Business angels that are devils in disguise: What happens if an ‘angel’ investor turns bad?

Jonathan Moules

Financial Times, September 19, 2011

Fundraising is hard, especially if you are running an early-stage venture – which is why business advisers put so much emphasis on finding early-stage investors, known as business angels. But what if your angel turns out to be the devil in disguise?

Hussein Kanji is an angel investor and former venture capitalist at Accel Partners, who moved to the UK from California to get involved in European technology start-ups.

He was recently invited to invest in a UK company, where one of the two original angel investors quit the board just as the business was going into first round of fundraising, seeking $6m. This money was eventually raised – but no thanks to the behaviour of the angel, Kanji says.

Good angel investors are those that offer guidance when needed and wait patiently for results, according to Kanji – and the best ones have already founded companies and sold them on.

“Folks who have done it before tend to be more patient,” he says. “They also tend to know if what looks like a crisis really is a crisis.”

David Giampaolo, chief executive of Pi Capital, a London-based investor network, sees two common mistakes made by angel investors, as well as company founders seeking investment.

First, some have unrealistic expectations about the performance potential or valuation of the business that they are putting money into. This may not be purely the fault of the angel, because the entrepreneur may also have unrealistic expectations about his or her potential, Giampaolo explains.

Second, business angels can be either too hands-off or too controlling. “An angel investor can provide some real value add, but there is a fine line between some advice and mentorship and interference,” Giampaolo says.

But he stresses that problems in angel investing come from both sides of the table.

“I am very critical,” he says. “I don’t only think entrepreneurs need to be more careful about whose money they take, I think investors have to be equally careful with whom they give their money.”

Giampaolo advises entrepreneurs to do due diligence and seek references for potential investors, just as they would expect to be checked out themselves.

“Focus on the calibre of the person rather than the valuation,” he notes. “I would rather have an £8m valuation for my company with the right partner than a £10m valuation from the wrong partner.”

Alex Hoye, chief executive of Latitude, a London-based digital marketing agency, is both an entrepreneur and an angel investor in internet, media, and consumer businesses.

He says the risk in taking money from angels who have previously had their own businesses is that you get someone who thinks that the way he or she ran their business is the way you should run yours.

“Most successful companies are disruptive by definition, which means they run into unchartered areas,” he points out. “This means that the way someone else has run their business is unlikely to be the way this business needs to be run.”

According to Hoye, the trick is to be diplomatic about how you receive an angel’s advice, adopting the tips on more “timeless” matters – such as how to find a good sales person or how to launch a product – and politely ignoring the advice on matters specific to the investor’s previous forays into business.

However, it is not just founders who can be stung by ill-suited or malevolent angels. Other investors can also fall victim.

Lois Cook had direct experience of this with a group of angels at a technology company she invested in four years ago.

After making her investment, another group of five angels came on board with an offer much larger than the founders had been looking for.

That group then installed their own chairman and finance director in the business and set out a new shareholder agreement that everyone signed up to.

“We didn’t want to prevent the company getting another round of funding, so all the angels signed up to it,” Cook recalls. “That probably wasn’t the best thing to do.” Shortly afterwards, the new chairman put pressure on the company’s founders to leave. Again, Cook gave the new angels the benefit of the doubt.

Then the new angels put in a new loan agreement for £50,000 and gave Cook and the original angels an ultimatum either to find the money to match the amount borrowed within 30 days, or face dilution of their combined stake to 10 per cent of its former value.

“We tried hard [to get the money], but we couldn’t match it,” Cook says.

She consoles herself that she and the other early angels only lost tens of thousands of pounds in the process – known in the industry as ‘whitewashing’. But it has made her wary of making any more angel tech industry investments.

Bad angels are a phenomenon that early-stage investing groups would rather not focus on. Bill Morrow, co-founder of Angels Den – a matching service for investors and entrepreneurs – insists that only a tiny proportion of the deals his organisation facilitates will go bad. But this is little comfort if you are the unlucky one.

