Living with Dragons: 8 realities of working with private investors
As Dragons' Den is just a portrayal of what it's like to pitch to and work with business angels, we ask what’s life really like with private investors
Dragons’ Den makes great car crash TV. As in all ‘reality’ programmes the most compelling scenes involved those who go blank, sweat, stammer, before being heartlessly dispatched.
The reality of raising private investment is a world away – thank God. But what we really want to know is what it’s like having these angels breathing down your neck, pushing and prodding for a glorious pay-day four years down the track. Read on for the good, bad and the downright ugly realities of living with Dragons:
1) Managing your expectations
It’s pretty obvious money’s top of the agenda. Beyond that, you may want more besides from your angel. Figure out what that is, says David Kilpatrick, founder of £17m turnover technology business Edenbrook. He took on angels and VC investment in 2001, with £200,000 coming from private investors for a single digit equity stake.
He points to Dragons’ Den where the likes of Peter Jones and Theo Paphitis make three or four investments per series. “Yours probably won’t be their major investment – it’s effectively pocket money to them.” Ask yourself:
- Will they really commit enough time?
- Will my business be a significant part of their portfolio?
- What access to their contacts will I have?
- How credible are they in the industry?
Extreme Media Group’s Al Gosling took on two angels five years after starting up, receiving £3m for 17% equity and in November last year was able to buy them out. He wanted proactive investors who could open doors and drive things forward. One helped implement board-level discipline. The other proved particularly busy with a vast array of other projects.
Dan Drury was left disappointed when promised sales leads failed to materialise from his angel investors. While he didn’t take the money for web analytics business WebAbacus for that reason the deal clearly didn’t meet his expectations.
2) Managing their expectations
As Actinic’s Chris Barling says, whether you like it or not, the likelihood is your sparkling business plan projections will not be hit. In 1998, after more than 50 pitches, he raised £165,000 for his small business software company, parting with 15%. He’s now sat on both sides of the fence and understands the pressures. “The chances are you’ll only reach 70% of projected sales,” he says. “If the investor doesn’t understand that, you’ve got a problem.”
Investors are either active or passive, so expectations will inevitably vary accordingly. Passive investors are likely to agree softer terms – and there are more of these by a factor of 20 or 30 says Gary Robins, chief executive of investment house Hotbed, which aggregates these investors’ funds.
Active angels who agree a hands-on executive role on the other hand will expect to be able to stick their noses in. “The underlying principle from an investor point of view is that they can monitor the investment and have reasonable access,” says Andy Curwen, who heads the corporate unit of Manchester- based law firm Rowe Cohen. “The problem is, if they don’t have a portfolio they can get bored and want to interfere all the time.” Professional private investors who have money in a number of companies are likely to be satisfied with monthly accounts and invitations to board meetings.
3) Day-to-day involvement
The bane of your life or something you can’t do without? This is an area where it’s hard to strike a balance. As Extreme Group’s Gosling admits: “I’m a determined entrepreneur who doesn’t want to be told what to do. Yet here I am saying I’d have loved more help.”
Chris Barling takes a similar view. “Our angel didn’t make a huge contribution, but given our egos that was probably for the best,” he admits.
Day-to-day operations should be sacrosanct, unless your angel agrees an executive role. Watch out for interference. There’s sometimes a sense you should do what served them well before. As one entrepreneur, who chose to remain anonymous, says: “Constant calls and emails questioning judgement calls, such as choice of supplier, recruitment policy and pricing structure became a complete pain in the arse but, given his shareholding, the last thing I wanted to do was piss him off.”
Another had the opposite experience, saying they had to ask for input more than they’d have liked because the angel’s other commitments meant that promised assistance and planned monthly meetings never materialised.
Gemma Lewis started private clinic Preventicum, which is based on a German concept, last year after raising £2m. She has zero equity at the moment and five parties bankrolling the project, including the German version of the business. She expects input, but adds that she feels it’s her right to be assertive. “There was talk of an ad campaign, which I didn’t feel was appropriate at the time as I’d rather we invested in sponsoring a major dinner. We reallocated the budget and went for the dinner.”
So sometimes you just have to put your foot down. FreshMinds’ cofounder Caroline Plumb’s investors adopted a different approach with her business. The market research firm received £100,000 at the start-up stage from three angels for 20% equity. “They were quite deliberately hands-off and wanted to give us the feeling of complete control. They felt they’d been too involved in some other investments.”
