Developing Time Series Data on the Size and Scope of the UK-2008

8/14/2019 Developing Time Series Data on the Size and Scope of the UK-2008

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Developing Time Series Data on

the Size and Scope of the UK

Business Angel Market.

FINAL REPORT

May 2008

Colin M Mason

Richard T Harrison

URN 08/1152


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AUTHORS

Colin M Mason

Hunter Centre for EntrepreneurshipUniversity of Strathclyde

Glasgow G1 1XHScotland

Tel: 0141 548 42590141 548 3482

Fax: 0141 553 7602Email: [email protected]

Richard T Harrison

Queens University Management SchoolQueens University Belfast

Belfast BT7 1NNNorthern Ireland

Tel: 028 9097 3621028 9097 5025

Fax : 028 9097 5156E-mail: [email protected]


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CONTENTS

Executive Summary 1

Author biographies 6

1 Introduction 8

2 The UK business angel market: an overview of previousstudies

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3 Developing a time-series dataset to measure business angelactivity in the UK: definitional issues

30

4 Data sources for measuring the investment activity of businessangels: a critical review

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5 Recommendations 60

References 67

Appendix 1. Questionnaire used by BANs to report on theinvestments that they had facilitated.

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DEVELOPING TIME SERIES DATA ON THE SIZE AND SCOPE OF THE

UK BUSINESS ANGEL MARKET

EXECUTIVE SUMMARY

This Report was commissioned to identify the importance of business angelinvestment in the UK, summarise previous approaches to mapping the scale and scopeof the business angel market, identify new approaches to measuring business angelactivity and assess the implications for policy.

A business angel is defined as an individual acting alone or in a formal or informalsyndicate who invests their own money directly in an unquoted business in whichthere is no family connection, and who, after making the investment, takes an activeinvolvement in the business (as an advisor or board member, for example) directly or

via a co-investor.

There is an important distinction between a business angel per se (pure businessangel investment) who is, generally, commercially motivated and driven byexpectations that there will be a financial return on the investment (although someangel investors do on occasion trade-off commercial returns for other social oraltruistic motivations). These meritocratic investors are distinguished from informalinvestors, a broader category that includes business angels but also includes investorsmotivated by primarily non-commercial motives (particularly family connections),described as love money or affinity investing. While both are important, only pure

business angel money is potentially available outside family and personal connectionsand is the primary focus of public policy interest.

Business angel investment is important to the development of an entrepreneurialeconomy. However, in the absence of directories of business angel investors theirinvisibility makes difficult the development of accurate estimates of the scale of the

business angel investment market and the identification of trends in that market.Based on a detailed review of previous research on business angels in the UK andinternationally, the report concludes that research-based knowledge of the businessangel market is ad hoc:

i. it is cross-sectional rather than longitudinal, and as such offers no evidenceon establishing trends in investment activity with any degree of robustnessor reliability;

ii. it is often based on small-scale samples, which creates problems ofgeneralisability to provide estimates of overall market activity levels;

iii. these samples are more often than not samples of convenience, raisingissues of the extent to which extrapolation can be undertaken when therepresentativeness of the sample is unknown;

iv. research is characterised by different definitions of business angel activity,raising the problem that comparative analysis is not based on a like-with-like comparison;

v. international comparisons are problematic;vi. as a result policy decisions are based on partial information.

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Recommendations

1. In view of the importance of business angel investment in supporting an

entrepreneurial economy, the Enterprise Directorate should developimproved time series data on business angel investment activity.

2. Data collection should be based on a consistent rigorous definition ofbusiness angels. The Report defines a business angel as an investor who:invests their own money, makes their own investment decisions1, is drivenlargely by commercial considerations (although some investors may tradeoff part of the commercial return for non-financial considerations), is notmaking within-family investments, and has a hands-on involvement withthe investee company either themselves or through a co-investor. Separatedata collection and analysis is appropriate to scope out the non-pure

informal investment activity in the UK to provide an overall assessment ofthe availability of risk capital.

3. Identifying business angels and the amounts they report to have availablefor investment is extremely problematic. Accordingly, the focus of datacollection should be on investment activity the investments made by

business angels rather than on the investors themselves. Data should becollected on both the activities of business angel investors and on thecompanies in which the investments are made.

4. The business angel investment market is evolving and the Report notes inparticular the emergence of business angel syndicates as a key part of thismarket. Given the increasing significance of angel groups and syndicates,therefore, the Enterprise Directorate should instigate a regular (annual ortwice a year) survey of angel groups and syndicates to collect informationon their investment activity. As similar information is being collected inthe US and is to be collected in Canada, there is scope for developinginternational comparisons in investment levels and trends.

5. Data collection on the business angel market can build on data that alreadyexists, working with existing data sources so that they can be used to

generate estimates of business angel investment activity. The Reportrecommends action on five fronts:

a. Seek changes to the questions in GEM (Global EntrepreneurshipMonitor) about informal investment to include questions about theinvestments themselves

b. Encourage BBAA (British Business Angel Association) to increase therange of data collection from members: while to some extent thisrepresents the tip of the iceberg in terms of market coverage, there is

1 This includes investors making decisions through a syndicate or upon the recommendation of a leadinvestor (or archangel) but excludes collective investments through Venture Capital Trusts.