For both entrepreneurs and investors, the lesson is that angel relationships should not be entered into lightly. As one entrepreneur puts it: bringing an angel on board is more like a marriage – and should be treated with the same care.

Crowdfunding in search of the next Apple or Facebook: How young people are piling their savings into start-ups in search of business ‘unicorns’

Nikou Asgari

Financial Times March 1, 2019

Sahil Bahl, a 24-year-old digital consultant from London, has invested £2,500 in four businesses via crowdfunding websites, ranging from tech start-ups to a coffee chain. The prospect of losing all his money does not worry Mr Bahl. He is in search of a business unicorn.

Online equity crowdfunding platforms — able to link new businesses with a “crowd” of multiple small investors — first emerged in the UK in 2011. The desire of young investors to back young and growing businesses with a disruptive streak is perhaps not surprising. It is possible to invest sums as small as £10 in an array of tech-driven and highly Instagram-worthy UK businesses.

The most popular online platforms — Crowdcube, Seedrs and Syndicate Room — enable businesses seeking capital to post videos as part of their investment pitch, allowing founders to speak directly to the generation that has grown up watching YouTube and Dragons’ Den.

Having stumped up cash to become a shareholder, young investors dream of being in at the start of the next big thing. Apple and Facebook, which started life in bedrooms and garages, are among the world’s most valuable businesses today.

Although few ever achieve the near-mythical status of a unicorn — a start-up that grows into a $1bn business — the allure of harnessing one is huge. The number of 18 to 24-year-olds investing through Crowdcube has nearly quadrupled since 2016 — a surge not seen in any other age group.

A cynic would put such youthful enthusiasm down to naivety. The risks of crowdfunding are high, and investors can lose all of their money if a business goes bust. But this doesn’t put off young investors like Mr Bahl.

FT Money meets the new generation of crowdfunding investors and asks what the traditional investment industry could learn from its growing popularity.

Follow the crowd

Crowdfunding is big business, and the success of household names such as craft beer brand BrewDog and challenger bank Monzo has catapulted the investment class into the mainstream. Since 2011, UK businesses have raised an average of £629,000 per crowdfunding round, according to data from start-up research company Beauhurst.

In 2016, Monzo set a record for the quickest crowdfund in history, raising £1m in just 96 seconds. In December 2018, it raised £20m over two days; giving the company the status of a unicorn company — a privately owned business valued at $1bn or more. Monzo investors hope it will become another Crowdcube-listed business to make a positive exit — but only nine exist so far.

Since the platform was founded, 60 per cent of its investors have been younger than 44. Seedrs says 80 per cent of its investors are aged under 50, and Syndicate Room says 57 per cent are under 45. The tangibility of investing in businesses such as tech companies, fashion labels and food and drink brands appeals to younger investors for whom the stock market or pensions may seem boring and distant.

The sums that young investors are prepared to stake are also rising. In 2016, the average 18-24-year-old investor staked just over £306 through Crowdcube. By 2018, this had nearly quintupled to £1,577. This stands in contrast with the overall average investment made on Crowdcube, which fell from £1,697 to £1,298 across the same period. According to Luke Lang, co-founder of Crowdcube, the most successful companies are “creating their own tribe, are purpose driven and community focused.”

These qualities attracted Shubhangi Sharma, a 22-year-old student, to invest in Monzo. “For me crowdfunding is a more engaging process than stocks and shares Isas,” she says. “With traditional stocks and shares, it’s hard to assess and understand company ethos and what they stand for and what the actual value offering is. The process of looking at firms [which are] crowdfunding and assessing their new and creative ideas and the specific problems they’re solving is far more interesting and easier to understand.” Saying she finds crowdfunding “exciting,” Ms Sharma’s interest grew from being a Monzo customer herself and understanding its features.

