Ben Lobel talks to entrepreneurs about how they made the transition to investing in other people’s businesses.

Despite the pledges made by government and the banks to make available £190 billion in business loans in 2011 – £11 billion more than the previous year – many businesses, particularly smaller ones, are still not best positioned to grab a slice of the pie.

In a prolonged stagnant climate for funding, business angels may offer a more open-minded source of finance, but this avenue has had its own problems of late. According to research by the Department for Business, Innovation and Skills (BIS), angels are having to wait longer to get exits and are increasingly having to invest in follow-on rounds, restricting new deal flow.

The result, according to BIS, is an early-stage funding market that has become ‘more messy and less distinctive’. Professor Colin Mason of the University of Strathclyde, a co-author of the study, says, ‘Angels need deeper pockets and more patience. The market is constipated. Without exits, angels are becoming fatigued and losing interest.’

Angel investors – the long view

For some angels, though, a rapid exit is the last thing on their mind. Jeremy Middleton says, ‘Most people want to invest, watch it grow, then sell and make a profit, and do it all as quickly as possible. I don’t. I want to invest in businesses for the long haul. It’s difficult to find a successful business and, if you do, you sell, pay tax and then wonder where to put the money again.’

Middleton ran home emergency repair firm Homeserve from 1993 with business partner Richard Harpin but hungered to get involved in other ventures. ‘I felt that my strengths were strategic rather than operational and I wanted to be involved with people who have the balls to start up on their own,’ says Middleton, who remains a non-executive director of Homeserve.

But initial projects can leave first-time angels cold. Middleton’s debut investment was £20,000 for a 30 per cent stake in a company that supplied market share data to estate agents. It grew to £2 million in turnover before the estate agency market fell apart in the credit crunch, but survived and is now at break-even. ‘I got my money back three years after investing, but it was disappointing because I wanted to help grow a much larger, sustainable business,’ he says.

The first investment can be high risk

Numerous first investments don’t even make it that far. Software expert Julian Ranger put £40,000 into the developer of an unmanned air vehicle used in military applications for a 5 per cent stake. ‘It was a brilliant technical innovation and I knew the sector fairly well from my defence work,’ he says. ‘But it turned out to be one of those classic mistakes where the idea is wonderful but the commercialisation just isn’t there.’

The project stumbled along but eventually went into receivership. ‘That was one of my first lessons – you mustn’t get seduced by one aspect of any idea. I knew the area, but I hadn’t paid enough attention to the short-term revenue plan.’

The process illustrates how necessary it is to hit the ground running, learn quickly and apply knowledge in the right way. ‘You have to learn how to pick them out, to understand the different types of businesses, from start-up to expansion and recovery funding, and what things to ask during due diligence. You need to know the tax rules like EIS [the Enterprise Investment Scheme, designed to help smaller companies raise finance via tax reliefs for investors] and the various clauses in shareholder agreements. And you can’t do much with less than a £10,000 investment,’ adds Ranger.

Due to the vast amount of knowledge that needs to be picked up, it’s best to start out slow to minimise risks. ‘You’re much more likely to make mistakes earlier in your investment career than later, so it’s best to begin with three or four smaller investments, say £20,000 each, and try to do it with more experienced angels on board too.’

Bigger fish

Once fledgling angels have learned the ropes, they may gain an appetite to do larger deals. Tony Hayday invested £250,000 in Barefruit, a technology company that replaces online error screens with sponsored clickthrough alternatives. He reveals the features he looked for in the company: ‘It’s a simple, scaleable business model, but with global potential, and that was appealing for a bigger investment.’

When forking out a quarter of a million, the utmost confidence in the team you’re investing in is naturally important too. ‘I’ve bought into the people as much as the product – they’re great, talented guys and driven enough to have weathered the three-year storm we’ve just had. They’ll still be there when the economy picks up again.’

With the bigger investments, there can be more reason for an investor to take a hands-on strategic role if things start to go wrong. Jeremy Middleton invested £150,000 for a 15 per cent stake in D-Line, a company that makes decorative trunking, but saw the company struggling for a couple of years due to confusion over which market to sell into. ‘Then we realised that it had to be sold into the DIY trade, so we managed to get it into B&Q and we made it profitable. Now we turn over £2 million and are expanding into Europe and the US,’ he says.

Again, personnel was a key reason to invest. ‘The guy running it is great; he had his own lighting business before, is down to earth and determined, and had developed an innovative product in a tired category. He was the main reason for investing.’

Driving business innovation

Business angels with the required capital for larger commitments can be afforded the opportunity to get involved with truly groundbreaking projects. In 2010, Ranger found himself the lead investor in Astrobotic Technology, into which he poured $200,000.

The team constitutes one of 22 competing to put a robot on the moon to win the Google Lunar X Prize – and US$30 million. ‘It’s a crazy venture; I’m amazed I could be the lead investor in something like it,’ says Ranger. ‘That’s the upside; you get to do things you wouldn’t otherwise do. To think that something I’m involved with could be the first thing back to the Moon since the Russians in 1976!’

Invest in what you know

While such an investment can provide an adrenaline rush, some believe it’s best to stick to what you know. ‘It’s easy to be taken in by stories,’ says Michael Kraftman, angel investor and CEO of contact lens retailer GetLenses. ‘If you’ve had your business in one area and someone comes to you talking about another sector, it’s easy to be drawn in by it, whereas if you’ve got some knowledge then you can distinguish better between pipe dreams and reality.’

And when dealing with such a reality, you have to accept that you’re in it for the long haul and there are no guarantees – you must keep your expectations in check. ‘You need to have been investing in new businesses for ten years or so before you should expect to see them achieve their full success,’ says Middleton. ‘People need to be wary going into it. It’s genuine risk money, and anyone who puts their cash into this area has to be prepared to lose it.

‘That said, it’s a great thing to do; you create business and jobs, and if you choose wisely then you’ll make more money on the one or two that work than you will lose on the others – but it’s definitely a rollercoaster ride.’