Managing High Technology SMEs to Obtain Institutional Venture

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Managing High Technology SMEs to Obtain Institutional Venture Powered By Docstoc
					How to Attract Venture Capital

    Definition of An Angel
  Angel Activity & Importance
Introduction

  What is an angel?
     (As known as: Informal investor; private
      investor.)




                                            2
Introduction

  What is an angel?
     An individual who invests his or her own
      money at arm’s length in a business owned
      by a third party.




                                             3
Introduction

  What is an angel?
     An individual who invests his or her own
      money at arm’s length in a business owned
      by a third party.
        Not friends, family




                                             4
Introduction

  What is an angel?
     An individual who invests his or her
      own money at arm’s length in a
      business owned by a third party.
        Not friends, family
     Tend to be high net worth individuals who
      have had previous success in business



                                                  5
Introduction
  What do angels Look Like?
      Mostly males, over 50
      High income & net worth
      Mostly successful entrepreneurs
           Very limited number of lawyers, physicians, dentists
           majority are business owners and former business
            owners
      Well educated
           professionals or have post-graduate degree



                                                               6
Introduction
  Must understand the process!
   The venture capital industry includes many
  firms with substantial funds to invest
  It is often a challenge for an entrepreneur to
  tap into this vital source of financing.
  The venture capital process begins with an
  introduction to a venture capitalist.



                                                   7
Venture Capital
  Venture capital provides long-term,
  committed share capital, to help
  unquoted companies grow and
  succeed.
  Venture Capital is a form of "risk capital”
   The main sources of venture capital are
  venture capital firms and "business
  angels"

                                           8
Venture Capital
  Obtaining venture capital is substantially
  different from raising debt or a loan
  Lenders have a legal right to interest on
  a loan and repayment of the capital,
  irrespective of the success or failure of
  a business
   Venture capital is invested in exchange
  for an equity stake in the business

                                          9
Venture Capital

  Venture capitalist prefer to invest in
  "entrepreneurial businesses"
  Venture capital firms usually look to
  retain their investment for between
  three and seven years or more.




                                           10
Choosing the Right Angel
  The criteria for selecting the right venture
  capitalists to approach include:
     geographic area
     industry specialization
     stage of development
     size of investment preferences.
  Also important are whether the fund will act
  as a lead investor and whether there are
  complementary or competing invested
  ventures within the fund’s portfolio.

                                                 11
Why are Business Angels
Important?

1. Money:
    angels provide substantial quantities of financing




                                                   12
Why are Business Angels
Important?

1. Money:
     angels provide substantial quantities of financing
2. Position:
     Angels invest in growing firms, in segments
     where so-called capital market gaps are argued
     to be limiting




                                                    13
Why are Business Angels
Important?
1. Money:
      angels provide substantial quantities of financing
2. Position:
      Angels invest in growing firms, in segments
      where so-called capital market gaps are argued
      to be limiting
3. Non-financial contributions
      enhance viability and improve growth
      performance



                                                     14
Money: How Much?
 On average, an angel invests about $110,000
 per firm in Canada.
 Have range of activity among angels.
     Some make 1 or 2 investments over five years;
     Others make 2-3 investments per year.
 Sometimes invest
     as part of syndicates;
     solo.


                                                      15
Money: How much?
              25%


              20%


              15%


              10%


                5%


                0%
                                    $25,000 -   $50,000 -   $100,000 -   $150,000-   $250,000-
                        < $25,000                                                                >$500,000
                                     $49,999     $99,999     $149,999     $249,999    $499,999

 Percent of Investors     6%          18%         23%         11%          10%         21%          9%



                                                                                                             16
Money: How Much?

 Angels provide substantial early-
 stage financing.
 How much?
     Recent large scale survey of 11,000
      SME(Small and Medium Enterprise)
      owners reveals 18% of business owners
      have made investments in businesses
      owned by third parties during the last
      year.

                                          17
Money: How Much?
 Suppose ~1,000,000 SMEs; and an
 average investment of about
 $110,000
       18% of 1,000,000
      @ $110,000 =
       $20 billion per year, nationally.
     Have at least four other assessments that
      Canadian angels invest between $1 and $5 billion
      annually.


                                                    18
Money: How Much?
 Compare with investments made by
  Canadian institutional venture capital firms:
     2000: $6.6 billion
     2001: $4.9 billion
     Wetzel (1983), Sohl (2001) report 4:1 ratio of
      angel to VC capital in US
 For early-stage firms, angels are
  collectively at least as important as the
  national VC market!