Funding a business that investors use themselves is a common theme. “I’ve invested in companies where I think there’s a bit of a future, where I understand from a service point of view what they’re offering,” explains Mr Bahl. His £2,500 investment across four crowdfunded businesses also stemmed from Monzo, in which he invested £1,000 in 2016. “That led me into the whole idea of crowdfunding and the realms of alternative investments,” he says.

Although Monzo crowdfunders have yet to receive a penny back on their initial investments, the rapid growth of this and other fintech firms strengthens their belief that it will happen one day — or that, at the very least, the potential upside is worth the risk of an investment.

Those willing to put money into crowdfunded equity assets may also sometimes qualify for valuable tax breaks (see below), even though these investments cannot currently be held in a tax-friendly Isa.

Devoted to disrupters

Since 2011, technology has been the most popular sector receiving equity crowdfunding investment in the UK, data from Beauhurst shows. Meanwhile, 12 per cent of equity funding recipients are food and drinks companies — comparatively, only 3 per cent of equity finance from the wider funding landscape goes into the food and drink sector.

In 2015, Camden Town Brewery became the first Crowdcube-listed drinks company to make a positive exit. After raising £2.75m, the brewery was bought by AB InBev, the world’s largest drinks company, for £85m.

Fintech company Revolut is another crowdfunding success story. In 2018, the bank’s investors received 19-fold returns on their original investments. Revolut became the second Crowdcube unicorn, after BrewDog achieved unicorn status in April 2017. The fintech app has also raised money on Seedrs.

Inspired by this trend, Victoria Carew, a 25-year-old adviser in financial services, has invested £268 across four businesses on Seedrs. Her largest investment — £150 — is in Wrisk, an app-based insurance company. “They’re introducing technology to what seems like an archaic industry,” she explains. Within the technology sector, 7 per cent of crowdfunded companies are developing an app, according to Beauhurst.

“Industry disruption” is a key trend in Ms Carew’s investment choices; she invested £66 in Hectare, a GPS land surveying app. “My parents are farmers, it’s quite a backwards, archaic industry. I looked at my parents, the manual process and inventory of, for example, how many sheep they have. An app out here that can do the simple book-taking for you is such a good idea.”

Similarly, three of Mr Bahl’s crowdfunding investments are tech companies, while the fourth is Grind, the open-till-late coffee chain. “Tech companies represent the majority of growth companies today because there’s a belief in the market that they will ultimately deliver revenue and profitability, I’m following that trend.”

He could invest in start-ups listed on the Alternative Investment Market (Aim), the London Stock Exchange’s international market for smaller growing companies, but Mr Bahl disparages: “Do I really know what the Aim companies are and what they do?”

Businesses raising money via crowdfunding engage potential shareholders in ways which are often more exciting than traditional investment options. Crowdfunding websites typically list descriptions and videos of UK-registered businesses seeking capital. On the pitch page, investors can see the share price, valuation, capital requirement, how much has been invested so far and whether the shares include voting rights and tax relief.

Mr Bahl appreciates the details provided: “I could understand what the service was and which venture capitalists or private institutions have also put their money behind it.”

Turning customers into investors

Many crowdfunding businesses seek investment from their existing customers.

David Abrahamovitch, founder of café-bar chain Grind, has twice enticed his customers to invest and is looking to replicate the past. The coffee and cocktails chain is launching its third Crowdcube campaign next Friday, seeking £3m.

Rather than looking for venture capital, Mr Abrahamovitch emphasises that raising money through Crowdcube’s “tech platform” makes complete cultural sense for a “young, digital, very Instagram-driven business.”

“A very high proportion of our investors were customers,” he says about previous fundraising, explaining that a mixture of direct marketing, social media and Crowdcube’s own marketing has led to overfunding previously.

Aged 33, Mr Abrahamovitch is one of the oldest at Grind and his employees are mostly in their early 30s or younger. The young business has capitalised the power of Instagram to turn coffee lovers into financiers — a strategy that more traditional firms can learn from.

Grind’s Instagram account has 118,000 followers and its photos are a mix of neon signs, latte art and weekly brunch giveaways, directly appealing to a generation who unapologetically spend money based on aesthetics and experiences.