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potential to capture data not otherwise available from other sources(for example, on valuations, deal structures, co-investment activity).

c. Undertake administrative changes to the process in of 88(2) forms byCompanies House to address the limitations of this as a source of data

on market activity. These changes would include: enforcing therequirement to file; ensuring the completeness of records; requiring thedisclosure of both loan and equity investments; speeding up thetimescale for filing; classifying the investors to identify insiders andoutsiders and connected and unconnected investors; and timely

publication of a list of 88(2) filings.

d. Undertake a one-off survey of business angels to identify the proportion that are members of business angel networks, theproportion of their investments that are made through these networks,and the extent to which such investments are distinctive from those

made without using such networks. With this information it would be possible to extrapolate from data on investment activity throughnetworks (as reported by BBAA, for example) to generate overallheadline market estimates.

e. Undertake a one-off survey to estimate the total share of business angelinvestment activity that is accounted for by EIS (Enterprise InvestmentScheme) and use this information to scale up EIS investment statisticsto provide overall market estimates. This would require surveys of

both business angel investors and EIS investors.

f. While efforts to improve the utility of GEM, EIS and BBAA statisticscould generate much improved information on business angel activityat relatively little cost, each of these data sources has limitations that

preclude using them in isolation. Accordingly, a multi-methodapproach to generating consistent reliable time-series data on the

business angel market is recommended. In addition to improving theutility of the 88(2) date, we recommend that consideration is given to:

i. Pressing the GEM research coordinators to change thequestions they ask about informal investment;

ii. Collecting more comprehensive data through BBAA on theirmembers investment activity;iii. Scoping a project, based on an appropriate sample, to asses the

overlap between EIS and pure business angel investment (thiscould also provide information on business angel networkmembership to permit scaling up of BBAA data).

6. Data collection on the business angel market can also be based on newdata collection, going beyond existing data sources, to develop a moreaccurate, consistent and comprehensive estimate of angel investmenttrends. The Report recommends that the Enterprise Directorate invests in

a company survey modelled on the Canadian Financing Data Initiative(CFDI). This is methodologically rigorous in its approach and can

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generate estimates of both the stock and the flow of business angelinvestments on an annual basis, and could build on existing surveys (suchas the Annual Small Business Survey) to minimise the otherwise high set-up costs.

7. With a CFDI-type survey at the core of a data collection strategy,reinforced by modifications to GEM, BBAA, EIS and 88(2) sources asdiscussed above, there would be a strong basis for collecting consistentand robust time series data on the UK business angel market. This wouldgive the UK the best statistical information on business angel activity andwould provide policy makers with and effective instrument dial formonitoring the early stage risk capital market and providing the basis forevidence-led intervention in the market. Given the diversity of datasources available and to be developed, and the importance of adopting amulti-method approach to market estimation and tracking, the EnterpriseDirectorate should commission and publish an Annual Reporton the UK

business angel market.

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BIOGRAPHICAL DETAILS

Colin Mason

Colin Mason is Professor of Entrepreneurship and Head of Department in the Hunter Centrefor Entrepreneurship (www.entrepreneur.strath.ac.uk) at the University of Strathclyde inGlasgow. He was previously a Professor of Economic Geography in the Department ofGeography at the University of Southampton. His research is concerned withentrepreneurship and venture capital, particularly in the context of regional development. He

has published extensively on topics such as the new firm formation process, the geography ofnew firm formation and growth, the impact of small business policy, and venture capital in

both the academic and practitioner-oriented literature. Over the past twenty years his mainresearch, undertaken jointly with Professor Richard Harrison (Queens University of Belfast),has been concerned with the availability of venture capital for entrepreneurial businesses -they are recognised as leading academic authorities on the informal venture capital market.

He has been closely involved with government and private sector initiatives to promoteinformal venture capital in the UK, including undertaking several consultancy projects for theDepartment of Trade and Industry, Small Business Service and Scottish Enterprise, compilingan annual guide to sources of business angel capital and investment activity report on behalfof the British Venture Capital Association, and undertaking research on behalf of the National

Business Angel Network. He is an honorary member of the British Business AngelAssociation (BBAA). Professor Mason was a member of the Governor of the Bank ofEnglands small business finance forum and the Treasurys Enterprise Panel which examinedthe role that business incubators might play in stimulating technology-based businesses in theUK. He has also advised the Australian Government and various Finnish and Argentineanorganisations on strategies to increase the supply of informal venture capital and has been aconsultant to the OECD and the European Union on issues associated with innovation andventure capital.

He serves on the editorial boards of six entrepreneurship/small business journals and isfounder and co-editor of Venture Capital: An International Journal of Entrepreneurial

Finance (Routledge). He teaches courses on New Venture Creation and Entrepreneurship and

Regional Development and has also lectured on raising venture capital on several MBAcourses in the UK and abroad. In addition, he teaches on a Masters Degree in IndustrialEconomics with Particular Emphasis on Small and Medium Sized Enterprises at theUniversidad Nacional General Sarmiento and Universidad Nacional de Mar del Plata,Argentina and has also taught at universities in Canada and Australia. He has also beeninvolved in several workshops for entrepreneurs on how to raise finance and participated inthe Fit4Finance Programme that was run by Hertfordshire Business Link throughout theSouth East and Eastern regions of England from 2002-6.

Richard Harrison

Richard Harrison took up the position of Professor of Management and Director of Researchat Queens University Management School at Queens University Belfast in January 2006(http://www.qub.ac.uk/mgt/), and assumed the role of Director and Head of School in

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September 2006. He was previously Dixons Professor of Entrepreneurship and Innovation,and Director of the Centre for Entrepreneurship Research, at the University of EdinburghManagement School, and has held professorships in entrepreneurship, strategy and executivedevelopment at the Universities of Aberdeen and Ulster. Professor Harrisons primaryresearch over the past twenty years has been in the area of venture capital and business angelfinance and encompasses three sets of studies. First, analyses of the operation of early stageventure capital markets (both business angel markets and formal venture capital markets) andtheir role in stimulating and supporting business development (and hence economicdevelopment). Second, policy analysis and advice directed at the more effective mobilisationof early stage risk capital, including assessment of public sector/state interventions in thesupply of capital at local, regional, national and international level. Third, internationalstudies of the emergence and development of risk capital markets in emerging economies much of this research is currently focused on East Asia (China, Malaysia, Singapore, Taiwan)and concentrates on the analysis of (a) the internationalisation of the venture capital industryand (b) the governance and regulatory issues in the development of an indigenous venturecapital industry in emerging economies.

He is founding co-editor with Colin Mason of Venture Capital: An International Journal ofEntrepreneurial Finance (Routledge) now in volume 10, this is the only refereed academic journal that specialises in the publication of research and policy papers on all aspects ofventure capital and entrepreneurial finance, including business angel finance.