                                                       19
Money: How Much?

In addition to the funds they invest,
 angels report holding substantial
 amounts of capital available for
 financing growing SMEs
The problem is not a shortage
 of risk capital.


                                     20
Importance: Position

  Angels seek out high growth firms
        To compensate for risk, angels look for
         annualized rates of return of at least 25%
        Are patient
     7-7 rule:
        for each $1 invested angels want to exit with $7
        after 7 years
     Only growth-oriented firms can meet
      these rate of return requirements

                                                      21
Importance: Position

tend to exit via strategic sale,
 repurchases by original founders, third-
 party acquisitions
exits via IPOs (initial public offering),
 sales to VCs happen, but not as
 frequently as other exits



                                         22
Importance: Position

  Business angels invest in most
  sectors (regional effects) and where
  many people say there is a „capital
  market gap‟ – in early stage growth-
  oriented businesses




                                     23
Importance: Position
      Angels tend to invest close to home in
      businesses with which they (or members of
      their syndicates) are familiar
       Capital is put to work locally because scale of
        investments does not warrant long geographic
        reach
       Contributes to creation, sustenance of business
        clusters
       Fosters local networking and innovation


                                                     24
Importance: Non-financial
Benefits of Angel Financing

  Surveyed 42 Ottawa-region
  technology firms to learn about non-
  financial contributions angels may
  have made to firms
     33 respondents identified 66 examples
      of contributions




                                          25
Non-financial Benefits of Angel
Financing
  Non-financial contributions were
  coded into six categories
     Advice
     Contacts
     Hands-on assistance
     Boards of Directors & Advisors
     Market & Business Intelligence
     Credibility

                                       26
Non-financial Contributions of
Angels
                                 30




                                 20
            Number of Mentions




                                 10




                                  0
                                                                                M arket & Business
                                      Advice   Contacts   Hands-On Assistance                        Board Involvement   Credibility
                                                                                   Intelligence
Number of M entions                     24        15              11                    7                    7                2




                                                                                                                                       27
Non-Financial Benefits of
Angel Financing: Advice
  “They [private investors] assisted by providing
  guidance to management, and … they also
  provided guidance in the development of a
  corporate governance process and reporting
  discipline.”




                                                    28
Non-Financial Benefits of
Angel Financing: Advice
  “In addition to making cash available, [the]
  investor provided assistance preparing
  our business plan to present to potential
  investors, provided legal opinions, helped
  map strategy when dealing with difficult
  situations encountered with customers,
  provided assistance in accessing
  government programs, [and] assisted in
  dealing with banks during negotiations
  concerning lines of credit.”

                                           29
Non-Financial Benefits of
Angel Financing: Contacts
  “Both our significant angel investors …
  assisted by providing guidance to
  management, and through their networks
  of … contacts they assisted in finding
  individuals    interested in  providing
  additional financing.”

   “[He] assisted with accountants, lawyers,
  hosting our website … got us meetings
  with his contacts that we would have had
  to work a lot harder to get otherwise.”

                                         30
Non-financial Benefits: Hands-on
Assistance

   “[They provided] legal advice, financial
  negotiations and seeks business
  opportunities … also brought to company
  rights to exploit several new technologies
  which he uncovered.”

  “[They provided] office space and office
  furniture …”


                                               31
Non-financial Benefits of Angel
Financing: Boards

  “Served as directors and provided bank
  guarantees for the company line of credit. Also
  provided personal loans.”

  “Sits on the board of directors, acts as a reseller
  of products, provides input for development,
  marketing, growth opportunities.”




                                                    32
Non-financial Benefits of Angel
Financing: Boards

   “[They] provided introduction to our original
  part-time CFO, original introductions to VCs, and
  some customers, introduction to our first
  executive recruit – VP marketing, and [they] sat
  on board of directors.”




                                                 33
Non-financial Benefits of Angel
Financing: Intelligence

  “… identification of possible customers, identification
  of technical partners or competitors… payroll
  benefits, handling employees.”

  “… close working relationship with key angels -
  consultancy, re: takeover targets, financing.”




                                                       34
Non-financial Benefits of Angel
Financing: Credibility

  “My company's ability to brag about a marquis
  investor opened doors to other investors, and
  potential strategic allies, and even a CEO.”
   “[Private investor(s)] … provided bank guarantees
  for the company line of credit.”




