Investing your Pension in Start-ups. How to Beat the Odds.

I was invited to contribute to a magazine article offering advice about using your pension to invest in business start-ups. My immediate reaction was: 'Don't do it. It's far too risky for something as important as a pension'. Not only does the business have to survive - and a high proportion simply don't - it also has to become saleable and then achieve that exit by being acceptable to the majority of the shareholders - otherwise your equity is only ever going to achieve modest dividends and then only at the directors' discretion.

So you might get nothing - ever. Angel investing is not an easy way to make money. And presuming you're considering using some of your pension because you've retired, you've now fewer earnings options than you used to have to feather that retirement nest. Pensions are about being sensible with what you and your dependents will need to rely on for the rest of your lives. They are the last things you should punt on finding the next Facebook.

Or are they? Why do I do it? Why do I buy into other people's dreams of building a valuable business? If I think it's so risky, why do I do it and not just once or twice, but serially. What gives me the confidence to put my money into one of the riskiest investment opportunities there is... shares in an unproven idea dreamed up by someone who can't afford to back their own venture and who therefore has probably never built a successful business before. They're probably also trying to make and sell something that no-one in history has ever successfully done before. Dyson, Gates, Zuckerberg and Branson are exceedingly rare freaks of fortune. My chances of winning big are therefore vanishingly small.

I think I do it for five reasons.

1. I can afford to lose what I invest in start-ups. Most of my wealth achieved from the sales of my own technology start-ups is safely in property or in the hands of fund managers controlled by an experienced IFA - who occasionally also alerts me to opportunities which have interested his other wealthy clients. I've probably put about 5% of my net worth into start-ups, most of which have yet to deliver an exit for me. But they're still cooking so they might. You not only need deep pockets, you need great patience.
2. It's exciting. You're often investing in ideas that can change lives and make a real difference - not just to their future customers, but also to the lives of the founders and their future employees. Whether the businesses succeed commercially or not is almost immaterial. At least you're helping to try to change the world just a little bit. The economy needs more start-ups to start up.
3. I really enjoy providing advice to typically young enthusiastic people who are keen not to make the mistakes I once made. Good judgement comes from experience, but experience comes from bad judgement! Always bet on the gladiator with the most scars. And boy do I bear scars.
4. And of course I do have the potential of multiplying my money. If you back the right horse, and you're very patient, we're potentially not talking small numbers. The government makes it attractive for you too, especially Seed EIS (currently 50% tax relief on qualifying share purchase and CGT exemption opportunities on exit).
5. It's a lot less stressful than starting your own business. Trust me.

So here are my personal rules and advice for investing in start-ups, using your pension, sparingly please, if you wish:

1. Only invest what you can afford to lose. You could very easily lose all the money you stake. You're gambling. Typically I don't invest more than £50,000 in any single business (other than ones I start myself), and less than £10,000 usually won't buy you much of a stake in anything that has a chance of multiplying (and you probably don't have enough available capital to be invited to join an angel club to meet businesses who need seed funding - see tip 3. Online communities like Kickstarter and Crowdcube might be more appropriate). If it doesn't cost much to start, many other people could have done it. So if no-one else has, there's probably a good reason why. Only relatively wealthy people can afford to risk tens of thousands. So wealthy people need to take substantial stakes in order to have the potential of them getting excited about any gains. If you stake too little for the potential exit value to interest you, why bother? Put it on a horse instead. At least you'll know quickly whether you've won or not. Start-ups will very rarely amount to anything for the best part of a decade in my experience - assuming they survive that long. You've probably a 50/50 chance that they'll survive and a 1 in 10 chance that they'll be bought for a profit within 10 years. It depends on the sector of course. High tech businesses are more likely to die and faster. But if they survive, their value can be many times greater than non-techs because once their start-up costs have been covered, it's highly profitable from then on. All my own technology start-ups that survived had very high profitability at exit.
   
   As an aside, someone recently told me that the definition of Technology is 'Something that doesn't work properly yet'. Wise words.
   
     
2. Only invest in businesses you understand and have had first-hand experience of operating in their market - ideally on the commercial side. There are several reasons for this:-
   
   Firstly and most obviously, you can better judge the business plan which inevitably needs dark glasses to de-bunk the hockey-stick growth predicted in years three onward. Any doubts, walk away. This isn't about trust. It's about faith. And faith is born from experience.
   
   Secondly the business needs to benefit from your experience - not just as a businessman, but as someone who knows something about the market they intend to exploit. I've managed to build a few successful start-ups from scratch over the years. They've taught me that all businesses boil down to one thing - sales. If you don't have sales, you ain't got a business. Everything else like finance, factories, personnel, marketing, boards of directors etc support that one vital business component. Is it a solution looking for a problem to solve or is there a problem that really can be solved by this company's product or service? So if you can judge that your target business has a reasonable chance of achieving significant sales, all other factors can usually be adjusted to achieve some sort of profitability and therefore survival. Whoever said 'sales for vanity, profit for sanity' was correct, but without sales, you can forget profit. And once you've achieved viability, then you can concentrate on growth and ultimately that crock of gold at the end of the rainbow, the exit.
   
   The third reason for needing to know something about the business sector is the potential to offer networking - if not directly for sales, then perhaps for operational assistance.
   
   And finally there's the exit. It will help enormously advising on who might purchase the business and helping the principals to dress it up.
   