Professor Harrisons teaching at Masters level (full time and executive MBA programmes)has focussed on a range of Entrepreneurship and New Venture Creation courses, with theemphasis on developing both knowledge of the entrepreneurial process and the application ofthe principles of entrepreneurship in practice in start-up and corporate contexts. Much of thisteaching is focused on opportunity identification and exploitation. Additional teaching lies inthe area of Business Strategy for Entrepreneurial Ventures and Leadership Theory andPractice, and courses have been run for participants from major financial institutions and

small business owners in a wide range of sectors, including the education sector. He has alsocontributed widely to MBA and doctoral education programmes in the US, Argentina andSweden.

Professor Harrison has served as adviser/consultant/speaker on venture capital, businessangels and financing innovation to, inter alia, UK Department of Trade and Industry (Smalland Medium Enterprise Policy Directorate; Innovation Unit; Small Business Service);Scottish Financial Enterprise/Scottish Enterprise; Welsh Development Agency; BritishVenture Capital Association; European Union DG XIII (EIMS Financing Innovationworkshops); European Seed Capital Fund Network (Liege workshop); Forbairt (Ireland);Enterprise Ireland; Fraunhofer Institut, Karlsruhe (Germany); Six Countries Inter-Governmental Programme; OECD; EURADA; European Business Angel Network; Swedish

Forum for SME Research; LINC(Local Investment Network Company) (UK); LINCScotland, CONNECT (Denmark), CONNECT (Sweden), and to advisors, policy makers andlocal development interests on venture capital and informal venture capital (including adviceon the funding of technology based businesses and the role of technology rating services in

particular) in the UK, Ireland, USA and Europe. He has undertaken research on behalf of theNational Business Angel Network and is an honorary member of the British Business AngelAssociation (BBAA). He has recently undertaken two major reviews of the early stage riskcapital market in Scotland for Scottish Enterprise (see for the most recent), and

prepared the background paper making the case for the Scottish Investment Fund (renamedthe Scottish Venture Fund), recently launched by Scottish Enterprise (see for details of the Harrison/Peters report).He was an invited participant in an Industry Canada experts roundtable on improvingstatistical information on the informal venture capital market in Canada (2002), and was an

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ad hoc member of the Finnish delegation to a US-Finland roundtable on developing theventure capital market in Finland (2004) as part of his association with the EmergingBusiness Research Centre at Tampere University of Technology and University of Tampere.He is also a member of the International Advisory Board of the CIRCLE (Centre forInnovation, Research and Competence in the Learning Economy) interdisciplinary research

project at Lund University, Sweden. He has recently been appointed to the InternationalAdvisory Group for the Management of Rapid SME Growth 2006-2010 research project atMcGill University Montreal and Helsinki School of Economics.

1. INTRODUCTION

A simple definition of a business angelis an individual, acting alone or in a formal orinformal syndicate, who invests their own money directly in an unquoted business inwhich there is no family connection and who, after making the investment, takes anactive involvement in the business, for example, as an advisor or member of the boardof directors. There is an inference that such individuals are likely to have a high networth in order to have sufficient disposable wealth to make such high riskinvestments.

Business angels make up what is often termed the informal venture capital market.This contrasts with the formal, or institutional, venture capital market whichcomprises professional investors venture capital firms who invest other peoplesmoney, typically raised from banks, insurance companies and pension funds, but alsonon-financial companies, wealthy families and charitable trusts. Their investmentactivity is recorded and reported by their national venture capital association (e.g. theBritish Venture Capital Association).2

Some researchers include investments by family (love money) and friends (affinitymoney) as part of informal venture capital. However, business angel investment isconceptually distinct from investment by family and friends. Angel investment is

primarily commercially oriented3 in terms of both the expectations of the investorfor capital gains and other financial returns and the terms and conditions governingthe investment - whereas love money is not. Thus, an angel investment can potentially

be made in any business whereas love money is restricted to situations in whichthere is a family or friendship connection between the investor and the businessowner. The Global Entrepreneurship Monitor (GEM) project has suggested thatfamily investment is more significant than disinterested or unconnected business

angel investment in the UK; for example, around 12% of reported informal

2 There is a tendency to assume that national venture capital statistics are an accurate measure ofinvestment activity in the formal venture capital market and therefore to use them uncritically.However, a study of the membership Swedish Venture Capital Association challenged itsrepresentativeness and hence the accuracy of its statistics - noting that it includes some firms that arenot proper venture capital investors and excludes some important investors. The effect is to understatethe amount of early stage investments (Karamerlioglu and Jacobsson, 2000).3 However, this does not preclude non-commercial motivations. Both Wetzel (1981) and Sullivan(1994) have noted that some angels invest for less than fully commercial reasons, for example becausethe product/service has social benefits, to support particular types of entrepreneur, or to support their

local community, and are willing to trade-off some financial return against these altruisticconsiderations. Nevertheless, these investments remain distinct from those made by family andfriends.

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investment is sourced from business angels, the remainder coming from family andfriends.

However, for the purposes of this report the terms business angels and informalventure capital will be used synonymously to refer to this pure angel investment.

1.1 Role of Business Angels

Business angels play a critical role in the creation of an entrepreneurial climate forthree reasons.

First, they invest largely in those areas in which institutional venture capital investorsare reluctant, or unable, to invest. Because business angels do not incur the transaction

costs of venture capital firms they are able to make smaller investments, well belowthe minimum deal sizes considered by venture capital firms. Investments by businessangels are also relatively more concentrated at the seed and start-up stages, whereasventure capital firms tend to provide finance for growth and development. This is bestillustrated by Freear and Wetzel (1990) in their study of the sources of finance used

by new technology-based firms in New England in the 1980s. They found that whilebusiness angels invest across the full range of business development stages, they arethe primary source of funds when the size of deal is under $1million and providemore rounds of seed and start-up capital than venture capital funds. For largeramounts and later stages venture capital firms dominated. Replication of this study inthe 1990s confirmed these relationships (Freear et al, 1997; 1998).

