In my many years of involvement with Cranfield’s Business Growth Programme, I have followed the journeys of participants who have chosen to sell up and move on. In most cases they have, so to speak, jumped the fence, to become investors in other people’s businesses. Who better, you might ask, to support the rising generation of company founders than those who have been there, done it and bear the scars of experience on their backs? It’s an activity that keeps them engaged in business but from a different perspective, stimulates them intellectually and is, as a rule, fun and rewarding.
The three ways to “invest” in businesses
Such investment takes three forms. You can give money, time, expertise or, indeed, all three. In this article I explore what is involved and some lessons learned along the way.
Investing cash in privately-held businesses is inherently risky, and the art of doing so successfully lies in managing and minimising those risks to an acceptable level. Nearly all seasoned business angels – as they are generally called – whom I know personally do two things immediately after making an investment: first, they write it off mentally, as money they may never see again and can afford to lose; second, they assume that at some future point the business will need additional funding, especially if it is growing successfully and meeting its targets. If they have invested x, they operate on the basis that eventually they will invest 2x. This is where the cool head of an experienced private banker is invaluable, to help you determine where your personal financial boundaries and appetite for risk lie.
Nick Gornall, Head of Entrepreneurs at Weatherbys Private Bank says: “The focus of our advice at Weatherbys is to support clients in managing their core wealth for which we would choose investment in public markets seeking efficient risk adjusted returns in line with our client’s risk tolerance and overall return objectives.
“By doing this we would allow our clients to determine the extent of their wealth they can set aside for more strategic non-correlated business risk in the knowledge that they have not over-assigned capital that they might later need.
“Investing in early-stage businesses is not an area we would advise clients on specifically although we are open to widening our network and introducing clients to angel clubs or early-stage opportunities through specialist providers noting any exposure would usually be considered a speculative investment.”
Nick Gornall, Head of Entrepreneurs, Weatherbys Private Bank
“Money is important, but the experience of the investor in the industry is more critical”
There are two main ways to manage personal financial exposure in this area. The first is what comes initially to mind, the use up-front of due diligence and skilled legal advice to create shareholders’ agreements and so forth. You need to do your homework.
However, the second approach is to devote time to share your experience with the businesses you are investing in, which may actually be the best way of securing both your investment and the success of the company in the longer term.
Robin Crumby and his wife Victoria Mellor sold their research and advisory firm some ten years ago, and have since made a number of investments in early-stage ventures. “What starts as a financial decision tends to evolve into a time commitment, where the real value is added,” Robin told me. “Money is important, but the experience of the investor in the industry is more critical.”
Invest in businesses close to home
Nearly all of the opportunities that have presented themselves to Robin and Victoria have come through their professional network. Those that have worked best conform to the model of subscription-based publishing on which the couple built their own successful business. This is quite common: many angels tend to invest in business models and sectors they know first-hand through prior experience.
Sometimes such investments are truly close to home. After selling her first business Pacific Direct, serial entrepreneur Lara Morgan made her initial external investment in a venture started by her very first employee, in the same industry. Another founder I know well, who has created and sold two aviation companies, has experienced his greatest early-stage investment success in the low-cost airline sector.
Angel networks
For those wishing to expand their early-stage investing horizons, a good place to start is with their local business angel network. Angel networks are simply groups of individuals who pool their financial and professional resources to invest in and support early-stage businesses or entrepreneurs.
These have historically been strongest in cities such as Oxford, Cambridge, London and Edinburgh, where universities have a tradition of encouraging spin-outs with roots in academic research. [The Cambridge-based computer chip designer Arm Holdings plc, now valued at over US$100 bn, is probably the best-known case in point.]
Pictured: Radcliffe Camera and All Souls College, Oxford University
Such networks have now spread throughout the country, and universities with a strong record of scientific innovation welcome interest from new investors. Their links to regional angel networks are also close. For novice investors, seeking out and joining such organisations has many advantages; not only is the pool of pre-qualified opportunities greater, but the experience of more established investors is invaluable.
One of the most successful angel investors I know almost always co-invests in early-stage business propositions brought to his networks, as he prizes the angel forums in which the opportunities are debated and evaluated. Once he has invested, he is also prepared to commit considerable time and energy to mentoring the founding team.
Exiting an angel investment
An experienced angel will normally insist on what are known as “tag and drag” rights, which protect minority shareholders when it comes to a partial or complete sale of the business. Essentially, the investor aims to sit on the same side of the table as the business founder[s]. And even if the investment is made for the long term, an angel will usually want to know from the outset how the founder plans to realise the value in the business, and thus how outside investors will turn their shares into cash.
In many cases this will take the form of new, later-stage investors coming in for a fresh round of fundraising, which allows the early angel investors to sell their shares and crystallise any gains.
Can early-stage private investors make money?
Anecdotal evidence is plentiful, but reliable hard data is scarcer. In part this is because business angel investing, certainly in the UK, is a relatively young activity and many smaller, privately-held companies can be hard to value: there is no real-time public share price.
Another angel I know well, who prefers to stay anonymous, says: “You won’t get your money back in most cases. Look at it as a numbers game – most will fail but hopefully the few that win cover the losses and more.” Most angels will operate with a “stable” of investments and a handful of winners justify the outlay.
From what I can see, the published evidence points to positive returns on average over time, but averages tend to mask a wide variation in performance. Those investors who devote significant time to their portfolios and do well, tend to stress the same fundamental point: knowing the jockey – the founder – is as crucial as understanding the horse – the business idea. They look for affirmative answers to three questions:
- does the founder have a mindset oriented towards growth?
- are they resilient in the face of the inevitable knocks and setbacks of business life?
- and if they are refugees from a big business environment, do they “get” the realities of life in a scenario where there is little or no support network?
It’s rarely a smooth ride, but investing in the next generation of independent businesses seems to bring rewards beyond the merely financial: the satisfaction of seeing others succeed and knowing you have played a part.
Important information
The views of the author are not intended to carry any form of recommendation – it is important to note that investing in early stage and growth businesses is very high risk and the businesses can fail. If this is the case investors would lose all the capital invested.
Nick Gornall, Associate Director at Weatherbys Private Bank, and our guest author of this article, Visiting Fellow at Cranfield School of Management, David Molian, have worked with successful entrepreneurs for over two decades.
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If this article has struck a chord and life after a business sale is high on your agenda, and you would like to discuss it further, please contact Nick Gornall on +44 (0) 7436 239639 or ngornall@weatherbys.bank, or Henry Wilson on +44 (0) 7501 384877 or hwilson@weatherbys.bank.
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