Gill South: Start-up companies' success or failure in the lap of the angels

PGG Wrightson chairman Craig Norgate triumphantly announced last week that he had arranged refinancing from the company's banks. Other public companies are chopping dividends to help their financial situation and leaning on long relationships with their financiers.

Not everyone is so lucky. Managers and owners of start-ups and smaller companies have rarely had access to these formal lines of credit. Maybe they've got this far with the help of family and friends and a hot market.

Now is a time when angel investors - backers who provide financial support for early-stage businesses and often help with contacts or expertise - will play an important part in keeping these companies afloat.

Andy Hamilton, CEO of business incubator the Icehouse, cites an interesting statistic: the 4 per cent of early-stage companies who succeed in getting funding will, in 10 years' time, create 50 per cent of new jobs. "That's why this part of the market is so important to NZ and to the economy," he says.

The Angel Association of New Zealand invited John May, Chair of the Angel Capital Association in the United States, to come and talk to a number of Ice Angels and other angel investors about how they should approach their future investments.

The kind of deal US angel investors are interested in, says May, is the company which is "within $500,000 of being a significant company".

The people involved in these businesses are also important.

In the current US market, angel investors are typically shoring up existing investments.

"In tough times the first thing an angel will do is support an existing company that has a track record," says May. "A start-up from university ... is the toughest and least-funded in this environment."

These wealthy backers will happily look at the companies of "serial entrepreneurs", says May. "I would think that angels would be much more interested in these than one where it's a 22-year-old with a great idea."

But an angel is unlikely to be interested if the business is too capital-intensive, he notes. In the US angels steer clear of pharmaceuticals and other areas that are heavily regulated by government, where a change in policy might wipe out a business. The most popular sectors for angel investors, he says, are IT, software and medical devices.

If you are a company looking for angel funding you should present potential investors with a proposition that will make it easy for them to do due diligence and shows how their capital is needed, advises May. In a recent US study researchers found that the more due diligence done by the angel investor, the higher the rate of return. Similarly, the more time spent by the entrepreneur on researching the angel investor, the better the result.

"The entrepreneur should do as much due diligence as the angel," says May.

Try to get the name of another entrepreneur that they have invested in, he suggests. Ask yourself how you will operate together after the cheque has been deposited.

Entrepreneurs should look for angel investors who would be useful on their board of directors, says May. They should be someone who is well-respected in business, preferably within your sector.

The trend, suggests May, will be cross-border angel investing - New Zealand angel investors putting in money alongside counterparts from Chile and the US, for example.

May warns business owners to be realistic about their situation. "In 2009 [entrepreneurs] will give up more of their company than in 2008," he says.

Perry Knight, a veteran of the New Zealand manufacturing industry and one of the Icehouse's Ice Angels, attended May's seminar. The businessman, who has made around 20 investments in young companies, stresses that he generally works with other angels to invest.

He agrees with May that this year he will be working at supporting the companies he has already invested in, but he says he is involved in angel investing because he enjoys the passion of companies with good ideas.

"The fact that I choose not to invest in something does not mean that we don't keep in touch; it may be that I introduce them to others," he says.

When meeting with potential companies, Knight says he is looking for leaders with the capability to take the business further. They are clever enough to be realistic about their company valuation and do not underestimate the amount of work which is required, he says.

For Knight's part, "we bring a lot of experience and skill, we are not just bringing money". People "have to be coachable, and have a willingness to change, to let go [and realise] they are not totally in charge".

If they don't have drive, he's not interested. "Entrepreneurs have got to show enthusiasm and passion. This has to be their dream; they have to be keen."

Knight knows how it feels to be in a start-up. "I understand how lonely it is to be in a small business on your own

... The investor can be a cheerleader, they offer enthusiastic support and encouragement."

The Icehouse's Hamilton says it's a good time to invest because valuations have been driven down. He is busy shepherding a number of deals through for start-up companies.

He advises businesses to network and form relationships. "Angels are investing in people they like and believe in. If you treat it as a transactional process, it'll never work." Nine out of 10 investments come through informal networks rather than formal ones, says Hamilton.

Health technology firm Nexus6, inventor of a digital asthma inhaler, has successfully used both angel investors and venture capital, says Hamilton. "It's a really nice story, and one of the investors is the CEO now."

Hamilton warns that because investment in companies is higher risk than ever at the moment, angel investors expect returns of 20 per cent plus.

You have to be realistic, he says. If you have a $20 million business but no cash flow, you might find the business is now worth more like $5 million. Gill South is a freelance business writer based in Auckland.