It therefore follows that the informal venture capital market is the largest externalsource of early stage risk capital, substantially dwarfing the institutional venturecapital market.4Robert Gastons estimate for the 1980s was that business angels inthe USA were providing capital to over 40 times the number of firms receivinginstitutional venture capital, and that the amount of capital they invested almostexceeded all other sources of external equity capital for new and growing businessescombined (Gaston, 1989a). A back of the envelope estimate for the UK in the late1990s suggested that the informal venture capital market provided almost twice asmuch early stage finance as the formal venture capital market (Mason and Harrison,

2000a). Recent research in Scotland, tracking all identifiable investment deals overthe past five years, has demonstrated that business angel investment significantlyoutweighs institutional venture capital investment (Harrison and Don, 2004; 2006).Indeed, business angels are often the only source of external seed, start-up or growthfinance available once businesses have exhausted personal and family sources andsources of soft money (e.g. PYBT, government schemes such as Proof of Conceptand University Challenge) funds.

Second, business angels are much more geographically dispersed than venture capitalfunds, which are overwhelmingly located in just a small number of major financial

4

However, as noted earlier, recent evidence from the Global Entrepreneurship Monitor (GEM), whichis discussed in detail later, notes that capital supplied by family members substantially exceeded theamounts raised by business angels.

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technology centres and concentrate their investments in a relatively small number oflocations (Mason, 2007).5In the case of the UK, BVCA statistics for 2006 reveal thatLondon and the South East attracted 42% of all venture capital investments and 60%of the amount invested. Early stage investments are equally geographicallyconcentrated, with London, the South East and the East of England attracting 49% of

such investments and 54% of the amount invested by value. This is in marked contrastto business angels which, Gaston (1989b) has suggested, live everywhere.However, since most business angels are current or former entrepreneurs they arelikely to be most common in regions with a thriving entrepreneurial climate. The onlyanalysis of the geography of business angel investing has been undertaken in Swedenwhere Avdeitchikova and Landstrm (2005) show that both investments (52%) andthe amounts invested (77%) are disproportionately concentrated in metropolitanregions (which has 51% of the total population). However, this is a lessgeographically concentrated distribution than is the case for institutional venturecapital fund investments. Furthermore, business angels tend to invest locally, makingthe majority of their investments in firms located within 50-100 miles of where they

live (Harrison et al, 2003). This is largely a reflection of the superior informationavailable on investment opportunities close to home and the hands on nature of theirinvestments. So, from a regional development perspective the informal venture capitalinvestment process helps to retain and recirculate wealth within the region that it wasgenerated, counteracting the effect of most investment mechanisms which act as aconduit through which personal savings flow out of regions to the nations financialcentres for investment in core regions and abroad.6

Third, informal venture capital is smart money. Business angels are typically handson investors who seek to contribute their experience, knowledge and contacts to the

benefit of their investee businesses. The opportunity to become involved is a majorreason for becoming a business angel. The analogy is with being a grandparent

being a business angel enables an entrepreneurial individual to become involved withand contribute to the start-up and growth of a new business but without the 24-7involvement of the entrepreneur (or parent). It is also a way in which investors canreduce agency-related sources of risk (the availability of information to one party in arelationship in this case the business owner that is not available to the other) andincrease the prospects that the business will be successful. Since most business angelshave an entrepreneurial background this involvement can also be expected to benefitthe businesses in which angels invest although to date research has failed to identifya positive relationship between involvement and business success despite the

reporting of such benefits (or the perception of benefits) by owners (and investors) insuccessive surveys.7

5 See Mason and Harrison (2002c) for an analysis of the regional distribution of venture capitalinvestments in the UK.6 For example, see Martin and Minns (1995) for a regional perspective on the effect on pension fundflows and Mason and Harrison (1989) who show that the flows of investment generated by theBusiness Expansion Scheme favoured the south over the north this example demonstrates theimpact of the institutionalisation of what was intended to be a development of the informal investmentmarket, as it is the pooling of funds (the imposition of an intermediary between the investor and theinvestee business) that is associated with this regional concentration in investment flows: it is likely

that direct investments in BES-eligible businesses were less subject to this north/south leakage.7 See the paper by Macht (2006), presented at the 2006 ISBE conference for a review of the literatureon the post-investment impact of business angels on their investee companies.

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1.2 Measurement Issues

Given the importance of a thriving informal venture capital market for the creationand maintenance of an entrepreneurial economy it is important that Government isable to measure the number of business angels and the level of their investment

activity. Measurement is important to monitor any decline in the number of businessangels, drop in their investment activity or change in the nature of their investments,any or all of which could threaten the ability of businesses to access finance for start-up and growth. Measurement is also required in order to assess the impact ofgovernment interventions and other changes in the external environment on informalventure capital investment activity. Equally, any evidence for an increase in thenumber and investment activity of business angel investors has implications for thedevelopment of additional market interventions to increase the supply of capital.

However, measuring the number of business angels and their investment activity oneither a cross-sectional (static) or time-series basis is extremely problematic. There

are two main problems: identification and definition.

Identification

First, as William E Wetzel Jr observed in his pioneering research on business angels,the total population of business angels is unknown and probably unknowable(Wetzel, 1983: 26) on account of their invisibility and desire for anonymity and theundocumented nature of their investing. From a practical standpoint this means that,unlike the institutional venture capital market, there are no lists or directories of

business angels. The consequence has been that research on business angels has hadto identify business angels through a variety of imperfect sources with no way inwhich to test for the representativeness of the samples that have been generated.Indeed, many studies have been based on samples of convenience, such as angelswho are members of business angel networks, or arising from snowball samplingmethods8, both of which are likely to generate biased samples, not least because theywill under-estimate the number of angels who are lone wolves, acting alone on theirown initiative, or are one-time or infrequent opportunistic investors9. Furthermore, thedifficulty of finding business angels has meant that most samples are small, whichadds to the representativeness problem and makes it problematic to extrapolate fromsample results to derive population estimates of activity with any degree ofrobustness.

