Three Part Harmony
It is certainly a time of financial crisis around the planet. Markets are slowing down, Governments everywhere are looking at brutal austerity measures, while cash-rich Big Business seems unwilling to invest. Business incubators are as affected by the crisis as anyone else, and they have the added difficulty of not only ensuring their own survival but also in contributing towards the accelerated growth of the businesses under their care. And this is where Business Angels play an important part – both to turn a good idea into a business success, and give incubators a little additional support in competitive markets.
Who are business angels?
The term Business Angel, or BAs as they are commonly referred to, are high net worth individuals, or “accredited investors”, who typically invest in and support start-up companies in their early stages of growth. BAs are typically experienced and successful entrepreneurs, financiers and professionals who offer not just financial support, but also guidance to the entrepreneur. BAs have proven themselves to be an integral part of the capital market and today, they are organized into groups (typically 20, and up to 100 individuals). As a collective, angel groups now have more resources, a light organisational structure to professionally manage the investment process (deal sourcing, screening, evaluation, negotiation, management, harvesting) and arrange regular meetings and follow-up.
Most groups in Europe refer to the European Business Angels Network (EBAN). As of 2010, the organization is an umbrella for 350 organized networks/groups, with 20,000 angels, who receive up to a total of 40,000 business plans each year. Total investing in Europe is currently estimated at over ¤3bn every year and annual investment IRRs (internal rate of return) above 20% are common amongst the best of these groups. As a matter of routine BAs tend to invest on a regional basis to be close to investees. However, according to EBAN, there is now a clear trend with BA groups looking at opportunities further afield, in different countries and even in less advanced regions throughout Europe. Incubators may well play a fundamental role in supporting this trend and make it viable for BAs to increase their scope of activity.
BAs increasingly co-invest with other BAs, and with early stage funds, which have been set up taking advantage of European structural funds and the facilities of the EIF(European Investment Fund). Europe 2020, the EU’s growth strategy for the coming decade, is also poised to provide important and much-needed stimulus, in association with the EIF, and the Structural Funds. EBAN indicates that there are a few hundred such funds, each valued at around €10m. EBAN predicts there will be further growth in BA investing over the next few years thanks to the emergence of a younger generation of investors and a greater involvement of “family offices” – the managing of investments on behalf of wealthy families.
Add to this, the new emerging “sidecar funds” that provide public matching co-investment with BAs (the fund management being with BAs) and suddenly incubators become ideally placed to provide a win-win situation for all parties, themselves included.
Experience tells us that the amount of invested capital that companies can realistically obtain from BAs range normally between €200k / €300K and €1m.
The bottom line in all of this is not only the creation of new opportunities for entrepreneurs who need financing, but also for incubators who can enhance their own financial sustainability as part of the overall picture.
Making the connection
Incubators play a crucial role in crossing that great divide between investors who say “good projects are scarce”, and entrepreneurs who complain that “we cannot find investors”.
While conventional training and investor readiness programmes are generically useful, today a much more proactive role is necessary. A “hands-on” understanding of the BA investment process is required of incubator managers, who need to think and act like a BA in order to best advise their clients. The incubator team has to think like a fund manager and follow the reasoning and processes that drives that decision-making process. The following fundamental steps may enable a better understanding of the investment process from the BA group’s point of view:
- The first step invariably involves making contact with the BA group and submitting the business plan, which is always best presented via referral.
- Once a plan has been accepted there is the interview with the BA screening committee, which normally includes someone with key skills in the industry of the candidate investee.
- The next stage involves the presentation to the BA group (typically a 15 min “pitch”) in order to collect preliminary commitments. Each BA indicates the amount she/he is personally willing to invest (typically between €10,000 and €100,000). Usually, total commitment can range between €200k - €700k and may stay below the €1m mark. However, some deals may not get enough commitment to progress to the next level, which can be very disappointing for the entrepreneur, obviously.
- Once the commitment has been cleared, there is usually a nomination of an “investment champion” (usually a BA with specific industry knowledge) to manage due diligence. This BA may, later on, represent BAs on the company board;
- Due diligence and negotiations are an important part of the process. Usually, the BAs will buy a minority of common stock although buying preferred stock is fast becoming a popular trend.
- The next phase in the process is the creation of the investment vehicle where individual commitments are transformed into shares. It is important to note that it is not the angels group as a whole that invests, but a sub-group of committed individuals. Also, investment typically occurs in tranches in accordance with pre-agreed milestones.
- An important part of the investment process is the mentoring and supporting of the entrepreneurs themselves while reporting back to other angels and keeping them apprised of developments. The BA role at this point encompasses strategy, international marketing, finding key managers, dealing with larger companies, getting high press visibility… all crucial to eventual business success.