Unsurprisingly, advertising works to entice young investors who may not have originally been looking to invest.

Ms Carew first spotted Wrisk on London Underground ads. “The advert promoted both the business itself and Seedrs,” she says, adding that it “said something about changing the insurance industry, so really caught my attention.”

Ms Sharma explains that she notices businesses with a buzz. “There’s usually some publicity that has been created around the firm or technology or the fact they’re having a new round of funding. Very rarely do I open and scroll through potential investments.”

Her investment approach distinctly contrasts with that of older investors. James Murdoch, a 63-year-old business adviser from London, uses crowdfunding to spice up his wider investment portfolio and has invested in 380 separate companies listed on Seedrs. He sees crowdfunding as a way of helping entrepreneurs and also “a relatively low-cost way of getting to know a number of businesses quite quickly.”

“I would not bet my financial future in risky investments,” emphasises Mr Murdoch, saying he puts “small amounts of money in a lot of companies.”

Others treat crowdfunding more like an expensive hobby. Gail McLoughlin, a 59-year-old retired landscape architect from Scotland, has invested £15,000 across numerous film and tech companies, but has yet to make any returns, admitting that crowdfunding is “only for when you’re feeling a bit flush.”

If their high-risk bets on crowdfunded businesses do not come good, younger investors could lose out in the future. They could also fail to maximise the benefits of matched company pension contributions or pensions tax relief.

Ms Carew says she has an Isa and a handful of stocks and shares. Her Seedrs investments, which cannot be held in an Isa, represent 26 per cent of her portfolio. Despite the long odds of discovering a unicorn, Mr Bahl says he understands the risks, and has invested more money in his conventional stocks and shares Isa than his crowdfunding investments.

Regardless, the sums that 18- to 24-year-olds invest in crowdfunding are rising. Between 2016 and 2018, the average amount these investors sank into new businesses on Syndicate Room rose by 60 per cent — to £1,646.

Average amounts raised from experienced investors have risen less sharply. Although 55 to 60-year-old investors on Syndicate Room invested an average of £5,360 in 2018, this has only risen 22 per cent in two years.

“Crowdfunding appeals to behavioural biases,” says David Stevenson, the FT’s Adventurous Investor columnist. “When people are presented with something sexy and higher risk, they go for it.”

One person who understands this investor behaviour is Cecily Mills, the 35-year-old founder of Coconuts Naturally, an organic dairy-free ice cream brand. She says that crowdfunding gained her business “loyal fans and loyal customers.”

The entrepreneur braved BBC2’s Dragons’ Den in September 2018 and shook hands with investor Jenny Campbell, securing £75,000 for a 30 per cent share in her business. But after the cameras stopped rolling, Ms Mills turned down the offer and instead took her company to Seedrs, where she raised £413,000 for a 22 per cent equity stake.

Risky business

Few crowdfunded businesses will achieve unicorn status, let alone make any money at all. “The majority of start-up businesses fail,” states Crowdcube’s website.

Of all UK companies which raised money through a crowdfunding website between 2011 and 2018, 16 per cent are now defunct — they have ceased activity, been dissolved or neglected — compared with 12 per cent of non-crowdfunded businesses, according to Beauhurst.

Some 2 per cent of crowdfunded companies have exited since 2011, after completing an initial public offering or being acquired. This compares with an exit rate of 9 per cent for companies that raised equity through non-crowdfunding platforms.

The data does not paint a pretty picture for crowdfunding investors; the risk of losing everything is high. When this happens, investors are not protected by the Financial Services Compensation Scheme and risk losing all of their money.

Within her £15,000 investments, Ms McLoughlin expects to lose £1,000 to Oobedoo, an on-demand video app for pre-schools, from which she has heard nothing since the death of its founder. Nevertheless, she says: “I don’t feel anxious about that. I don’t lose sleep about that.”