Definitions

Second, there is definitional ambiguity. In order to gain a robust and accurateunderstanding of the size and temporal dynamics of the business angel market, datacollection protocols will have to address the issue of how to differentiate betweenwhat we refer to here as pure business angel investment and the wider informalinvestment market. There are four dimensions to this issue.

8 In this approach, a small number of angels are identified and they are asked to identify other angels

that they know in order to expand the sample.9 Previous research (e.g. Mason and Harrison, 1992) has suggested that these investor types will becommon in a random sample of angel investors.

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First, the term informal investment is increasingly used, notably by GEM, todescribe non-institutional risk capital investments in unquoted businesses. Asnoted above, this includes investments made by family, friends and businessangels, with business angel investment being the smallest category. However,

business angels have to be seen as conceptually distinct from love money

invested by family and friends. Angel investment is primarily commerciallyoriented (subject to the caveat that there is a sub-category of sociallymotivated investment) whereas love money is not. Moreover, an angelinvestment can potentially be made in any business whereas love money isrestricted to situations in which there is a family or friendship connection

between the investor and the business owner. Adding to the definitionalconfusion is the fact that whereas a clear distinction can be made betweenfamily members and others, the definition of a friend is much more

problematic: surveys of pure business angels have consistently identifiedsocial, as well as business, networks as sources used to identify potentialinvestment opportunities. A further confusion is that the same individual can

be a source of both angel finance and love money.

The population of business angels is not fixed or static. Rather, being abusiness angel is a transitory state. A virgin angel is someone who is lookingto make their first investment but as the experience of business angelnetworks in the 1990s attests, many of these individuals never make anyinvestments. Another problematic category are individuals who have madeone or more investments but are not currently looking to make newinvestments, either because they have no further liquidity (but may becomeactive investors again once they realise proceedings from a successful exit

event) or because they have invested and have withdrawn from the market onthe basis that this activity is not for them10. Counting either category ofindividual as a business angels risks exaggerating the total number of activeangels in the market and hence the investment capital potentially available. Afinal category is latent investors individuals who would not describethemselves as active investors but who will invest opportunistically if suitabledeals pop up. The implication is that approaches which use the businessangel population as a source of information on investment trends (i.e. supplyside measurement) must address the issue of how to identify these variouscomponents of the angel population in order to generate reliable estimates ofthe availability of finance from business angels. In practice it may be

conceptually clearer to focus on actual business angel investment flows ratherthan the amount of capital that business angels say they have available forinvestment.

The angel market is evolving, notably with the creation of angel syndicatesand other angel groups. These groups operate in two ways. First, they may actas formal or informal syndicates in which each member of the syndicate takesan active role in the investment opportunity identification, screening andinvestment processes. Typically such syndicates will be relatively small.

10 One example of a successful entrepreneur who exited from his business, initially set out to be a

business angel investor and ceased to consider further activity after two unsuccessful investmentsconvinced him this was not something he could undertake successfully is given in Mason and Harrison(2006).

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Second, they may operate on the basis of a small group of active investorsoffering passive members of group the opportunity to invest in deals that theyare offered but had no role in identifying, evaluating or negotiating and willnot play any hands on role in the investee businesses. This second group might

be considered to have broken some aspects in the conventional definition of a

business angel. Nevertheless, as the members are investing their own moneyon a deal-by-deal basis and making a basic investment decision (yes or no)they can still be considered to be business angels. Rather more problematic arethose angels groups that operate on the basis of pooling their investment fundsand devolving the investment decisions to the syndicate leaders. This model ismuch more common in the USA than in the UK, where such investments arenot eligible for tax relief under the Enterprise Investment Scheme. The realityof angel investing is therefore that it operates on a spectrum, occupied at oneend by the solo investor who makes his or her own investment decision toinvest directly, and at the other end by investors who are part of angelsyndicates who simply say yes or no to the investment opportunities that

they are offered and play no direct hands-on role in the investee company. Thehands-off investor who invests in a pooled fund, and delegates the decision onwhich investments to make, would not be considered to be a business angel onthe basis on the definition adopted here.

There is a final definitional issue which has become important in economiessuch as the UK. Since the introduction in 1981 of the Business Start-upScheme, and the later replacement of this with the Business ExpansionScheme and the Enterprise Investment Scheme (EIS) (discussed below), andthe introduction of Venture Capital Trusts (VCTs), there have been tax-

efficient vehicles designed to encourage and leverage private capital intounquoted businesses with a view to closing the equity gap. However, whileschemes such as EIS allow for direct investments by individual investors and

business angel syndicates (to make their investments tax efficient), there is a problem with pooled investments under EIS and through VCTs, whereindividuals commit investment, to take advantage of the tax breaks available,to fund managers, who make the investment decisions and undertake the post-investment monitoring. This divorces the investor from the investmentdecision-making process, and would not qualify as business angel investmentas we define it here. It is a moot point as to whether the introduction of pooledEIS funds and VCTs has diverted investment funds that would otherwise have

come to the market as business angel investment.11

While much EISinvestment in particular will meet our definition of business angel investment,some will not, and most VCT investment will not meet this definition. Giventhat EIS investments are captured and reported by Inland Revenue one keyquestion is the extent to which it is a useful approximation for overall businessangel investment activity?12

11 The extension of VCTs to allow investment into AIM-quoted companies takes this investmentchannel beyond the business angel market and make it impossible in any case to rely on VCT data as atrend indicator in the business angel market.12

It also raises the issue of the extent to which the development of a time series should be based on

capturing data on the investment activity of a specific group of actors in the market (business angels)

or on scoping out the commitment of investment to a specific set of circumstances (defined variouslyas start-up/new ventures, equity gap issues, technology ventures etc).