- Of course, the final goal is the exit. The normal and preferred way out from the investment is through a trade sale to a larger industry player. Exiting to venture capitalists is not uncommon however, while listing on a stock exchange through an IPO can be rare, though not unheard of.
Since BAs invest in early stage companies having little track record, trust and ethics are especially important. BAs prefer companies that already have a proven track record, and are validated by lead customers or lead users who express a strong need for their innovations.
Key questions that BAs ask themselves are:
- How attractive is the market and how disruptive the technology?
- Is the IP protected?
- Can we trust the team with their vision, motivation and industry knowledge?
- Will they be available to get guidance from us and implement necessary changes?
- How good are the key company partners and suppliers, distributors, experts, coaches, etc.?
- Is there a credible exit strategy on the horizon?
- In what time frame will this happen?
- Does the business plan convincingly explain scalability and how to reach high growth?
- Last but not least, is the pre-money valuation realistic?
Another important aspect when considering the angel investment route is to see which sectors are particularly attractive for BAs? BAs have both profit and “doing good” objectives. Increased attention is being paid to so-called “impact investing” – profitable businesses that also have the specific objective of creating positive social and environmental impact such as renewable energies, medical instruments, life sciences (biotech/pharma are the most demanding), and the environmental sector. It is expected that the share of impact investing from high net worth individuals’ portfolios will reach €1.2bn in 2013. ICT, mobile, social networks and web media have high appeal because of the low initial investment and perceived high potential for scalability. In order to more easily match BA’s investment criteria, should incubators be looking for tenants in these sectors?
A keystone role
Keystone organizations play a crucial role in business ecosystems. Fundamentally, they aim to improve the overall health of their ecosystems by providing a stable and predictable set of common assets that other organizations use to build their own offerings. Keystones can increase ecosystem productivity by simplifying the complex task of connecting network participants to one another or by making the creation of new products by third parties more efficient. They can enhance ecosystem robustness by consistently incorporating technological innovations and by providing a reliable point of reference that helps participants respond to new and uncertain conditions. And they can encourage ecosystem niche creation by offering innovative technologies to a variety of third-party organizations.
Given all of the above, the business incubator is the ideal partner for BA groups, as it helps generate quality deal flow, accelerate growth, lower risk, leverage additional finance through incentives and banks, organize executive coaching, identify managers and key human resources. In addition, incubators activities are essential to bringing BAs from metropolitan areas to invest in peripheral regions that do not have BA groups of their own.
Incubators offering executive coaching to investees enable better implementation and faster growth. Company growth – and so investor profitability – depends on the ability of the team to manage complex processes for sales and distribution, production, logistics, budget control, R&D, administration, personnel, etc. However, skilled managers may not be available to young companies on a full-time basis and as a result, executive coaching becomes a viable, alternate route to enabling business success.
Whilst members of the board provide strategic input, the executive coach helps turn strategy into reality, building discipline and skills, as well as making a positive impact at the entrepreneur level. The executive coach works with entrepreneurs and key managers to facilitate implementation of appropriate decisions and thus help align strategy and operations. He or she will work with the entrepreneur and other key staff to help them introduce necessary changes in company culture and attitudes that investors may expect. The coach therefore is key to investment success.
The big picture
One can therefore see an evident similarity of vision and objectives as well as the complementary skills between incubators and BAs. And incubators can take advantage in several ways from the growing flow of private investment into promising companies. The most obvious way to profit from this trend is for incubators to join BAs investments. The size of each investment for the incubator would equal the typical individual BA commitment (between €10k and €100k), which seems to be an affordable amount for many incubators. Even a relatively small investment can help trigger commitments from other BAs and therefore reach sizeable total amounts. Statistics indicate this is a potentially higher return on investment, as better capitalized companies are better tenants, and will buy additional services from the incubator.
The incubator’s financial sustainability is also positively affected by the improvements in the skills of managers and staff who work with BAs and learn from them, as this generates improved business processes and greater overall market impact. By acting together in the new challenging investment environment, incubators BAs may well become the keystone of renewed entrepreneurial growth so essential to all our economies.
Antonio Sfiligoj is board member at BIC-Incubatori Friuli Venezia Giulia, Senior Adviser - corporate finance, with Advicorp PLC, Investment Manager with Ingenium Slovenia Zernike-Metaventures and co-founder of IAG (Italian Angels for Growth). He was Programme Manager of the Innovation and Technology Management group at BATTELLE Geneva and researcher at ZELTRON (R&D division of Electrolux / Zanussi). He has contributed to the establishment of the Innovation System in Slovenia which includes technology parks, incubators and national agencies.
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