                                                   35
Impact of Angel Activity:
the Case of Ottawa

        A Case Study
Growth of Technology Companies in
the Ottawa Region (Source: OCRI)
                                 1500
Number of Technology Companies




                                 1200    > 120% increase ‘90-95;
                                         > 65% increase ‘95-’00
                                 900


                                 600


                                 300


                                   0
                                        1990 1991 1992 1993 1995 1996 1997 1998 1999 2000 2003



                                                                                           37
 Technology Jobs in Ottawa (Source: OCRI)

100000




75000




50000




25000




    0
         1976 1981 1986 1990 1991 1993 1995 1996 1997 1998 1999 2000 2003



                                                                    38
 Ottawa Growth
  (Source: OCRI)

             1995                             2003


   No (0) Venture Capitalists!!         14 Venture Capitalists
        665 IT Companies                1400+ IT Companies
          20 were public                   40 were public
35,229 employment in technology   75,000 employment in technology
       10.3% vacancy rate                3.9% vacancy rate




                                                           39
Ottawa Growth: 1990 to 1995

   120% increase in number of
  technology-based businesses
      20% increase in technology-oriented jobs
      Yet, had NO institutional VCs in
       Ottawa between 1990 and 1995
         What financing accounts for growth of
          cluster before 1995?


                                                  40
Sources of Risk Capital
(% of firms that had received external equity financing)

                        100
Percent of Businesses




                        75
                                 67.2

                                               52.1


                        50


                        25                                       9.4        9.4



                         0
                              Business    Institutional    Non-Financial   Other
                               Angels    Venture Capital   Corporations

                                                                                   41
Breakdown of Equity Sources
(Based on Fall 2000 Carleton University survey of 600 technology
firms, 185 responses)



                           Had NOT           HAD
                           Received        Received        Total
                           Venture         Venture
                            Capital         Capital
          Had NOT
          Received              129             14             143
          Angel                 (70%            (8%)           (78%
          Investment   )                               )
          HAD
          Received              18              24             42
          Angel                 (10%            (12%           (22%
          Investment   )               )               )
          Total                 147             38             185
                                (80%            (20%               42
                       )               )
Angels and VCs

In Ottawa,
  57% of firms financed by angels also
   obtained VC funding;
  10% of firms without angel financing
   received VC funding



                                      43
Why Do Angels Make Such a
Difference?
  angels’ financial and non-financial
  value-added!
     Angels are a (perhaps, the) primary means
      through which local businesses and
      individuals network.
     Leads to high rates of technology transfer
      and skills mobility.
     Angels play a critical role in the
      commercialization of innovation.

                                              44
Angels Foster Innovation
  Ottawa experience: A virtuous circle
      Angels help to commercialize innovation
      Involvement of angels leads to business
       success, job creation, and wealth creation
           more angels

      more angels, in turn, participate in further
       commercialization of innovations through their
       investment and mentoring activity




                                                    45
What Are Angels Looking For?
What Are Angels Looking For?


  3 Key Things:
     People
     Market potential of the product or
      technology
     Adding significant non-financial value




                                               47
Majority Noted People as Most
Critical Factor

  “I invest in jockeys not horses. Good
  jockeys will ride good horses.”




                                     48
Majority Noted People as Most
Critical Factor

  Want people who are:
     Honest.
     Exhibit strong work ethic.
     Understand how to make a business
      succeed.
     Are invested in own business.
     Have realistic notions of how to value the
      business.

                                             49
Majority Noted People as Most
Critical Factor

   SMEs owners are not well prepared to
   attract private investment (investor view).
     Inability of potential entrepreneurs to
      manage the commercialization
      process,
     Inappropriate views by entrepreneurs
      re the value of the firm and value of an
      idea compared to overall value of
      business.

                                                 50
Majority Noted People as Most
Critical Factor

      “… A lot of times they have a great
       idea, but have no idea about how the
       cash is going to come in. I can think of
       cases where my first question is „how
       is this idea going to pay your bills?‟
       They say „well, I don‟t know‟. I say
       „well it‟s a great hobby then‟. It‟s not a
       business until they can answer some
       of these questions.”


