Angel investing (1): 10 top tips for a virgin

Sooner or later, it happens.

Maybe your superstar young colleague quits his (it is almost always his, not her) well-paid job, to start his own company. And gently lets it be known he is raising a bit of money, with tax breaks….

Maybe you have just had your biggest yet annual bonus, and the tax consequences are making you sick. Your mate at work mentions a startup he is putting money into, which “reduces his income tax bill”. So you google ‘investments that reduce your income tax bill’….

Maybe your mate’s boy wonder kid is setting up his second business, and in the first one your mate made five times his money, so presumably on his second time around he’ll make even more….

Maybe you have been reading the weekend papers columns about angel investing….

Maybe your IFA has suggested if you don’t like VCT funds, you could consider EIS funds….

Or maybe you’ve sold a business, and not very long after some of those great characters you hired are starting to branch out on their own. They wouldn’t mind some help, and that money you made wouldn’t have been all possible without these folks, so it’s only right to put a bit of it back to work in their hands….

Sooner or later, an angel investing opportunity will cross your door. After all, you’re financially savvy, you’re in the London eco-system, and you are intellectually curious.

I first started angel investing almost twenty years ago. I have made a number of angel investments since then. I’ve made some mistakes, and I’ve had some successes.

For many ‘amateurs’ angels in the UK, the tax breaks of EIS/SEIS are a big draw. While these tax breaks are very powerful, and in fact distort the market in a way you should be aware of, I would say that the tax break should never be a prime consideration in making an angel investment. None of the tax breaks turn a loss into a profit, and if you turn down a good angel investment because it didn’t qualify for EIS/SEIS, you are not going to look too clever.

Here’s what I would suggest you consider, the first time you consider making an angel investment in an early stage business:

1. Can you do without the cash? If you can cope, without stress, losing your entire investment, then you’re in the right place. If you would get stressed losing 50% or more, you are not. I always consider any angel investment as money that is thrown away – to a broadly good cause, who I never expect to give me anything back.
2. Why are you investing? If you are imagining the profit you’ll make, that’s not good. If you really believe in the founder(s) and want to support them, that’s much better. If you know quite a lot about the space and think this new business has the right angle, and won’t be easy to compete with, then that sounds good. If you have seen all these vegan things going on, and this vegan restaurant business sounds like it’ll be perfectly positioned, and although their new site is in a location that nobody has lasted more than 2 years, at the end of the day you’ll enjoy eating there yourself, then I’m afraid it isn’t going to end well.
3. Is the deal equity, or debt? Broadly speaking, angel investors are buying equity. They are investing in high risk situations, where there is no prospect of cashflows to service the debt let alone repay it. If you are contemplating loans not equity then either this blog post is not for you, or you should reconsider.
4. Will your relationship with the founder/business change? If you don’t have much of a relationship, then be careful; it is more rewarding/fulfilling when you know the management well. But if you do know the management well, make sure that an investment isn’t going to sour the relationship. In my experience though, equity is much ‘cleaner’ and lower impact on relationships than debt – which is why a lot of wise people say they will never lend to a friend.
5. Do you want to get really involved? If so, do the founders want you to get really involved, or do they just want your money? Will they listen to you? Are you a well-behaved ‘backseat driver’ or do you really only like driving your self?
6. Are you an obvious investor in this business? Or was it just a mate’s mate in the pub? If you think you might fancy a bit of angel investing one day, but this business is not the one your wife / sister / etc would expect you to back, then maybe it’s best to pass, but think about how to find a better opportunity?
7. How many others are investing? Don’t be alone. But if there are a mixture of experienced angels, some guys who know the team well, maybe a customer or two, that’s a crowd with some wisdom in it.
8. What is the maximum amount you could imagine committing to this investment, over time? Don’t invest all that amount up front. You should hold some ‘in reserve’ ; most startups need to raise money more than once, and sometimes ‘in distress’. In distressed situations, existing investors can be wiped out – though they are usually able to protect their position if they are prepared to put more money in. Keep some powder dry.
9. Who is ‘leading the round’? Angel investment rounds usually have somebody ‘leading’, who will be an experienced angel investor who negotiates terms, reviews the documents, and so on. On your first deal, this won’t and shouldn’t be you. But on your fifth deal, it might be. If the round is properly ‘led’, you can learn a lot.
10. What level of information and representation are you going to get? It is common, particularly for inexperienced angels, to ask for board seats, but that may not be practical. However, getting financial information and regular updates is a very reasonable request – try to negotiate that commitment from the management before you commit.

In a subsequent post I will talk about what happens a bit further down the line, once a couple of angel investments start to progress.

In the meantime, any questions from virgins, or comments from angels who’ve been around a few blocks, would be very welcome!