As the year 2013 draws to an end, the recent article by the Wall Street “What You Need To Know To Become An Angel Investor” (December 2, 2013) has caught our attention.
“This question is particularly interesting as we consistently receive related questions by investors across all of our five regions”, says Achim Neumann, President, A Neumann & Associates, LLC, a New Jersey based regional merger & acquisition and business brokerage and firm. “In a nutshell, there are a lot of investment funds with many investors seeking viable business propositions, but there are still too few viable businesses available for sale.”
This continues a trend from the recession – as counter intuitive as it was then – the quantity of investors still outnumber the sellers of viable businesses. And the quintessential question remains for the savvy investor – where to place his or her funds in order to obtain a good, and more importantly, safe return?
One of the key issues correctly identified in the article is the vastly increased number of channels to invest, partially due to relaxed government controls. For example, crowd funding, online investment syndicates, online web platforms, and others – all provide opportunities for investors to seek the next “Facebook” or “Twitter”. However, the ease of reaching out to, and participating in, these opportunities often neglects the challenges that angel investing brings.
For example, shares may not be liquid, meaning an investment can very often not be sold for many years, or worse, an equity investment might require additional capital input by the angel investor if the initial business plan does not materialize as planned. In other words, a clearly defined “exit” strategy is not always possible. Further, a mechanism to bind the founder(s) has to be established, because the angel investor typically wants to allocate a significant time commitment to provide his industry specific hands-on experience in guiding the business out of the initial stages.
Further, any angel investment will require a thorough due diligence to identify flaws in the business plan – more so than buying an ongoing business. And finally, there is the value determination of the initial investment versus the share percentage to be obtained.
Consequently, many of angel investor challenges are similar to purchasing an ongoing, well-established mid-sized business: due diligence, valuation, “stand-by” capital and investor time allocation are quite comparable. However, whereas the angel investor is very often not the individual making operational decisions on a day-to-day basis, the mid-sized business buyer/ owner is his “own captain”. Here, the business owner has true hands-on responsibility, including the thrill of being rewarded for a flourishing business.
And whereas angel investing certainly CAN provide considerable more upside, it often does not. “There are many horror stories of such investments where the investor was misled, the business plan was flawed, or the founding partner(s) left with significant disagreements – ultimately rendering the initial investment a loss” says Gary Herviou, Managing Director, Central NJ. Here again, a buyer of a mid-sized company does not have to deal with such issues, but can rely on her/himself, plus, the buyer usually can rely on a valuation based on historic, well-established cash flows.
“We have numerous ground floor investments and turn-around situations available in our firm’s sell-side portfolio” says Frank Arcoleo, Managing Director, Central Pennsylvania, “however, we always caution investors to thoroughly weight the purchase of a cash flow generating business versus a new startup. It takes a different mentality (and a different stomach to absorb).”
In sum, whereas angel investing is often perceived as vehicle to beat “returns in the market” with an “easy” investment in a start-up business, the reality is that there are many down falls. Ultimately, the prudent angel investor should undergo most of the same pre-investment steps as a typical business buyer, a major difference being that the business buyer will actually “drive the bus” later on and obtain the rewards all for himself.
Within this context, our entire team of professionals wishes everybody Happy Holidays and all the right investment decisions for 2014!