                                                    51
Market Potential Is also Key

 “… if you are looking at something that is
 coming to you across your desk I would tend
 to look more for a technology that is what you
 would call "a platform", like something that
 has really great potential ... Something that is
 exciting. After that a very key thing are the
 people involved.”



                                              52
Seek Opportunities to Make Non-
financial Contributions

  Some investors are passive,
                      But
  Majority say they want to, and do, take on
  active roles in the management of the
  firms in which they invest




                                           53
Non-financial Contributions:
Angels’ Perspectives

   Being able to provide the benefit of their
   experience and knowledge is crucial to
   investors
       “… An investment criteria for me is to be able to
        determine what value I can add and if I see no value
        that I can add to an investment then I tend to walk
        away.”
       “When I want to be passive I go to the NASDAQ or
        the new York stock exchange.”
       “I definitely want my hands on the steering wheel
        and they [business owners] know that up front.”



                                                               54
What Do Angels Say They Want
From Governments?

      We asked them.
Investors: Encouraging More Private
Investment

  Feb.-April 2001: 11 focus groups held with
  approx. 70 angels and local facilitators across
  Canada
      Asked participants how additional informal
       investment might be encouraged
      Focus group participants were invited to provide
       suggestions about ways by which government
       might encourage additional private investment and
       to rate various ways investment might be
       encouraged.

                                                     56
Investors: Encouraging More
Private Investment

  Two primary responses:
     Reduce tax burden
        Note Canadian context, passive investments in
        VC funds are tax-incented
     Facilitate angel networking




                                                    57
Investors: Encouraging More
Private Investment

  Angel Networking
     Best done through various types of angel
      groups
        Allows angels to learn from each other
        Allows angels to refer prospects to others with
         more topic familiarity
        Allows formation of syndicates
        Allows mentoring from lead investors



                                                       58
Investors: Encouraging More Private
Investment

  Angel networking
      Can be low-key         and informal
         e.g. dinner party
      Can be large scale
         Investor forums
         Newsletters, internet
         Matchmaking facilities
         Market-maker facilities


                                             59
Investors: Encouraging More
Private Investment

  Re: Tax Credits
    “The problem with tax credits is sometimes the investment
    becomes more of a tax reason as opposed to an investment
    reason. … just simpler tax laws, lower tax laws, rather than
    targeting. … The danger with [targeting is] that [when] you
    start pushing in one place … you're [hurting] some other
    entrepreneur somewhere else.”
    “I'm in the grape industry, and I saw where the business was
    going. So we pulled out all the crap grapes, put in good
    grapes. Right after we do that, [government initiated] new
    incentive programs for all the slugs in the industry who
    wouldn't do anything [and then they] got grants to pull out
    their crap grapes and replace them. Why would I be on the
    leading edge when the slugs get the money from the
    government?”


                                                               60
Investors: Encouraging More
Private Investment

  Re: Loss Carry-Back
     “As many angels have sold out of
      [investments held for many years], they paid
      capital gains. Then if they were to lose money
      going forward on a new investment, they could
      only carry the loss back three years. … So, it
      [seems to make sense that], for angel
      investments, government should find some
      way that the tax loss carry-back on those kinds
      of investments could be extended [back
      farther]. Then you at least you're taxed evenly
      [on gains and losses].”


                                                  61
Investors: Encouraging More
Private Investment

  Overall, respondents expressed the view that
  what is really needed is a generalized reduction
  of tax rates across the board.
  In their view, this would:
     Help to attract and retain managerial and technical talent
      (human capital);
     Reward successful commercialization of innovative
      activities;
     Increase the availability of financial capital.




                                                             62
Investors: Encouraging More
Private Investment

  The primary, indeed dominant, reason
  that angels reject investment
  opportunities in new firms is their
  perception that the new firm
     Lacks the management talent
  To commercialize successfully the
  innovation.

                                         63
Commercializing Innovation
  Need more than a better mousetrap
  Need the
     management,
     financial,
     marketing,
     exporting
  knowledge and experience that transforms an
  innovation into business growth and wealth
  creation

                                           64
Investors: Encouraging More
Private Investment
  In the view of most angels, there is a gap in
  the market: an absence of well-managed
  investment opportunities.
  It follows that needed most are:
     an educational infrastructure that produces
      individuals able to manage the commercialization
      process;
     a tax regime that retains in Canada and rewards
      talented management; and,
     means of bringing these elements together with
      other angels and with innovative ideas.



                                                    65