    
3. Ideally only consider businesses who have been vetted by an angel club. I am a member of one of the country's most successful and vibrant clubs known as the Surrey 100. We meet every couple of months or so, usually in Guildford. Typically half a dozen selected businesses pitch to us - Dragon's Den-like. Each business will have been coached as to what sort of things we'd like to hear. Their experience, the market they're aiming at, their competition, their forecasts, any research they've performed, investment they've already achieved etc. They get 10 minutes to Powerpoint us and then we emerge to chat informally over a glass of wine and nibbles with any business that took our fancy. At the same time we can explore demonstrations or prototypes they might have brought to their booth. Perhaps we'll also meet other members of their team. Of course investment decisions are never made on the spot. Cards are swapped and follow-up meetings arranged. Club members also get to know one another and typically find they can team up to explore targets as a pack. You tend to find each member will have a different set of experiences to help evaluate the candidates and the exploration of new ventures in a team can be good fun as you chat offline about the ideas and characters involved. And it's always fascinating. Every business that pitches to us is different from run-of-the-mill bakers, builders, professionals and metal bashers. It's all about judging the risks and their potential to scale. So you're very unlikely to be offered businesses who don't have national or even international aspirations. Surrey 100 particularly specialises in businesses who were born from high technology arenas due to its close association with Surrey University and a group of other universities united in their entrepreneurial objectives and collectively known as SETsquared.
   
    
4. Do research. Or more importantly, make sure the principals have done enough. You need to know that there's not just a gap in the market, but there really is a market in the gap. There's often very good reasons why gaps exist. One of the fun things I've done over the past 20 years or so, is to mentor small businesses, especially start-ups. But I've also acted as a business advisor by now to hundreds of people who have pitched to me their ideas for starting a business. Usually these are very modest in aspiration, but they are all invariably based on one amateur planning principle - wishful thinking. Rarely have they ever done professional market research to back up their product, place, price or promotion planning. When asked why they didn't do any research, most will answer that they don't know where to start and assume it's too expensive - which it normally would be. They might also be reluctant to have their dreams trashed by a dose of reality. But that's what they need before sinking their own pensions into a doomed venture.
   
    
5. Invest in local businesses. If you're going to get involved, possibly as a NED, you don't want to have to travel too far. Personally I prefer to maintain an advisory or mentoring role with the business founders rather than a more formal directorship arrangement. But commuting and business travel are not the sorts of things anyone should do in their retirement. Angel clubs will usually offer local opportunities which again make them a worthwhile source for start-up investments as opposed to the raft of crowdfunding sites appearing these days. It would be coincidental if companies that took your fancy on these sites where in the same county let alone a few minute’s drive away and it will be hard to apply any of the above principles to businesses you couldn't meet and stay involved with.
   
    
6. Get help doing the deal. I made my money selling things, not reading acres of lawyer gobbledygook wherein thereto notwithstanding. Equally, as long as my businesses were making money, I left it to the financial wizards I employed to sort out the legal, tax and governance stuff. Important though it probably is, it bores me rigid. Which is why when I'm buying a chunk of somebody else's business I use professional help crafting a safe deal for both parties - and not forgetting my accountants who have to sort it out for HMRC afterwards.
   
   There is also more than one way of sticking money into a company. For example, I like to release the funding in phases if agreed milestones have been reached. You don't want the principals popping into their nearest Ferrari showroom waving your cheque. Valuing businesses is also never easy. But valuing a start-up, especially pre-trading, is much more of an art than a science. Forgetting the ridiculous profits they always predict in future years, you have to negotiate a sensible slug of equity for yourself. Usually you'll find that friends, neighbours and assorted sweatquity contributors have already been given outrageous slices by naive founders, leaving them precious little to offer you without losing control. Tough! Brave it out. They desperately need your money and skills, and you are taking a massive risk. Evidently what they've been doing before hasn't worked as they'd hoped or they wouldn't be asking you for money now. The simplest way to increase the amount of equity they provide to you (probably their first heavyweight investor) is to expand the share capital and dilute everyone (whose shares are worthless anyway without your help).
   
   Other members of your angel club can probably help you in your negotiations. Ideally they're already part of your hunting pack. There are two types of investor 'clubs'. Those who participate in the deal, like my Surrey 100 Club, and those who take a commission - typically these will be offering you larger second round funding opportunities where businesses have already proved themselves and will be seeking growth funding. You'll get less equity, but it's much safer. Of the latter group, there are again two types. Those who act for the investors and those who act as brokers for the businesses. Make sure you know who's negotiating on whose behalf!
   
    
7. Don't look for profit... and at least not while you own the shares. This sounds counter-intuitive, but it's growth you want and therefore the potential to sell a business that is going to deliver large amounts of profit for the people who will one day buy the shares from you. Another important consideration in valuing a business, and in particular estimating its possible value on exit (so you can calculate the potential multiplication of your money), is that one business that makes £1m profit at exit may be worth hugely more than another business making exactly the same profit. The difference is about they're potential to make even more. Buyers of companies calculate the price they'll pay based broadly on two things: Secure profits which they will see as dividend returns, and the opportunity to grow. Angel investors are rarely seeking the first. If they were seeking income, they could put their £50k in the excellent Funding Circle which delivers a steady 10% for me (there's no way they'll get that from a start-up in its early years). Angel investors seek stellar growth. So they always looks for businesses with a potential to accelerate astronomically and potentially never deliver a profit during the early years as it invests everything it makes in that growth. Amazon has never made a profit but it grows every year. Angels seek early Amazons.

Angel investing should be fun and fulfilling. You won’t get any pleasure from popping your savings into bonds, FTSE 100s or commodities. They might grow, but where’s the sense of achievement? Start-ups are very high risk and not without their inevitable roller-coaster routes towards rare exits. But I love them and want to help as many sensible ones to prosper as I can – but I’m not counting on any of them to deliver anything other than a warm feeling of satisfaction that it’s more than my money that’s making a difference.