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The Project

The project specification defines the objective as being to lay the foundations uponwhich a robust time series dataset can be developed to measure business angel

activity in the UK. The ability to measure and monitor changes is seen as beingbeneficial both to government in developing policy to increase access to finance bysmall businesses, and to stakeholders and finance providers. The specification sets outfour key elements in the study:

Establishing criteria that will define which informal investment activity will beclassified as business angel activity;

Reviewing data sources currently available on the business angel market;

Developing a methodology to collect robust time series data on the size andscope of the UK business angel market;

Address data collection issues.

In Section 2, as background, we provide a comprehensive overview of studies thathave examined the UK business angel market, noting in particular the approachesused in these studies to identify and define business angels. Section 3 offers adefinition of business angels and their investments. Section 4 reviews the researchliterature to provide a critical assessment of data sources that have been used in theUK and elsewhere to identify business angels and measure their investment activity.

Based on this review, Section 5 makes recommendations on the most appropriateapproach to develop a robust time series data on:

The number of active business angels in the UK;

The characteristics of business angels;

The number, size, sector and characteristics of their investments.

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2. THE UK BUSINESS ANGEL MARKET: AN OVERVIEW OF

PREVIOUS STUDIES

2.1 Introduction

The UK business angel market has been the subject of research for nearly 20 years.This section provides a review of our current knowledge of business angels and theoperation of the informal venture capital market. The review is in three sections. It

begins with a summary of the first ever study of business angels in the UK by Masonand Harrison (1994) that was conducted between 1989 and 1991. Second, it identifiessubsequent in-depth studies that sought to extend the Mason and Harrison study.Third, it examines studies that have sought to examine specific aspects of theinvestment process. We pay particular attention in this review to the approaches usedin these studies to identify and define business angels.

2.2 Mason & Harrison (1994): ESRC Small Business Research Initiative Study

The first ever study of business angels in the UK was undertaken by Mason andHarrison between 1989 and 1991 as part of the ESRCs Small Business ResearchInitiative. At that time awareness of business angels in the UK was extremely low.However, a report by the Advisory Committee on Science and Technology, a CabinetOffice committee on barriers to the growth of entrepreneurial businesses which was

published mid-way through the research, did emphasise the importance of businessangels, arguing that an active informal venture capital market is a pre-requisite for avigorous enterprise economy (ACOST, 1990: 41). Mason and Harrisons study washugely influenced by US studies, notably Wetzels pioneering study of businessangels in New England (Wetzel, 1981; 1983; 1986a; 1986b) and the subsequentstudies funded by the US Small Business Administrations Office for Advocacy,notably Arum Research Associates (1987), Gaston and Bell (1986; 1988)13 and Haaret al (1988).14 Its aim, following Wetzel (1986a: 132), was simply to put some

boundaries on our ignorance, its approach to identifying business angels was basedon the approach used by Wetzel and the questionnaire was modelled on the one usedin the US SBA studies, in part to facilitate UK-US comparisons.

The study had five objectives: (i) to identify the characteristics of UK business angelsand compare them with their US counterparts; (ii) to document their investment

activity; (iii) to identify the characteristics of their investment portfolios; (iv) toexamine their involvement with the companies in which they invest; and (v) toidentify their motivations and factors which they take into account when evaluatinginvestment opportunities. Following the approach of US studies, questionnaires weresent to individuals on selected mailing lists which appeared to target individuals withthe characteristics of business angels (business owners, high net worth individuals).This generated 47 completed questionnaires from over 4000 questionnaires. A further12 questionnaires were completed by subscribers to Venture Capital Report, a

13 This research is accessible as Gaston (1989b)14 Visits in the late 1980s and early 1990s by Harrison to the SBA and by Mason and Harrison to

Wetzel and his colleagues at the University of New Hampshire gave them access to the reports andsurvey instruments and an understanding of the methodological issues involved in finding businessangels.

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subscription-only magazine containing information on businesses seeking finance,one response came from questionnaires sent to individuals who placed adverts in the

Financial Times seeking investment opportunities in unquoted companies, and 13came from investors who were either known to the researchers or referred to them bya third party. This gave a total of 86 responses.

The key findings were as follows:

(i) Personal characteristics

UK business angels are predominately male (99%), predominantly in the 45-65 year age group.

They are experienced entrepreneurs, two-thirds having started at least one business, and 70% of these being serial entrepreneurs. Half of theentrepreneurs were cashed-out.

The occupational classification is dominated by business-owners, self-employed and consultants (a description often used by entrepreneurs who hadsold their business).

Relatively high incomes and net worth but not as rich as might have beenexpected (only 16% were millionaires).

(ii) Investment activity

High rejection rate invest in only 8% of all opportunities that they consider.

Median amount invested is relatively small (22,000 at 1990 prices).

Only a small proportion of their wealth is committed to such investments

(typically under 10%). There is considerable diversity amongst investors in the number of deals

considered and investments made.

Most angels are infrequent investors and nearly one-third reported making noinvestments in the three years prior to the survey (Nb. all respondents self-defined themselves as business angels).

Information on investment opportunities largely comes from businessassociates and friends and the investors own search these were also thebest sources in the sense of being most likely to receive investment. Formalsources (e.g. accountants, lawyers, bankers) provide relatively few referralsand have low conversion rates.

Most angels (70%) cannot find sufficient investment opportunities and havefunds available to make more investments.

(iii) Investment characteristics

Investments are concentrated in start-up and early stage businesses.

Investments occur in all industry sectors but there is a strong bias totechnology businesses (self-defined) (33% of the total).

The average size of individual investments is 10,000 only 12% ofinvestments exceed 50,000 (of course, deal sizes were often larger because

some angels invested with others). Provide a mix of equity and loan finance.

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Around one-third of investments involve other angels however, the majorityof investors invest on their own.

Most investments involve a minority equity stake in the investee business.

The majority of business angels are hands on, although only a minority jointhe board. However, nearly one-third are passive, merely receiving

shareholder information and attending shareholder meetings. Investments tend to be local, with two-thirds in businesses located within 100

miles of the investors home or office.