If you do expect input, don’t push the angel for more than they’re happy to give. One serial investor we spoke to has actually found himself wanting to be left alone to concentrate on his core business. “I won’t make any more investments where the entrepreneur anticipates my involvement beyond the money,” he says. “It takes up too much time and I don’t get any payback. I could get the same financial returns investing elsewhere, without the time and commitment problems. And I feel my own business has suffered through lack of my attention.”
4) Where angels add value
Almost unanimously the entrepreneurs we spoke to could identify a number of areas where angels have added value. As Robins points out they are likely to have a network of influential contacts, be they potential clients, suppliers or even other investors. They can also help mould management teams and offer sound commercial business advice.
Many also act as mentors, bringing on potential. As one unnamed angel says: “The companies I tend to invest in are run by the seat of their pants. It does help having someone experienced and independent on board to help form, shape and map out the business’ future.”
David Kilpatrick found that his VC investors relied on the company’s angels to tacitly rubber-stamp key decisions and cites one example where, having networked at a senior level with no luck, the angel brokered an introduction with the prospect’s managing director. “For the client it removed the risk of engaging with a relatively young business,” he says.
They can also bring structure. One of Gosling’s angels brought corporate level investor relations to the business, which proved invaluable as the company expanded rapidly. Plumb points to people management, which was a key area she and her co-founder had no experience of and is often overlooked when there’s a natural flair for networking and client winning. She was also grateful for their ability to see the bigger picture. “When you have a ‘black day’ they force you to take a look above the parapet.”
The third area of value for Plumb was knowing when to hold firm in negotiations with a FTSE 100 client. “They made sure we didn’t expose ourselves on the contract,” she says. “They pushed us to negotiate on areas such as liabilities, which we would have given more ground to in client negotiation. We were worried we’d lose the whole thing and were so excited we would have let them get away with more than they should have.” Similarly, Innocent Drinks’ angel played devil’s advocate and challenged his thinking, says co-founder Adam Balon, and also encouragingly pushed for international expansion.
One of Lewis’ investors made his money in property. He helped her business secure premises and agreed the lease. Another investor, from the hospitality sector, helped source staff uniforms and crockery. And finally, the private investor Drury brought in as chairman at his former company, was influential in raising venture capital and bringing in another eight angels from his own network. After Drury identified a potential merger, he also took care of negotiations, thrashing out the deal.
5) ‘Shareholders’ agreement
Be prepared: this document can be quite fearsome, although chances are much of it will never become an issue.
Investors will expect to see certain warranties, statements of fact underpinning the investment. This includes what’s in the business in terms of its assets, contractual arrangements, unforeseen liabilities (such as litigation round the corner), and warranties on the business plan you presented. They will agree expectations of management performance, and forecasts must be based on reasonable assumptions. That’s all fine, but also where it starts to get tricky.
They will expect two types of covenants. The first type, corporate covenants, cover what the company can and can’t do. This may include their rights to monitor the investment, receive management accounts four weeks from month end, 12 board meetings a year, a seat on the board, and the need for various consents (covering borrowing money, issuing new shares, capital expenditure not in the budget, changes to the business plan, senior appointments or removals, and contractual obligations affecting profit and performance in the medium term). The second type, management covenants, provides assurances that you spend your full-time and attention on the business, won’t set up a competitive business if you leave, and that corporate covenants will not be broken.
“With corporate covenants it’s just a question of how many,” says Curwen. “How restrictive does the investor want them to be? This decision will largely be based on your track record and the stage of the company’s development.”
Articles of Association focus on the rights angels can exercise. They may insist on separate classes of shares, such as A or B, giving them a preferential dividend linked to profits, say. It could also grant them stronger voting rights, with shares enhanced by a factor. These will typically only kick-in if something has gone seriously wrong.
By Company Law 75% is enough to pass a special resolution, including changing the company’s articles, winding up, getting financial assistance, or changing the company name. Investors will seek more than 25% in order to block you acting unilaterally. If they have less than 25% their rights are fairly limited.
If investors look to recoup their outlay over the course of the investment, it can be achieved through dividends, straight capital, monitoring fees or directors’ fees. And they may also expect to be able to transfer shares more freely than management. This could be dangerous from a management point of view as you could end up with an investor you don’t want. To avoid this you need to have the right of first refusal – pre-emption rights – enabling you to buy out the investors’ shareholding before they sell to a third party.
Equally, management would not have rights to sell shares at all initially as you are the ones the investor has backed. This restriction tends to last for two years and is negotiable, says Curwen. If you do leave a ‘good leaver’, ‘bad leaver’ clause will enforce further restrictions on you, potentially leaving you with no return for your efforts.
