My last Friday Link was to substantial piece of work on investment in entrepreneurial business in Scotland, published by the RSE and partners (The Supply of Growth Capital for Emerging High-Potential Companies in Scotland (pdf)). I hope that this work will influence policy and help guide medium to long-term growth in the availability of different types of funding for Scottish business, but in the meantime I though it might be interested to share my thoughts on the current environment.
The majority of companies I work with, I see at events, and I meet at networking either have investment, are seeking investment or are likely to seek investment from Scotland’s local investment community, which consists mostly of Angels and Angel groups. The same names keep coming up – including the best known groups like Archangels, Par, Kelvin, Highland, TriCap, Equity Gap, Discovery and Gabriel.
Why do so many companies go after local investment when there is a whole wide world out there, filled with investors in all shapes and sizes? Why do so many go for Angel money when there are plenty of VCs out there?
I’m not an economist and I haven’t done any sort of systematic study, but here are some thoughts from my own experience on why the companies I work with tend to go for local Angel investment…
Why Investment is Local
“Cold calls to investors don’t work” is a common piece of advice for companies seeking investment. Sending in a business plan unsolicited just doesn’t work. You need a warm introduction from someone already in the investors network. As networks tend to be strongest locally, this pushes people towards local investors. Networks of directors and advisers tend to be local too.
It is also often said that investors invest locally, especially Angels. This is because they will want to be able to monitor their investments and attend board meetings, which is much easier if the investment is just down the road than if travel is required.
Regulations tend to be different across borders– investors and their advisors in one country usually have less idea what will be needed to do business elsewhere. How many Boston or California VCs or their lawyers will understand UK investment deals?
There is currently very little in the way of local VC activity in Scotland – and a lack of VCs in local networks leads to the difficulties in the last few paragraphs. One reason for this is may be that some UK VCs see the Scottish market as over-valued. I have had a conversation with a VC in the south of England who said “I don’t look for opportunities in Scotland – the combination of EIS, SIB and strong Angel groups up there means deals are mostly over-valued and we simply can’t compete. I have since had agreement from two others when I ran this past them
VCs and Angels Don’t Always Mix
Relatively few VCs invest at the seed stage so the first round usually has to come from Angels – and this is true anywhere in the world. Most Scottish Angel investors use a tax relief called EIS (or SEIS) to reduce their income tax liability on the money invested, and reduce capital gains tax on any exit. To take advantage of this generous scheme, they take Ordinary Shares. When a company needs more money, Angels tend to prefer to find more money themselves as if VCs come in they take “Preference Shares”, which can mean that the VCs get the lions share of the proceeds on exit unless the company is a huge success. So it’s hard to get VC money at seed stage, and if you have Angel investors using EIS they tend to steer you away from VC later.
This means that business plans tend to be written for Angels, but a plan written for Angels is not the same as a plan written for VCs. VCs tend to want to go from seed round to more substantial rounds of growth capital quite quickly as they tend to have more capital available than Angels. Few companies have the time or resources to write a second business plan for the small number of VCs with seed funds.
A Self Perpetuating Cycle
The Angels are local. The people I know with investment all got it from Angels. The deals I have worked from were all with Angels. The investors I know are all Angels. The advisors and non-execs I work with all know the Angels. The events I go to are nearly all about how people raised Angel money.
If I’m looking for investment, where will I go? I’ll go where I know people and where I know how deals are done, which is undoubtedly where my chances are highest of getting the money I need! Often we say “this might be a VC opportunity”, but by the time we have written the business plan for Angels (as the most likely source) and had some interest, we quickly start seeing VC as a distraction rather than an opportunity.
Of course there are people in Scotland who have raised VC money, but they aren’t hanging out in the places I am so I don’t know them. Nor do my colleagues or advisors. If they had the same networks after all, they wouldn’t have gone for VC money. Now they have VC money, they are so busy executing that they aren’t talking to me!
Virtuous or Vicious Circle?
One perspective is that this is really a virtuous circle. We have some of the most sophisticated and active Angels in the world here, and with SIB co-investment they also have pretty deep pockets by global standards. Raising investment locally using well-established networks and approaches is efficient and lets companies focus on their markets.
I also hear it described as a vicious circle. Our companies aim low and get relatively small investments from Angels who then don’t let them move to the VC funding they really need but instead “drip-feed” them small follow-on rounds, so the opportunity is wasted through under-funding. Companies going for Angel funding are just not ambitious enough.
Bring In the VCs – The More the Merrier
Regardless of whether you think the circle is virtuous or vicious, I think that creating more opportunity and more options by enabling external VC investment in Scotland seems like a good idea – at least superficially. Access to more money, more expertise and more global thinking can only be a positive thing. So what would we need to do to make it work?
Here are some ideas – some practical, some more far-reaching…
- Create better networks with external VCs – it is true worldwide that warm connections are important in investment, and it also helps identify the right VC!
- Network with people who have experience of raising money from VCs, to share stories and gain advice
- Add people with VC contacts and experience to our teams, boards and advisory groups
- Learn how to write business plans for VCs – what growth rates, funding round sizes and valuations are realistic
- Access to advisers (lawyers, accountants, business) with experience of cross-border investment deals
- More co-operation between Angels and VCs, with well-understood mechanisms allowing seed rounds from Angels can be followed by VCs without anyone losing out
- Reduce the perception or reality of excessive valuations in Scotland
- More VCs interested in seed-stage investment
- More local VCs
Of course there are already initiatives in place in a number of these areas, and the RSE report mentioned above has detailed proposals in some of these areas. In principle I’m excited by the opportunities that international VC investment presents.
Meanwhile, I have to think very carefully about how I spend the limited time and resources of the companies I work with, and Angel investment remains the most likely route to funding and so gets the majority of my attention…