(iii) Investment motivations

Business angels are motivated primarily by financial considerations, notablythe opportunity for high capital appreciation. However, non-financialconsiderations also play an important role, notably to participate in theentrepreneurial process.

(iv) Investment appraisal

The key factors which angels take into account are the management team andthe growth potential of the market.

The vast majority of angels rely on their own evaluation, either exclusively orsupplemented by outside advice.

Comparison with US business angels (Harrison and Mason, 1992a) reveals fewdifferences in demographics, although those in the UK tend to be older. However,there are significant contrasts in the operation of the market. In comparison to US

investors, those in the UK have more investment opportunities brought to their attention, seriously

consider more opportunities but invest in a smaller proportion.

are more likely to invest independently.

are less likely to be approached by entrepreneurs seeking finance.

All of this suggests that the informal venture capital market in the UK may beoperating less efficiently than its counterpart in the USA, particularly with respect toinformation flows on information opportunities. Landstrm (1993) added evidence on

business angels in Sweden to enable a three-way comparison which suggested thatSwedish investors operated in ways that are closer to the US than the UK forexample, the ratio of opportunities considered to investments made, investmentactivity, time spent in evaluation and syndication. However, it is unclear the extent towhich differences between these studies in the identification of business angelscontributes to this variation.

In parallel, Mason and Harrison also undertook a survey of investors registered withLINC, a federation of local business angel networks (or business introduction servicesas they were originally known). Usable responses were obtained from 53 current and

previous members. LINC investors were distinctive from the respondents to the ESRCsurvey in three respects: they were younger; they had higher incomes and lower net

worth, and made larger investments (Mason and Harrison, 1996a). This raised thepossibility that business angels who join business angel networks may be distinctive.

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The Mason and Harrison study has stimulated further research. Subsequent studieshave been of two types. The first type are further large, comprehensive studies of theUK informal venture capital market which have sought to extend, qualify or challengethe profile of the UK informal venture capital market presented by Mason and

Harrison (1994). However, the profile of business angels presented by Mason andHarrison (1994) has proved to be remarkably robust. The second type is a set ofstudies that have sought to add detail to the broad-brush profile of business angels

presented by Mason and Harrison (1994) and subsequent researchers. This has mostlyinvolved a shift away from what has come to be termed the ABC studies of investorcharacteristics and investment activity in favour of in-depth studies of particularinvestor types and specific aspects of the investment process.

One implication from this research is the difficulty of identifying business angelinvestors, and the significant resource costs incurred in trying to build up a sufficientsample for analysis and extrapolation. Accordingly, as in this and other subsequent

studies, market estimates, even in cross-sectional terms, are hard to come by, and thelogistics of the research preclude easy elaboration of the survey approach into the

basis for time series analysis.

2.3 Beyond the initial Mason and Harrison study

The first major study of the UK informal venture capital market following Mason andHarrisons (1994) pioneering exploratory study was research undertaken by PatrickCoveney at the University of Oxford for a PhD which was repackaged as a how to

book for businesses seeking to raise finance (Coveney and Moore, 1998). However,the key findings had been published some time earlier as Stevenson and Coveney(1994; 1996). The key contribution was to document the heterogeneity of businessangels by developing a six-fold categorisation:

Virgin angels individuals with funds available looking to make their firstinvestment but have yet to find a suitable proposal.

Latent angels rich individuals who have made angel investments but not inthe past three years, principally because of the lack of suitable investment

proposals.

Wealth maximizing angels rich individuals who invest in several businessesfor financial gain.

Entrepreneurial angels very rich, very entrepreneurial individuals who backa number of businesses for both the fun of it and as a better option than thestock market.

Income seeking angels less affluent individuals who invest some funds in abusiness to generate an income or even a job for themselves.

Corporate angels companies which make regular and large angel-typeinvestments, often for majority stakes.

For each group the study sought to identify the funds available for investment,demographic and financial characteristics, investment criteria and, where relevant,

barriers to investment.

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The study was based on a sample of nearly 500 investors and 467 investments(involving over 200 investors) a much larger sample than used by Mason andHarrison15 and achieved by working in collaboration with Venture Capital Report, amonthly investment opportunity magazine with a subscriber base of over 700 who

paid a subscription, at that time, of 350 per annum. Over 90% of respondents were

either VCR subscribers or had made enquiries about subscribing. It might be expectedthat the requirement to pay a significant subscription would have biased thesubscribers to the largest and most active investors.

The most significant difference from the Mason and Harrison study was that Coveneyfound a much higher level of investment activity, which is not surprising in view ofthe sample frame used. Investors invested more frequently, made much biggerinvestments (median investment of 40,000 per investment) and had biggerinvestment portfolios. The proportion of passive investors was also lower. However,these differences are likely to have arisen on account of the approach taken to identify

business angels which is likely to have favoured more active and bigger investors, and

the inclusion of corporate investors (9% of all respondents) which will also have biased investment amounts upwards (see Mason and Harrison, 1997 for a fullcritique). Other findings, such as the inability of angels to find sufficient investmentopportunities, friends, family and business associates being the main referral sources,and the dominance of investments in start-up and early stage businesses are allconsistent with those reported by Mason and Harrison (1994).

The second major study in the wake of Mason and Harrison was by Mark vonOsnabrugge, another Oxford University PhD student. This was a more theoretically-

based study. The emphasis was to compare the investment approaches of businessangels and venture capital funds: the focus was therefore on the investment processrather than the size and scope of the informal venture capital market. Major issuesexamined included the following: deal flow, screening, investment criteria, duediligence, contracting, and post-investment monitoring and control. The research was

based on 262 questionnaire responses from business angels and venture capital fundmanagers and 40 personal interviews. Findings were published in academic papers(e.g. Van Osnabrugge, 1998; 2000) and integrated into a book which reviewed theentire investment process (Van Osnabrugge and Robinson, 2000).

