How To Become A Business Angel. Richard Hargreaves
So were you to decide to make approximately ten investments with your £250,000 that would imply a unit investment size of £25,000 at a net cost of £17,500 per investment without rollover relief and £10,500 with it.
However, you also need to plan for further investment rounds. There are lots of good reasons you might invest more in your developing portfolio and sometimes you have little choice unless you are prepared to accept a complete write-off. If your total risk amount before tax reliefs is £250,000 you might put aside from £50,000 to £100,000 to invest in further rounds. This could reduce your typical initial investment unit to £15,000.
If, on the other hand, you decided to risk £250,000 net of upfront tax reliefs and you can claim rollover relief the unit size could rise to over £35,000 (£15,000 divided by 42%) on the same analysis.
Whether to invest more
As the ventures develop and ask for more money, there are easy decisions such as how much to invest in a rights issue when the venture is developing well. There are also hard decisions, such as do you invest more in a venture which has missed its plans and needs more money just to survive?
The decision to invest more and still see the venture fail – the good money after bad scenario – clearly lowers returns in a portfolio.
It is always easy to invest more. The company executives argue passionately that they will achieve success with just one more round of investment and the investor wants to believe them or he loses all his investment. The decision is made harder if the investment terms are such that those who don’t invest are effectively diluted to valueless stakes – this is often referred to as the wipe-out or put up or shut up round.
Other portfolio issues
Alongside a plan to offset the high risks of any one venture by building a portfolio, you need to be clear about sector and stage of investment.
You might decide to only invest in software because you understand it. Whilst your risk would then be concentrated in one industrial sector, that may be more than offset by your sector knowledge, your ability to do due diligence and to understand exit valuations, and the possibility of adding value post investment.
On the other hand, you may decide to invest across a number of sectors of which you have no intimate knowledge. In that case, one way of offsetting risk is to only invest in companies that are already established with customers and revenue. Another is only to invest alongside people who do understand the sector.
It goes without saying that the earlier stage that a venture is at, the higher the risk of failure and vice versa. Though if an established company has large amounts of debt it too can be in the higher risk category.
Time spent deciding how much to invest, in how many companies, at what stage of development and in what sectors is time well spent. As is reviewing this profile from time to time.
Other approaches to investing in unquoted companies
You may decide that being an angel is a step too far for you but you still wish to have exposure to unquoted companies in your portfolio. Or, as an angel, you may want to diversify the risk in your unquoted portfolio with some fund investments.
In either case, there are many opportunities to invest which are less time consuming than angel investing – though also much less fun and satisfying.
Funds
There are two main types of funds available to individuals, namely VCTs and EIS funds.
What they have in common is that participants invest in a blind pool managed by professional fund managers and receive significant tax benefits. Both funds are the result of successive governments’ encouragement of entrepreneurial activity via tax advantages.
The diversification of risk that funds offer, coupled with the inevitably high fees charged by managers and promoters, does mean you cannot expect the level of return that angel investment can deliver.
In practice, and it is very sad to say this, many of these funds are thinly disguised tax shelter schemes. These are designed to give investors an investment return through the use of tax reliefs in the safest way that can be squeezed through the legislation – in other words the economy sees little or no benefit. That to me is an abuse – albeit legal – of the tax system and hard to defend morally. It illustrates, though, how much smarter the tax shelter industry is than the public servants who design these schemes.
A minority of these funds – and it is a minority – do back real growth businesses in the full spirit of the legislation.
The key differences between funds and angel investing are that the investor has no say in which companies will be in the portfolio nor how they are helped post-investment. The investor in the fund has to trust the fund manager to do what they have said they will.
Let’s look in more detail at VCTs and EIS funds, taking them in turn.
Venture Capital Trusts (VCTs)
A VCT is a company whose shares are listed on the London Stock Exchange which must invest in qualifying companies – broadly smaller UK businesses carrying out a permitted trade. The investor subscribes for shares and receives income tax relief on his investment. All dividends and capital gains on the shares are tax free if certain rules are obeyed.
The VCT has become a central part of the tax shelter industry and very large sums of money have been raised. The most successful fundraising year was the tax year 2005-06, when £779m was raised and, more recently, £330m was raised in 2011-12.
However, following the close of the 2010-11 season, one IFA was quoted as believing that only around 30% of new VCT money goes into investment in small unquoted companies: “Much of the rest is going into other investments which, while allowable under VCT rules, are not so much in the spirit of what VCTs were originally intended for,” he said. One example he cited was the pre-sale financing of annual season tickets for premier league football clubs. “So, while the headline VCT sales figures may appear to be very good news for small British companies, the overall reality is likely to be somewhat different,” he commented.
If you want to learn more about the rules VCTs operate under, a good starting point is the HMRC guidance notes available from its website (www.hmrc.gov.uk/guidance/vct.htm).
Enterprise Investment Scheme (EIS) funds
Unlike the VCT, the EIS fund is not really a fund at all in the sense of being a discrete investment vehicle. Instead, it is a series of parallel investment mandates controlled by a fund manager – but this technicality is not important to the investor. Like VCTs these funds are generally marketed to the general public.
Despite having a flexible and attractive set of tax benefits, EIS funds have historically raised much less money than VCTs. However, over the past few years there has been increasing government commitment to EIS – reflected in improved tax benefits – and government disenchantment with VCTs – reflected in reduced tax benefits.
Taken together with the increased highest rate of income tax and sharp reductions of the amounts that can now be invested in SIPPs, the EIS has become more and more appealing. As a result EIS funds are now the tax advantaged vehicle of choice.
The amount raised by EIS funds overtook that raised by VCTs in the tax year 2007-8. The tax changes made by the coalition government since it came to power can only reinforce the trend.
Approved and Unapproved funds
There are two types of EIS fund, the Approved and Unapproved. These formal HMRC terms are ill-chosen as they imply the Approved fund is lower risk. It does offer certainty of getting EIS reliefs, which some might