Despite making no money so far, Ms McLoughlin emphasises that her investments in films have instead granted her once-in-a-lifetime experiences: “I’ve been to the premieres and met the directors. I’ve had an experience with these things [and] met some lovely people.”

Investors must also consider the issue of liquidity, since they are unlikely to be able to sell their shares at will and are usually locked into a business for several years.

Seedrs’ secondary platform, the only secondary crowdfunding market, enables investors to buy and sell shares of Seedrs listed companies. Since its launch in 2017, more than £2.1m has been traded across 314 companies on the market.

Shareholdings may also be diluted. If a business decides to issue more shares, the proportionate shareholding of an original investor will be squeezed.

Andrew Taylor, a finance director from London, has invested £90,000 through both Crowdcube and Syndicate Room. Four of the businesses that he invested in went bust, losing him approximately £50,000. “Those that go bust go bust early on,” he notes.

Despite the high risks that come with this investment approach, Mr Bahl remains unfazed: “I parted with cash knowing that I don’t need it.” Ms Carew echoes this sentiment. “I only ever invest what I can afford to lose.”

Peer-to-peer pressure: do the risks outweigh the rewards? With record amounts invested in the sector, the financial regulator is preparing a crackdown on its marketing

Dan Mitchell

Financial Times March 22, 2019

You may have seen them on a London tube platform or social media: the advertisements ask why your money is languishing in a cash account when it could earn 7.5 per cent elsewhere.

It is the typical siren call of a peer-to-peer lender, a new breed of fintech company matching customers seeking high returns on their cash with companies or individuals wanting to borrow money.

Such companies are targeting cash savers and have mushroomed in popularity in recent years as traditional lenders have retreated from higher-risk lending and savers have sought refuge from anaemic cash rates.

But peer-to-peer investing is nothing like cash saving. Investors in peer-to-peer run the risk of losing large chunks of their capital if the borrowers in their portfolios default, and their investments are not covered by the Financial Services Compensation Scheme (FSCS).

Meanwhile the financial regulator is preparing a crackdown on peer-to-peer marketing this year, worried that customers are being lured into high-risk products without adequate warning. So just how risky is peer-to-peer investing?

How it works

The principle of peer-to-peer investing is simple. Customers seeking a return on their cash lend money to individuals or businesses which may not be able to get a loan elsewhere or are seeking a better rate.

The industry has expanded rapidly in the years since the financial crisis, as banks and traditional lenders have retreated from higher-risk lending and low interest rates have pushed down the returns on savings and investments.

Last year, peer-to-peer companies lent a record £6.1bn, according to data published on Monday by Link Asset Services and data company Brismo, a 20 per cent increase on the previous year.

Across the four largest P2P companies — Funding Circle, Zopa, RateSetter and MarketInvoice — the value of outstanding loans reached £4.5bn last year. That is more than double the amount outstanding at the start of 2016, and a staggering 42 times the £106m outstanding eight years ago.

In 2016, the Treasury gave the industry a further boost by launching the Innovative Finance Isa, enabling investors to hold peer-to-peer investments inside an Isa wrapper and earn high rates of interest free of tax.

Investors can now spread their allowance of £20,000 for the 2018-19 tax year between a stocks and shares, cash and innovative finance Isa.

Unlike a stock market investment, which investors can buy and sell at any time, peer-to-peer loans generally pay out over a set term. Investors can sell their loans, generally for a fee, but only if a platform operates a secondary market. If borrowers default on their loans or fail to pay them back on time, investors can lose large chunks of their capital, which is not protected by the FSCS — unlike cash savings.

In return for tying up their money, potentially for several years, and taking more risk on often less creditworthy borrowers, peer-to-peer lenders are able to earn rates of interest which far exceed those on comparable corporate bond funds or gilts.

The targeted rates on offer (investors could find they take home considerably less) range from around 3 per cent for lower-risk loans, to 10 per cent or more for investors willing to extend high-risk bridging finance or property development loans.

