Dear Reader

Before you disappear for your summer holiday, I hope you find our 50th issue of the AngelNewsletter Online a good read.

We are growing and developing here and from now on you will start to see how we can provide you, not just with value from learning and information, but also in many other ways.

We start this month with a special offer from MWB Business Exchange on their meeting rooms and it would just plain crazy of us not to recommend their offer of a free laptop for every workstation you take in one of their serviced offices between now and 31st August. Watch out for more exclusive offers in the AngelNewsletter Online next month!

When I am thinking about strategy I seek the advice of a wise corporate financier I know called Philip Marsden. I have got to know him through my relationship with Vantis plc. If you need someone to help you with a fundraising or an M&A deal or just some sensible professional corporate finance advice, I recommend you give Philip a buzz. He understands, angels, venture capitalists and entrepreneurs. To give you a bit of background on him, in case you do decide to call, click here to read our Interview with him. Philip can be reached on +44 (0) 207 467 4000 or email him on philip.marsden@vantisplc.com

Thank-you to our readers who responded to the AngelNews EIS Survey. I am pleased to report the results later on in this AngelNewsletter. I also hope you enjoy the first in our series of observations on business angels around the world, starting with Israel, which I visited recently. You may also be interested in our thoughts on “the good that comes out of profit.

Have a great summer.

Best

Modwenna

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MAKE YOURSELF RECESSION PROOF

It is pretty certain that we are now heading into a recession, but this is good news if you are a nimble young company. You will be lean and mean and quick to react so you will be able to steal a march on you competitors. It is also good news if you are a cash rich investor – there will be bargains to be had! Recessions on average only last 9 months but the effects can be pretty nasty if you are not prepared.

Before you disappear on your holidays here are some things you might like to do to make sure you survive this downturn

As an entrepreneur

1. Talk to your staff and involve them in the issues you are facing.
2. Talk to all your customers and assess what is happening to them and how it will impact on you.
3. Think strategically when it comes to marketing. Step up your smart marketing effort; reduce unprofitable or “nice to have” marketing arrangements, but considering the long-term impact before you make any final decisions – recessions can be short lived.
4. Take out credit insurance for all big contracts.
5. Renegotiate with your suppliers now – ask for discounts if you pay early or agree longer payment terms – don’t ignore them.
6. Switch utility providers where you can, especially telephones and broadband
7. Move into serviced offices. MWB Business Exchange our Preferred Partner has some good deals for new customers at the moment. See AngelNews recommends
8. Cut your personal expenditure.
9. Review your expenses – look for specific and overall savings
10. Bring forward fundraising plans and negotiate lines of credit or loans with your bankers

As an investor

1. Stock markets tend to perform well in recessionary periods, so do not walk away from equity investment of any type just because the markets are nervous
2. In general, take advantage of lower prices to do some tax planning
3. With your current angel investments, make sure you are on top of what is going on from day to day.
4. Consider allocating more time to supporting management teams in your portfolio companies
5. Look for new investments that are so small or young today that recession will not affect them, but will be poised to exploit the upturn
6. Decide how much cash you are going to invest in supporting existing investments vs. making new ones. Also decide if you would be prepared to guarantee a company’s debt facility, if asked.
7. Pay close attention to the personal financial position of the entrepreneurs you have backed or plan to in the near future.
8. Review cash flow projects and match them to evidence of a sales pipeline.
9. Reassess your criteria in respect of time risk, something that is especially important for the investments that will burn a lot of cash.
10. Look to the future. Recessions create entrepreneurs and they will have new ideas, especially young entrepreneurs. Now is the time to scout around student entrepreneurship clubs and incubators looking for entrepreneurs who have not yet got used to a “comfortable” lifestyle.

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The good that comes from profit

It seems ironic. The spike in the cost of oil, perhaps the ultimate tradable good that defines capitalism, is quite likely to do the job of encouraging people to cut back on consumption in a manner that will most please the environmental lobby looking to reduce the impact of mankind on the world and thereby deal with Climate Change. At the end of the day if people feel pain in their wallets it forces them to change their behaviour quickly; quicker than appealing to their better nature or explaining long term impacts.

Behavioural change always creates interesting stories. I heard the other day that people who were previously the fastest drivers on the motorway have slowed their speeds significantly so optimize the efficiency of their engines, save fuel and reduce costs. They are now driving more slowly than the average driver. I wonder if they are boiling over with frustration as they watch people pass them in the middle lane or stroking their wallets bulging with extra cash? And in Bristol, car sharing has taken off as commuters look to reduce their costs. The consequence – there will be lower CO2 emissions in the West Country this year. Perhaps the high oil price does do some good after all.

