Business Angels: How to make Profit from Risk

Business AngelsNew research published today by NESTA (National Endowment for Science, Technology and the Arts) in collaboration with the BBAA (British Business Angels Association) reports for the first time that Business Angels stand to make a substantial profit from investing in start-ups, with an average Internal Rate of Return (IRR) of 22% over four years, compared with 27% IRR in the US.

Business Angels – investors who put personal money directly into young unquoted companies – are a significant source of early stage finance. But despite their increasing importance, little is known about their outcomes and returns in the UK.

The report reviewed 1,080 investments. More than half were directed at very early stage, pre-revenue start-ups – the riskiest time of a company’s life. This was reflected in the investment returns. Despite the fact that the majority of investments make a loss (56% in this study), a substantial number (44% in this study) lead to positive returns with 9% generating more than 10 times the capital invested.

The report also suggests a number of strategic choices and practices that may lead to better investments outcomes such as investing in one’s area of expertise, performing at least 20 hours of due diligence before investing and staying connected with the business, preferably at a board level.

Commenting on the research, NESTA’s Chief Executive Jonathan Kestenbaum says

“Angel investing can be a strong viable complement to traditional forms of investment which are not making anywhere close to 22% returns. As the UK grapples with finding new sources of finance to build the sectors that will drive our economic recovery, Business Angels will form a critical new asset class.”

The study finds that the EIS (Enterprise Investment Scheme) and other tax incentives contribute substantially to angel activity with 82% of British angels using the EIS at least once; and the angels stating that about 24% of their investments would not have been made without the tax incentives.

NESTA and the BBAA are calling for the Treasury to increase the Enterprise Investment Scheme tax relief from the current level of 20% to 30% for the much higher risk start ups.

Anthony Clarke, Chairman of the BBAA says

“This research has proven that Business Angels are now the key source of investment in early stage high risk companies. BBAA estimates that angels are currently investing c.£1billion p.a. in the UK and it is important that further individuals should be encouraged to consider this asset class supported by targeted financial incentives. Angels bring not only their own finance, but business –building skills. The UK needs to significantly increase the pool of business angels to invest in the successful innovators of tomorrow.”

The report says that on average Business Angels in the UK invest £42,000 and each investor makes around 6 investments. Investors typically reviewed 20 opportunities each and acquired 8% of a company. Co-investments are seen as the preference for investing in start-ups with on average 5 investors co-investing in any one round. The figures generated by this study were comparable to the performance of the US Angel market relative to the size of the Angel community.

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