Compare these rates with those in the mainstream fixed income market. For example, the yield (a measure of income) on a UK corporate bond exchange-traded fund called iShares Core £ Corporate Bond is 2.6 per cent, despite the fact the average bond in the portfolio matures in around 12 years. The yield on UK five-year gilts stands at just 0.9 per cent today, while even the interest on a 10-year UK government bond is just 1.17 per cent.

Peer-to-peer companies come in a range of shapes and sizes, from those such as RateSetter and Zopa, which lend to individuals, to others such as Funding Circle, which lend to small businesses. Companies either spread customers’ money among a range of borrowers or allow customers to choose the businesses they want to lend to.

Zopa is the UK’s oldest peer-to-peer company, having facilitated loans to around 420,000 borrowers since it launched in 2004. Lenders must invest at least £1,000, which is then divided between a minimum of 100 smaller loans to diversify the risk.

Its Core loans, which include the least risky borrowers, target a return of 4.5 per cent after fees and bad debts. Its Plus Account, where loans are extended to less creditworthy borrowers, targets a rate of 5.2 per cent. Its loans are fixed term — between one and five years — but investors can take their money out earlier by paying a fee.

Funding Circle, which listed at the end of last year at a valuation of £1.5bn, splits its customers’ investment between a host of small British businesses. The company claims 91 per cent of diversified investors on its platform are earning more than 4 per cent annually.

Investors say they have been lured by the high rates on offer, particularly as global stock markets are teetering near record high valuations.

“The market is tough to get into now, [UK] shares looks very expensive to me. It’s hard to see where the growth is going to come from,” says 45-year-old Ceri Williams, who works at investment platform Downing and invests with RateSetter, Zopa and Funding Circle.

“I wanted something that would not necessarily give double-digit returns, but would definitely beat cash,” he says. He says he has so far made “about £15,000–£16,000 with RateSetter since I started investing and I’ve taken a lot of the money in my stocks and shares Isa and put it into this.

“I’ve not been brainwashed. It’s just not obvious to me how much value there is in the stock market, and I think the disintermediation of banking and financial planning is earning me more money,” he adds.

Ben Yearsley, director at Shore Financial Planning, invests in loan-based crowdfunding — lending to individual businesses — via Downing Crowd. He says he had “some cash on deposit that was earning absolutely nothing, which I got fed up with” and adds he wanted a pot of money “doing something different” from the equities in his pension and investment pots.

“I like picking and choosing which companies I lend to and taking an informed decision on the risk I’m taking.”

He says his loans are currently generating returns of about 5.5 per cent a year on average across his portfolio and his interest payments have always come through on time.

A regulatory crackdown

But storm clouds are gathering above the peer-to-peer industry, which faces a regulatory crackdown in the coming months.

The Financial Conduct Authority has grown increasingly worried about glossy ads promising sky-high interest rates that appear “fixed” and said investors were ploughing more money than they can afford into the sector. It has proposed a ban on direct marketing to unsophisticated investors.

According to a survey of 4,500 investors by the Cambridge Centre for Alternative Finance, quoted in the FCA’s report, some 40 per cent had invested more than their total annual income in peer-to-peer investments and half of those had invested more than double their annual income in such investments.

According to the watchdog, peer-to-peer ads often promote target rates of return “in a way that investors might easily mistake for fixed returns” and often fail to make clear that investments are not covered by the FSCS.

New rules are set to be handed down before June this year, which could include marketing restrictions and limits on the amount everyday investors can invest in peer-to-peer.

Peer-to-peer companies have hit back against the proposals. RateSetter said the marketing restriction “raises questions around personal freedom, fair competition and financial exclusion.”

But even peer-to-peer fans say they have not felt adequately warned about the risk they have taken on.

Mr Yearsley says: “Some of the advertising is disgraceful. [They] should not be comparing these things to cash. As an investor you are exposing yourself to market fluctuations and interest rate movements and a lot of other things with peer-to-peer. Linking it to cash is wrong.”