Cash & Liquidity ManagementInvestment & FundingInvestment ManagementAlternative Funding: There Must be an Angel

Alternative Funding: There Must be an Angel

In the wake of the global financial crisis, it has become increasingly difficult for small businesses to obtain credit. In many cases banks are not only tightening credit policies but also reducing or withdrawing established lines of credit, leaving some businesses short on working capital. While the UK government has introduced some measures to address this, in particular the Enterprise Finance Guarantee (EFG) scheme, these have failed to make any significant impact. To address this challenge, small businesses must increasingly look at alternative funding options to capitalise on the shifting balance of investment opportunities. But where to start?

Making the Right Choice

There are different options available depending on the stage a business is at and the type of funding it requires. The first £100,000 of funding for a business is usually regarded as the friends and family round and securing this investment demonstrates the commitment of the entrepreneur, while at the other end of the spectrum the venture capital houses are a potential option for those businesses seeking funds in excess of £5m. However, for the companies who have worked through the initial start-up phase, yet do not require investment in excess of £5m, the reduction of bank credit has had a heavy impact. These companies must now look at alternative means of funding in order to plug the investment gap.

Debt factoring and invoice discounting are strong options for companies requiring short-term funding between customer payments to increase cash flow. These methods can significantly improve a business’s cash flow by securing funds against an invoice as soon as it is raised. This will enable companies to access money as early as possible in the invoicing process to provide immediate working capital.

For those seeking long-term funding, the government’s EFG scheme goes some way to fill this gap, as it is specifically designed to help businesses struggling to secure investment. The EFG provides loans up to £1m for businesses with a turnover of up to £25m. However, like its predecessor the Small Firms Loan Guarantee, these secured loans can be difficult to access as only a few banking business managers are aware of the terms or availability. Furthermore, since the government only secures 75% of the loan and banks take on the full risk, this type of loan is difficult to secure. Consequently, relatively few businesses stand to benefit from this scheme.

For companies requiring between £100,000 and £3m, angel investment – where an individual provides capital in return for a stake in the company – is rapidly proving to be the most viable option. The growing popularity of this type of investment is evidenced by the British Business Angel Association (BBAA), who found that business angels’ share of private sector investments in early-stage ventures rose from 16% in 2000 to 41% in 2007.

Angel Investment Explained

Angel investment usually involves an affluent individual offering a business capital in return for a stake in the company. Unlike many other forms of investment, angel investment offers the investors’ ability to not only to commit financial resources but also to provide guidance and advice on a more practical level. This allows the start-up or early stage business to benefit from both the increased funding and the investor’s expertise. According to a survey conducted by Newcastle Business School1, the vast majority of angel investors (70%) have previously founded and owned a small business, so are well-positioned to add considerable value. In addition, 40% of them consider the investment of their general management expertise and experience equally as important as their money.

The level of involvement varies with each investor, with many taking a structured approach to spending time with the investee, often meeting on a regular basis rather than confining their involvement to crisis situations. The motivation to become a business angel also varies between different investors. Some are motivated by financial considerations, but many also regard it as an enjoyable business related activity away from the pressures of a nine-to-five job.

When dealing with this type of investment, sometimes the returns for investors may seem too high. However, unfortunately many companies do not survive, which means investors sometimes lose their money. Therefore, they have to make high returns on winning investments to cover the losses on those that fail, which is often as high as 60% compared with 10-20% that achieve success.

Individual business investors tend to invest on a longer-term timescale than venture capitalists. For the large part, they invest as share capital that, unlike bank debt, cannot be withdrawn at short notice. Perhaps more importantly, they can often help businesses build by accessing their wide experience, contacts and know-how. In seeking such alternatives to bank debt and venture capital, small businesses must put in place certain measures to ensure success.

Securing Angel Investment

The funding landscape has changed dramatically since the onset of the credit crunch and the subsequent financial crisis and the once popular options such as debt finance have suffered as a result. During the downturn, it is clear that sufficient funding is essential for business to grow or even just to survive and avoid cash flow crises.

It is clear that there are various funding options available to entrepreneurs, and each of these should be weighed up against the individual criteria of the business. Their choice will depend on the amount of funding required, the level of involvement that they are happy for an investor to have, and the required length of the investment. Angel investment offers a number of advantages. Not only is it the only viable option in many cases, such as when a business is unable to offer security, but comes with the added bonus of knowledge and consultancy from the investors. If a business does decide to opt for angel investment, there are several steps that the owner can take to improve their chances of successfully obtaining it.

In order to raise finance successfully, businesses must ensure they are well-prepared, follow certain best practice rules, and meet the strict criteria of investors, including developing clear economic and commercial plans that will provide returns to investors as well as to the entrepreneur. It is also vital to demonstrate that the business has a solid management team, as angel investment often takes the form of a relationship with individuals as opposed to solely a business transaction. Finally, providing a realistic business evaluation is crucial to successfully obtaining an investment. Those that get it right can receive significant rewards and be set up for future success.

1The Post Investment Period of Business Angels, Involvement and Impact, July 2007.

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