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Frustrations of an Angel Investor 1: 80% of new businesses fail, so why take the risk?

Why do investors keep pumping in money when most start-ups fail?  To an extent, it’s blind faith, but a lot can be attributed to the EIS tax avoidance system.

This was perfectly illustrated in a recent presentation I attended.

This isn’t exactly what was said, but I think it’s a fair illustration:

  • An investor puts a total of £100,000 into 100 startups – £1000 each – making the following assumptions:
  • 80 will fail, so that £80,000 will be lost
  • 10 will trade successfully (but not phenomenally) and the investor will get their money back eventually, let’s assume with no premium.
  • 8 will be sold at an average multiple of 3x the original investment
  • 1 will sell at a multiple of 10x
  • Just one – the nascent “unicorn” – will sell at a multiple of 50x, netting the investor £50,000

So overall, the investor will get back £94,000 – which looks like a loss of £6,000 on the original investment. But in fact, through the EIS scheme, the investor immediately recovers 30% of their investment as a tax rebate, so the original outlay is only £70,000. Assuming the above scenario takes 5 years to realise, that’s the equivalent of 6% compound interest.

But it gets better, as there is no Capital Gains Tax to pay on the eventual sales – so, assuming a CGT rate of 20%, the equivalent average interest rate is 7.5%. Right now, with interest rates at an all-time low and fears of another stock market crash, that’s a very attractive return.

On top of that, even for the hardest-headed investor, the excitement of gambling comes in. If fewer investments fail and the ones that succeed sell at higher multiples, then the potential gains are far greater.

Most Angel investors wouldn’t recognise it as gambling.

Some will study the business propositions, talk to the principals and feel like they are making sound business decisions. Others will accept the recommendation of “funds” or angel investment groups, and assume that the startups have been thoroughly vetted by others. Often, though, they’re deluded.

Throughout my own business life, I was always told that it was essential to have, and maintain, a Business Plan. Apart from needing it to show the bank and any investors, it was held out to be essential as a thought-out road map that would help focus and drive the directors of the company. I became a True Believer. I’m told that it’s still described in the same way and taught in MBA courses.

So why do so few start-ups arrive in front of investors with no Business Plan – or perhaps, at best, an inadequate one?

The belief seems to have been fostered that all that’s needed is a “Deck” – a set of PowerPoint slides. This may be a US-driven concept; certainly it’s quite common for executives in the USA to only read Executive Summaries and only look at slide decks. That would be fine, if the financial numbers displayed could be justified by studied facts – but what’s common now is simply to present the high level, with numbers that could have been (and quite possibly were) plucked out of thin air.

In the next article in this series, I’ll expand on my thoughts on business plans and initial valuations.

By Oliver Dowson

Over the last 40 years, I’ve built companies in many countries from the ground up. I have created, managed and sold businesses in UK, USA, Canada, Australia, Brazil, India, China, Germany, Czech Republic and Spain. I have travelled extensively in over 120 countries, spending an average of 8 months a year over the last 20 years away from my home base.
In my early business life, I successfully created 7 new businesses in different sectors in the UK for overseas owners. I moved on to invent and build one of the world's first energy and environmental management consultancies – long before Global Warming became a headline issue. Over the following 30 years, I grew that company, EnTech, into a true international business by opening 11 offices in 9 countries - and along the way, set up many more international companies for others.

I’m fortunate and proud that EnTech became the international energy management company of choice for Fortune 100 multinationals, selling services directly to GE, GM, HSBC, Citi, Honeywell and many others. Working closely with them gave me invaluable insights both into how multinationals work and the different business cultures in countries around the world. In April 2014, I sold EnTech to EnerNOC, becoming a Vice President and overseeing a seamless M&A transition over the next 18 months.

In all my business activities I’ve also used my languages and programming/software development expertise.
I am also now a Business Angel, investing in companies with international ambitions where I can provide mentoring and support from my practical experience, especially those headed up by women and minorities.

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