial valuations are too high, even if the start-up is successful the end result may be a fairly prosaic return versus the risk you are taking.
So many valuations are hyped – by entrepreneurs, crowd-funding platforms, by accelerators, by incubators. Take a deep breath, really think logically about how big the company could get and if its market place, product and, crucially, its unique (and defensible) selling points are strong enough to create a company 10 times+ the valuation you are investing at.
Top Tip: Consider what resources it will take to get there. If it’s going to cost millions and millions it is likely you will be diluted heavily by future investors, adding to the risks.
6. A pipe dream or a something that will set the angel world alight
An idea is worthless in itself, a presentation is just tomorrow’s fish and chip wrapper. You need to see real traction and progress. Have the entrepreneurs really proved anything? If not, why not and how long will it take them to get there? Can you touch and feel or use the product? Do you love it? Do you understand it? Can you see it selling and if so will enough people be prepared to buy it?
Backing something you know, like and have experience in can give you important insights into the chances of success and failure. Plus, if you can help the entrepreneur with advice, support, networks and your own experience it can materially increase the chances of success. Good mentors are worth their weight in gold.
7. Be prepared
Do some due diligence about the opportunity. Check the paperwork is in order. Speak to your own network to find somebody in the industry or sector and get their opinion. Take your time to make an informed decision. You are mad to invest without some sort of sanity check.
… and of course, the golden rule… only invest money you are willing to lose…
Angel and crowd-funding scandals and huge losses are inevitable as the market grows. Don’t be part of a future disaster story.