Whenever I fly abroad I enjoy the HSBC adverts in the corridors of the UK’s airports. Their good:bad images comparing broccoli with chocolate cake echo an important issue that rearing up in the investment world. To some, the equation goes like this. VCs good:angels bad and to others it is this, angels good:VCs bad. It will depend on who you are talking to on any given day I suppose.

There is another more complicated good:bad equation that is also being played out in the corporate world. That is the issue of red blooded capitalism vs. social enterprise. With Warren Buffet handing over $50bn to The Bill and Melinda Gates Foundation he is sending the world a clear message that there is not much point in making a lot of money if you cannot do some good with it before you die. Meanwhile the inspirational Anita Roddick dies and leaves her fortune to a charitable trust, not to her children, with their agreement. Over in West London, Innocent Drinks is giving 10% of its profits to charity; mainly to the innocent foundation to fund rural development projects in the countries where it sources its fruit. And the search engine, Everyclick, gives 50% of its revenue to charity.

Of all of these models, Everyclick’s is the simplest as it takes money off the top rather than the bottom line. It’s pretty cool that it is doing good as well as being a very persuasive marketing tool. This is a deeply clever way of buying new customers and retaining existing ones. We will wait and see who else gets very rich on the back of it.

Meanwhile for the rest the corporate world, the debate about giving money to charity quickly evolves into the philosophical argument around whether that “spare profit” should instead be shared with customers, suppliers or even staff, let alone long suffering shareholders. For management teams, the “profits to charity” debate, frequently instigated by employees, tends to mean working out a way to squeeze suppliers tighter or making even higher margins off the customers, assuming of course that staff do not want pay rises AND to give money to charity. Perhaps it is fairer on all business stakeholders if entrepreneurs wait, like Warren Buffet, to make their charitable donations out of their personal wealth which has been generated and then extracted from the business environment?

If you have any views on how capitalism could or should meet factors that do social good, I would be very interested in hearing them. Please email Modwenna@angelnews.co.uk to share them with me.

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AngelNews works alongside Daniel Stewart to bring AngelNews readers analysis on quoted companies and the AIM Stock Market. Every day we publish the brokers’ recommendations and analysis from Daniel Stewart’s team of researchers.

In the last month the AIM All Share Index has nose dived by 8.8% and as of early July is back to the levels last seen at the end of 2005.

Source: ADVFN 3 July 2008

As the market becomes more turbulent, here at AngelNews we see increasing value in our readers considering their angel investment activity in the context of how AIM companies and the AIM market are performing. You can find Daniel Stewart’s research at the website

We also thought you would like to know the four best tips Daniel Stewart’s analysts made in June.

The five best tips in June

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Population: 7.3million

• Number of separately identifiable business angels: 29
• Number of prominent business angel groups/networks: 7
• Sector bias: TMT, followed quite distantly by Clean Tech and Life Sciences
• Relationship with VC community: integrated via IVC.
  • Veteran entrepreneurs and VCs are forming into angel groups and two leading Israeli funds, Evergreen and Gemini have backed an angel group called Startup Factory
• Typical types of network: 2
  • Traditional: several angels and industry veterans grouped together to utilize benefits of being a network e.g. eXeed Technology Investments
  • New: Groups engaged in locating and screening potential projects which are directed to appropriate angels from a wide network maintained by the group e.g. Tevel Angels.

Earlier this summer I had the opportunity to moderate a session at the Israeli Venturing Associations Annual Conference in Tel Aviv. I have never been to Israel and was delighted to be given such a good reason to visit such an interesting country. So I jumped on a plane and was there!

Israeli entrepreneurs are not a noisy bunch, but nonetheless are very open to new ideas and good at follow-up. There is a general spirit of sharing and connecting and it was in this context that I was offered a copy of the IVC Research Centre’s 2008 handbook which includes a directory of individual business angels (not just business angel networks) across Israel. It has prompted me to start a series of articles in the AngelNewsletter Online comparing angel communities across the world.

Many entrepreneurs outside Israel will be surprised to find, having recounted the tale of their own struggle to identify and meet angel investors, that if you are in Israel you could get hold of a copy of this book and just email around 30 of them. Not only that, but you could target your approach, as they have shared publicly the numbers and names of their existing investee companies and also details of what they like to invest in. Angel readers who work hard in other countries to protect themselves from public view will be amazed that in Israel it is acceptable to provide so much detail and a personal email address and phone number in a publicly available handbook.

Similarities are as important as differences. In Israel the angel profiles show that their investment habits do not differ much from angels elsewhere, although they do appear to be more TMT, and especially IT, biased than a typical group of angels in Western Europe. I think this reflects the technology biased nature of the Israeli economy and the clear influence of the US tech VCs, many of whom have links with or offices in Israel, rather than a lack of interest in other sectors.