Curwen says that if he’s advising an investor he wouldn’t expect to agree terms of dilution on a second stage of investment. This could make plugging a funding gap awkward if the company has under-performed or if circumstances have changed. “If the private investor does not have the means to invest further you would be between a rock and a hard place,” adds Robins. “They may not be prepared to go ahead with dilution and are only prepared to be bought out, leaving you spending your funds buying them out. There’s no cosy solution. A private investor could promise you the earth, but there’s no guarantee they’d put in another £100,000.”
6) Angels in control
“When someone has a gun in their holster they don’t need to take it out,” says Barling. “We didn’t try anything – we completely adhered to the agreement.” This is generally the case. If an angel does exercise their power of veto it’s most likely to be one of following:
- Decisions to sell the business
- The appointment of new directors
- Remuneration packages – gone are the days of 50% pay increases
- Decisions to acquire
- Significant new borrowings
Can you deal with that? If you can you probably won’t have too many problems.
One entrepreneur we spoke to had worse. Her angels decided she wasn’t taking the business forward as they would like and manoeuvred to take control, removing her in the process. She stood her ground, faced her lawyers with theirs and held on. Without the controlling stake she had it could have been an entirely different outcome.
You may be relieved to hear some angels feel you have the power in most instances. One with more than 15 years’ experience of investing spoke off the record. He says that regardless of the shareholders’ agreement “the entrepreneur, in 99 out of 100 cases, has the whip hand. What will you do without management? You can sue in practice, but it’s a huge upheaval. I don’t think I’ve ever exercised a right of veto – it’s thoroughly counter-productive”. He takes the view that it comes down to reasonable behaviour on both sides and invests in people first.
7) Planning for the angel’s exit
Angels’ motivations are selfish and you have to recognise that. You won’t find one that will invest without an agreed exit plan. “You’ve got to be really wide-eyed that three-and-a-half, four years in these guys need to move. They need to move naturally, they cycle through investments,” says Gosling.
They may be prepared to put it back a while if further investments or acquisitions have been made say, but from the outset you need to think about providing an exit.
The good news is they may be able to help with that too. “Investors have often built up and sold businesses,” says Robins. “All too often good companies with potential will not spot the optimal time or route, be it trade sale or buy-out.”
8) Parting company
When it gets difficult it gets personal. And it can get very difficult. That was the view of one unnamed entrepreneur we spoke to.
“Buying out shareholders where there’s been a fall-out happens all the time,” adds Robins, who says there’s rarely a pre-agreed formula for buy-out. If it comes to it, the buy-out option in an investors’ agreement is known as a ‘Russian Roulette agreement’ or a ‘Texas Shoot-out clause’, says Curwen, because it’s so treacherous. This is because it only arises as a result of a fundamental breakdown in relations and leaves both parties playing bluff.
In practice you would name the price per share you’re prepared to pay. The investor can then either accept to sell for cash or submit a counter offer buying management out for that price – so you’ve got to find the right compromise. “It’s not in every shareholders’ agreement by any means as it involves trying to read the other person’s mind,” says Curwen. “It favours the management more as they tend to be trying to find a way to extricate themselves from the relationship and the premise of any angel agreement is that the management is fundamental.”
10 Top Tips: Taking on Angel investors
1) Don’t do it without advice. Lawyers and accountants, especially if it’s a significant amount of money. Good advisers also have people they can introduce as available sources of capital
2) Talk to other private companies. Get references: don’t take on the unknown. Once angels are in and on the phone every day it’s too late.
3) If the investor’s intention is to get involved in the day-to-day don’t bring them in. You should generally be looking for strategic input
4) Check the angel’s flexibility. Be aware that as much as you’ve come up with new concepts they might be closed to looking at new variations and focused on the short term or exit
5) Find out whether the angel will be open to further investment. This may reduce profi ts in the short term, but increase value in the long term.
6) Check credentials. Is it really them that added value to other successful investee companies? Be healthily sceptical
7) Get an idea of which worthwhile contacts investors have. But treat people who say they can open doors with scepticism
8) Be aware of anti-dilution caveats. A lot of private investors insist on them. Ask what would happen if you require further rounds – it could shift the power base if your relinquish more equity
9) Try to ensure rights are linked to the reporting of the company. The investor agreement won’t restrict them to contact once a month, though.
10) Take communication seriously. The minimum you should provide is a monthly set of accounts. They may expect to attend board meetings. Some provide larger board packs, covering company performance, key issues and targets, a discussion of sales and challenges, in addition to accounts. Passive and minority shareholder investors deserve to receive quarterly reports