Getting into angel investing can be daunting. It is undoubtedly rewarding, but it is also high risk and many would-be investors never work up the nerve to try.
Angel investing can best be described when a high-net-worth individual provides financial backing to a small business or entrepreneur. This transaction will typically return a portion of ownership equity in the company to the investor, and it’s not uncommon for angels to be in some way related to the person or business into which they’re investing.
As with any form of investment, there are highs and lows, and the trick is to know exactly where you’re putting your money and to have confidence when doing so.
With this being said, Chantelle Arneaud from Envestors has generously provided The Fintech Times with a special guest-authored piece, in which she details five areas angel investors should be most conscious of.
Envestors’ digital investment platform brings together entrepreneurs and investors across geographies, communities and sectors – creating the single marketplace for early-stage investment in the UK.
They partner with accelerators, incubators, and angel networks to provide a white-label platform empowering them to promote deals, engage investors and connect to other networks.
Founded in 2004, Envestors has helped more than 200 high-growth businesses raise more than £100 million through its own private investment club; and is authorised and regulated by the Financial Conduct Authority.
With Envestors’ 17 years of experience in early-stage investing – we have raised over £100m investment for 200 companies – we understand both the common and uncommon mistakes those new to investing can make. We sat down with expert angels (we changed the names) with years of experience to compile our top five lessons:
1. Check who owns the IP
One of John’s first investments was in an interactive app for tourists. “A lot of research, branding and grit had gone into making a stellar product and so I confidently invested. Not long after I parted with my cash, the company got into financial trouble and folded.”
John later came to learn that it was the CEO and not the business who owned the IP. This tiny little detail meant that when the business folded, the CEO could walk away with its greatest asset, the Intellectual Property, and start a similar company.
A key takeaway from this situation is to ensure that all IP is owned by the company, not the CEO or any other party.
2. Be wary of ambitious expansion plans
Tom invested £50,000 into a bakery business eager to capitalise on the global craze for their signature product. He was so enamoured, he even set up a franchise of the business at Heathrow airport.
Yet, he explained, “Cracks started to show as the CEO was overly relaxed about the financial affairs of the company. He was keen to show growth to investors and so expanded quickly to around twenty sites.”
This rapid expansion caused issues, leading founders to go back to shareholders looking for more capital to keep the business afloat. “It was not a good situation,’ continued Tom, ‘Not only had the revenue not come in, but the customer experience had suffered as a result of the business trying to do too much too quickly – which impacted the brand.”
Quick expansion and high standards not being able to remain consistent led to the critical mass never being reached. “It was inevitable that the company was going to go into administration once the overheads outweighed the revenues by a ridiculous amount.”
Interestingly, the company was bought by someone in the industry with more experience and it is now a thriving business with stalls across London train stations.
The lesson here is about speed and experience. Of course, as a minority shareholder, you can’t dictate the company’s plan, but you can counsel them. And if you see them trying to go too fast in an industry in which they are new, put up a red flag and introduce them to that contact you have who has done it all before, so they have the guidance and the support they need to make it work.
3. Check data sources are credible
This lesson came six months after an initial investment into a flower distribution company when it was discovered that the business owed £350,000 in VAT. Caroline explains, “I have a thorough approach to everything, and my due diligence on this investment, like all my investments, was done with a fine-toothed comb. The problem, I later learned, was there was missing information.”
The Business Plan that was sent to Caroline didn’t disclose this financial information. If it had, she would have quickly seen the company was insolvent.
The lesson here is a nuanced one. Of course, Caroline did her due diligence, so how could she have avoided this situation? At Envestors, we always recommend our companies work with accredited advisors to show investors information has been reviewed by a qualified third party. This could be an accountant or corporate finance advisor or, failing that, we recommend investors work with an investment network that is regulated by the Financial Conduct Authority to protect themselves from situations like this. A regulated business will ensure all information is clear, fair and not misleading.
4. Be vigilant
Julie was excited to make her second angel investment. The timing was a bit tight, but she managed to conduct her due diligence in time to get the benefit from the Enterprise Incentive Scheme (EIS) in the year, which meant her £10,000 investment would be subject to 30% tax relief and if things went badly a further £2,800 in relief, so the total amount she stood to lose was £4,200 and not the full £10,000.
“Sadly,” says Julie, “while they had a stellar brand, the business was absolutely not the next big disrupter. I could tell from the outside things weren’t going well.” Then the inevitable happened, the business folded. “I was upset when I found out, but I exploded when I learned my tax relief wasn’t coming.”
While Julie believed the business was eligible for EIS, she later learned the paperwork had been incorrectly filed and there was no tax relief to be had.
The lesson here is to ensure that all paperwork (including EIS) related to your investment, is being handled by a qualified individual such as a lawyer or company secretary. S/EIS is notoriously complicated, and it is easy for non-specialists to make little, but expensive mistakes.
5. Expect the unexpected
As the pandemic has proved, external factors can’t always be controlled. Tanith learned this lesson after investing £20,000 into a boating business.
“The company was doing really well and decided to expand. We were all onboard with it. To purchase more boats, the company took a loan from an international bank.”
However, when the financial crisis took hold in 2008, the bank pulled in the loans. While this decision had nothing to do with the business, it left the founders scrambling to find new backers in the worst financial crisis in recent memory. Unable to do so, the boats were sold off.
A key lesson to take away here is that stuff happens. The only way to protect yourself against the uncontrollable is to build a diverse portfolio to balance risk.
As you can see from the stories of our experienced angels, there are plenty of things to watch out for and keep in mind. To minimise risk, we recommend you work with a regulated investment network that screens all investment opportunities.