Just like elsewhere, Israeli angels clearly have a well defined and unique sense of what they believe to be the best deals. In the lists of portfolio companies in the IVC handbook I could only spot the odd company in which there was co-investment. The portfolios also show that Israeli angels tend to be very focused on certain sectors and the majority like to invest in R&D and seed deals, making them not so different from elsewhere in the world.

Although most state that their preference is to invest in Israeli companies, the links that many have to the US can be seen in the numbers of US companies in which they have invested and the numbers of angel who offer contact details based in the US. This international bridge is interesting, especially in the context of the EC funded EASY Project which is promoting pan-European angel and early stage investment activity.

At the current time there are no statistics available about how much Israeli angels invest so this cannot be compared with other countries, but looking at the statistics available on the value of IPOs, the size of venture capital funds and the overall sums that the formal venture community is investing in companies suggests that typical investment amounts per company are in line with the US and western European economies.

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Imperial Innovations, the IP commercialisation and investment company based at Imperial College London, was ranked second in the UK on volume of deals by Director magazine in 2007. We thrive on being at the forefront of innovation and start-up company incubation.

To enhance the quality of our deal flow pipeline in the cleantech sector, we are collaborating with the Carbon Trust and WRAP to deliver incubation services to the best low-carbon and recycling technology start-ups in the UK.

What's in it for us?

An opportunity to work with the best UK-based businesses and potentially invest in their further development.

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This month we have asked Gabriel and The Cherub to give us their views on this question

We cannot agree with our investors on what valuation they should base their investment on. Our lawyers have suggested that one solution might be a ratchet that will give us a greater share of the equity in the future if we meet the targets set down in the shareholders’ agreement. Should we do this?

If you have a question that you would like Gabriel and The Cherub to answer please email it to gandc@angelnews.co.uk.

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These cases are interesting because both of them are trying to achieve an exit within the 3-5 year time range that entrepreneurs usually quote when pitching for money and yet I suspect company two’s owner will walk away with a bigger % return than the angels in company one, although both will sell out in a trade sale.

Trade sales are increasingly important. 22 companies have listed on PLUS markets so far this year with 11 waiting in the wings whilst 23 have listed on AIM. These figures are way off 2007 when 182 companies listed on AIM alone. So it is pretty safe to assume that IPO is not going to be an exit route for any, but the strongest propositions in the next few months.

So how do you the angel get the most profitable exit in a trade sale? Hopefully you did the groundwork back when you invested, making sure that you stand as high up in the queue as possible for any proceeds from the sale. Later stage investors are notorious for inserting clauses in their term sheets that ensure that stand ahead of everyone. A typical trick they use is to negotiate rights that give themselves a guaranteed return ahead of ordinary shareholders. Known as liquidation preference, watch out for phraseology which means they have the preference in the event that things go very right as well as very wrong. Another trick they use is with convertibles where they will have clauses to ensure that whatever the outcome, they maximize the cash they will receive. Without tactics on your part this simply means that you will get less than the cap table might have inferred you are entitled to.

You need to think about these issues in the context of the EIS eligibility of your own shareholding. Will the financial benefits you accrue from EIS be less than or more than if you take preferred ordinary shares like the VCs if things go right? Too many investors talk to me about investing as a way to avoid paying tax rather than a way to optimize returns. It may that they should be looking harder, like VCs, at how to protect their upside as well as their downside at exit.

I am continually surprised about the concerns investors have about paying taxes on income generated out of a business making profits. Lots of investors tell me they do not want dividends because they are taxable. As the economy tightens, I believe investors should look to get cash where they can first and look to shelter it from tax second. The joy about a dividend is that after you have had the cash you are still left with your equity holding which could make you money at a later date.

Even founders of companies that sell out at a great profit tend to grumble when they see their early stage investors walk away with a big cheque when they had “only handed over a bit of cash”. The time that you freely gave may be long forgotten. This is why you need to think from day one about what intangible value you may have provided and whether you should have crystallized this either via some fee income which was paid in cash or at the very least accrued in a shareholders’/directors’ loan account.

The best sales of businesses are planned for several months and treated like a military campaign. Assuming you have enough influence you should make sure that the company is as clean as possible, that profits are being maximized and the sales pipeline is fantastic. The more you can do to meet the likely needs of the buyer post acquisition will also help to optimize value. One thing you can do if you are a technology business is to make sure that your IP is strong not only in the countries in which you and/or the buyer operate, but also in the countries where the buyer may be looking to sell your products in the future.

