Potential exam Q's
Q1. What are business angels? In what respect do they differ from the formal venture capital industry?
Two parts: but first part is short i.e. what are business angels. (Dragons den?) Second part is more in depth. Business angels are wealthy individuals with an interest in particular businesses, Venture capitalists do not use own money on the other hand i.e. use government funds etc. One uses own money, the other uses public funds. Angel investor may put different procedures in place to deal with moral hazards because an angel investor with fund businesses that they have expertise and interest in so that they can work closely with the company, which is different to venture capitalists. Lots of ways to answer the question, but stick to the two main differences: Both take an equity share in the company. Very similar. Both interested in business growth. Venture capitalists interested in significant growth more as they want to sell at the end of a certain time. Entrepreneur will feel more comfy with angel investor because it will not feel like there is an outsider in the company as the angel will be more hands on. However, on the other hand, may be more involved and have less control of the business?
What is venture capital?
- VC provides finance from pooled investments of 3rd party investors.
- Different from private equity. There are formal and informal venture capitalists. Venture capitalists use the capital from Investors money i.e. governments, high net worth individuals, insraucen companies, endowments etc. Investors pay money out to a venture capitalist firm to choose a company to invest into. The VC manages aspects of the SME and charges a fee for this in return for giving money to the SME. They then get a return on their investment which is passed on to the Investors, the VC monitors and advises the SME in return for a share of the SME's equity.
- Issues with VC: VC may puck wrong SME to invest in (only SME's that have doubts about their success tend to seek funding), this can be combated by due diligence and syndication. Spending considerable sums investigating the market and tracking the entrepreneur of the SME's track record (due diligence) and syndiacting the deal so that risk is shared with others (syndication).
- Moral hazards: SME's once receive £ may not feel they need to grow. So VC's monitor this and set up a legal contract. The VC oppoints the NED and invests funds slowly at stages to feed appetite of SME, entrepreneurs are then remunerated via share options rather than a salary but such share option sonly accumulate value over time.
1. Seed funds: small amounts of finance needed to test new idea: provided by government grants, specialist funds etc.
2. Start up: early stage finance for product development/marketing
3. 1st round: funds for early stage growth/manufacturing
4. 2nd round: working capital for early stages of companies that are launched but not making profit yet.
5. 3rd round: (mezzainine financing): funding for expansion of new but profitable company
6. 4th round (bridge financing): needed for expenses of IPO/floatation.
- VC's looks for sound detailed business plans, enthusism, qualified team who have personally invested, and a defined exit route. As VC is risk financing: target rates for return=v.high usually 40%pam share ownership start at 30-40% w/seat on board of directions for close watching.
- US has most developed VC industry in world. In 2008, $280bil in 4000 ventures (NVCA, 2009). In UK, £30bil invested into 1700 ventures (British VC Assoc, 2008).
The demand for equity from VC
- no interest payments, good for when accessing other funding is tough, leverage other borrowing, VC provides support and money is patient, will want to exit at some point so there is hope.
- loss of control, diluted ownership, dividents may be expected, outsiders may want to interfere, require significant growth=pressure, free rider problem, dilution of equity, hastily pushed towards IPO, valuation v.diff because of uncertainty, will take significant proportion of profits, will require detailed and intrusive info.
- Winners, failures, living dead, trundlers.
What are business angels?
- Informal VC=business angels to provide alternative type of investment to formal VC's. Usually high net worth individuals who invest own £ directly in unquoted companies in hope to financially gain+typically play a hands on role in the business (Mason, 2006). BA's=important source of equity finance as they tend to target an area of perceived difficulty in raising funds=the so called equity gap of SME's of 50k to 1m, most make investments of 50k to 250k=much smaller than VC funds, and they are also prepared to finance earlier stages of the process including seed, start up and 1st stage funding. According to Mason 2006, a typical BA profile=
1. Male (95%)
2. Cashed-out entrepreneurs- most have their own successful business and invest those proceeds
3. 45-65yr olds- reflecting time to build sufficient wealth to invest.
- The European Business Angel Network: 75k BA in Europe who invested 3bill in 2006 (although this isnt entirely reliable figure). In US: BA's invested $26b into 57k ventures
- Wiltbank and Boeker 2007: a study of 500 BA's in US indicated 52% of investments lost £, whilst 7% returned £'s ten fold. Factors of impact: due diligence, experience, participation!
Business angels vs. Formal VC
- Rich individuals investing normally in start up or v.early stage (Dragons Den people). Range from 0.02m to 0.3m. Total invested in US=30billion. Quick decision making, time horizon=4-6 years, interested in commercial but also different and interesting projects, can afford to be patient, may have personal/local knowledge of sector, angel is personally involved in the company, finance staging less likely=lump sum, management costs are v.low. Syndication possible. Will want growth prospects, dilutes ownership, dividends may be expected, will want to exit in future, will take significant proportion of profits and will want detailed/intrusive info. Trunki and MagicWhiteboard used this form. vs.
- Corporate individuals investing in starts ups to develoment capital but generally more maturer projects. Range from 0.4m to 5m. Total invested in US=30-35m. Speed of decision can take weeks, time horizon=6-9yrs, interested in strictly commercial projects, seeking expert views and specialise in sectors, appoint NED's and stage their financing and link entrepreneur returns to business performance (more encouragement?), management costs are higher. Syndication possible. Will want to exit in future, will take significant proportion of profits and will want detailed/intrusive info, will want significant growth, will want to interfere.
Loans vs. Equity
Equity (private or VC):
- Growth leading to increased business valutation=objective of supplier of equity, no collateral needed, available for up to 7yrs, no interest charged, ownership for supplier, sometimes/often soft assistance, minimal chances of obtaining this form of financing, quite stringent monitoring.No fixed repayment plan for investors who are rewarded only when business can afford it. Entrepreneurs tend to value control over own destiny above other considerations, this is not a favoured method of funding. Private equity/VC represents only 3% of SME's in UK (Bank of Eng, 2003). On the other hand, internal equity (own funds of entrepreneur) represents 30% of capital structure of new venture (Jarvis, 2006). vs.
- Repayment of loan with interest on time, ideally want collateral, short to medium term duration, interest charged, no ownership of business taken, rarely any 'soft' assistance provided, high chance of obtaining this v. widely used form, monitoring of business' performance continues. Amount borred paid back from income accruing to the business. Payment schedule to be maintained whatever the state of the business. Accounts for 60% of external finance of small firms (Cosh & Hughes, 2000).
Business Angel examples...
- Matt co-founded Virtual Signage after seeing a gap in the market, and after developing a strong marketing and video package, they felt it was time to set up the company. Virtual Signage offers a solution to affordable video advertising. They were lucky enough to have been involved in a previous successful business model, which they knew they wanted to follow.
- Virtual Signage felt limited because they were constantly at full capacity, and unable to expand. They lacked financial and human resources which meant they struggled to acquire new business and at the same time provide a quality service, so they turned to Angel Funding. After pitching at a Manchester Angel Club event, Virtual Signage initially had 5 investors interested on the day of the pitch. After only 8 weeks they received funding from their 3 investors.