Planning when to sell will be a mixture of external timing (are the buyers really out there?), internal timing (when you will get as much as possible, but still leave enough potential to appeal to a buyer’s greed) and tactics. You and the founders will probably need a good adviser to help you. Clean up the company as much as possible yourself before you start incurring fees, then appoint a corporate financier and a lawyer to set up an auction. Talk to tax people as well. Notwithstanding my earlier comments about tax as an external investor you need to make sure that the cash generated from the sale gets into your hands in as tax effective manner as possible.

Lastly remember that, whatever the shareholder agreement says, the interests of the founders and management shareholders may not be aligned to those of the external investors. It is quite likely that the buyers will be holding separate negotiations with them about their roles post acquisition. Take care to make sure that your own interests are not quietly undermined.

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"Business Partners"

A man is flying in a hot air balloon and realizes he is lost. He reduces height and spots a man down below. He lowers the balloon further and shouts, "Excuse me, can you tell me where I am?"

The man below says: "Yes. You're in a hot air balloon, hovering 30 feet above this field."

"You must be an angel investor" says the balloonist.

"I am" replies the angel. "How did you know?"

"Well" says the man, "Everything you have told me is technically correct, but it's no use to anyone."

The angel below says, "You must be an entrepreneur."

"I am" replies the man, "but how did you know?"

"Well," says the angel, "You don't know where you are, or where you're going, but you expect me to be able to help. You're in the same position you were before we met, but now it's my fault."

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The results of the AngelNews EIS survey have suggested that whilst the Government is doing a lot of things right in the way they apply the Scheme to help enterprise, there is also a lot more they could do. These are the overall results of what you told us.

Information and statistics

The EIS Scheme should have its own website with clear explanations of how the Scheme works and the ability to complete forms online. It should also contain more data on how the Scheme is being used to help the market innovate. Someone even suggested there should be a database of the names of all EIS companies that are fundraising.

In addition to the website, respondents also liked the idea of HM Revenue & Customs holding a conference for intermediaries and investors to explain the Scheme and advertising in the specialist trade press for investors, but not in the national press.

Changes to the Scheme itself

The respondents, who were a mixture of entrepreneurs, investors and advisers, felt most strongly that the EIS Scheme should be changed in the following ways.

1. All the terminology and rules around the Scheme should be more simply and clearly defined
2. Everyone should be able to invest in any business which qualifies for EIS, including in a business they have founded.
3. Connected parties should also be able to benefit from EIS.
4. EIS should be adapted to take account of the commercial and technological developments in the entrepreneurial market place; in particular the rules that can be breached because a company is “too successful, too quickly” should be removed e.g. qualifications based on size of business.
5. Between 70% and 88% of respondents thought that the rules around control tests should be removed for various reasons including:
   - reinvestment in a business that needs further funding can lead to a breach of the test and therefore lead to EIS relief being withdrawn
   - shareholder lending to the business can also have the same effect, even if this lending is in the best interests of the business
   - smaller investors can be penalized if a larger investor breaches the control test
   - the control test means that investors can be prevented from taking an equity stake in proportion to the value of the cash and the personal effort they commit to the company.
6. Whilst most of the time restraints were acceptable, the three year qualifying rule needs changing because it is not in the interests of the investors to sell out within this timeframe, even if it is right for the company to do so.

Regulation and breaches

The government would be well advised to clarify the wider regulatory framework around business angel investment. 57% of respondents thought that this is one of the things puts off new investors and their advisers from getting involved in business angel investing. 69% of people thought that companies should be able to promote themselves directly to investors without having to have an adviser to represent them. 60% wanted a lighter regulatory regime, supported by an arbitration process to deal with disputes.

Whatever solution is decided, the person who decides whether the rules apply should have the ability waive a rule, if appropriate. Over 80% of respondents thought that the HMRC should have a lighter touch when it comes to dealing with breaches. Accidental breaches should not mean EIS relief is withdrawn and nor should it be withdrawn if the breach was made because of an action that was in the best commercial interests of the company.

Conclusion

Overall it appeared that people liked the EIS Scheme. On your behalf we have anonymised the responses and have shared them with HM Treasury and hope to have a further meeting with the EIS Consultation team during the summer. We will keep you abreast of any developments from now on.

*The AngelNews EIS Survey was conducted from 7th April to 19th June 2008. There were 47 respondents ranging from investors to entrepreneurs and intermediaries.

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If you had been investing back in May 1983, these are the sort of opportunities that would have been on offer to you!

Did you back any of them or do you know someone who did? Perhaps you know what happened to them for some other reason. If so, please let us know – we would love to find out (email replies to modwenna@angelnews.co.uk)

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We know you all want to meet each other, get more out of us and our Preferred Partners and generally make AngelNews work for you. So we have decided to up the ante on the number of events we would like to invite you to. Here is a list of them. We do hope you will be able to make it to one soon.

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