Mason and Harrison have undertaken two further significant studies. The first of thesewas based on funding from the DTI to undertake a follow-up of their ESRC study

which investigated other aspects of the informal venture capital market that remainedshrouded in mystery. So here again the study was not particularly interested in issuesassociated with the size and scope of the market. The methodology involvedquestionnaires being distributed by 19 business angel networks to their investors: 127usable responses were obtained, mostly from this source.16 This research led to the

publication of three papers. Mason and Harrison (1999) provided a critical review ofthe impact government intervention to stimulate the informal venture capital market,looking specifically at the use of tax incentives (EIS, roll-over relief and VCTs) and

business angel networks. They concluded that policy was too supply oriented andneeded to address deficiencies on the demand side. In conjunction with evidence from

15

However, the size of the questionnaire, and hence the detail in the data collected, was much smaller.16 Some questionnaires were also sent to business angels who had been identified through informalcontacts and recommendations.

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a later study (Mason and Harrison, 2002a) this led them to argue that policy needed toaddress the issue of investment readiness (Mason and Harrison, 2001; 2004a). Thesecond paper from this research (Mason and Harrison, 2002b) provided the first everevidence on the returns achieved by business angels, their time to exit and method ofexit.17 A related paper found that investing in technology businesses generated an

almost identical returns profile to that of investments in non-technology businesses(Mason and Harrison, 2004b).

Their second study was based on a survey of investors registered with BANs thatwere part of NBAN (Mason and Harrison, 2002a). This supported the clear picture of

business angels being self-made high net worth individuals (62% were millionaires;71% were or had been business owners), motivated largely by financial considerations

but also from the satisfaction of being involved in the entrepreneurial process,typically allocating between 5 and 10% of their total investment portfolio to angelinvestments. It confirmed their earlier study that the tax regime was the main macro-level influence on their willingness to make angel investments. In this study 38% of

investors had used the EIS. Over 90% of respondents were looking to make furtherinvestments no doubt this was a reason why they were members of BANs. Thestudy therefore probed the barriers which prevent business angels from making asmany investments as they would like investment preferences (linked toindustry/market knowledge, and location) and the quality of investment opportunitieswere both influential. However, investors did indicate that they relaxed theirinvestment criteria in certain circumstances notably if the management team hadhigh credibility, if the investment amount was small, if the business was close tohome and if the opportunity had been referred by a trusted source. The failure tosuccessfully negotiate investments, typically because of differences of opinion on

price and size of shareholding, was also identified as a relatively frequent occurrence.

A fifth significant contribution is a study of business angels in Scotland by Paul et al(2003). Scotland has a long tradition of business angel activity. Following research byKPMG (1992) the stimulation of the business angel market was identified as a keyfocus for policy intervention in the Scottish Business Birth Rate strategy. Thisresulted in the establishment of LINC Scotland in 1992 which, under its ChiefExecutive, David Grahame, is one of the most respected and innovative businessangel networks in the world. Scotland is also distinctive in terms its number of

business angel syndicates. The KPMG study was based on interviews with 38business angels who had made 89 investments in the previous four years involving an

investment of some 4.4m, with an average of 50,000 (skewed by five investmentseach of over 250,000). These investments were predominantly in seed, start-up andearly stage businesses. Investments were made primarily for capital gain rather thanincome, the investment instruments was overwhelmingly straightforward equity andtransaction costs were kept low by not costing time and in most cases keepingdocumentation to a minimum. Some 80% of investments were less than 50,000.Investors expected to be personally involved in their investee companies. Theinvestors were predominantly aged 40-55 and were either cashed out or disengagedentrepreneurs or experienced managers who had retired or taken redundancy. The vast

17 An earlier, unpublished version of this research seems likely to have influenced government policy,

the evidence on holding period prompting government to reduce its capital gains taper from 10 years tofour years and evidence on the size of shareholding prompting the abolition of a minimum qualifyingequity share (Mason and Harrison, 2002b).

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majority of investments were within 50 miles of their home or work. Investmentswere typically sourced through personal networks. Consistent with other research,investors could not find sufficient investment opportunities. Based on its surveyevidence the study estimated that the size of the informal venture capital market inScotland, in terms of both money available for investment and amounts already

invested, was around 25m.

The Paul et al (2003) study was based on a questionnaire survey of current and previous LINC Scotland investors and members of one angel syndicate. Thisgenerated 140 usable responses, including both virgin angels and those who had madeone or more investments. For the most part the profile of angels and their investmentactivity reinforced the picture presented in earlier studies. Scottish angels are

predominantly male and aged over 50. However, in contrast to other studies, only aminority had a SME background. They were motivated by capital gain, with interestand fun as subsidiary reasons. The entrepreneur/management team was their keyinvestment criterion. The sample included 30% who were looking to make their first

investment and, at the other extreme, 14% who had made more than five investments.This skewed distribution also emerges in terms of the amount invested, with 45%investing less than 50,000 and 6% investing over 500,000. Half invested as part ofa syndicate. Echoing a constant theme in the literature, most investors wereconstrained from investing more by the lack of investment opportunities. There wasno attempt to estimate the size of the market.

Finally, it is important to highlight two somewhat obscure studies from the greyliterature which sought to profile the angel market in the UK. The first was asummary of a study of 50 business angels (and 47 intermediaries) undertaken on

behalf of the National Westminster Bank Technology Unit (Innovation Partnership,1993). This study pointed to the diversity of angel types and involvement in themarket (in terms of amount invested, frequency of investment, size of investment andamount available for investment). Age (average age of 50), motivation (capital gain)and background (52% former entrepreneurs) confirmed other studies. It alsoconfirmed that angels tended to find deals through their personal contacts. In terms ofinvestment criteria the report confirmed that investing close to home was an importantconsideration for a majority of investors however, this was influenced by the size ofthe investment, about of involvement required and ease of travel (how far can Itravel in an hour). With this caveat, most investors would consider any investmentopportunity on its merits: only a minority had clear investment criteria and found it

easier to express these in terms of what they would not invest it. Most investorswanted to play a hands-on role in their investee businesses. The typical investmentwas 20,000-50,000 but the range extended from 5,000 to 500,000. Finally, thestudy noted the difficulty of getting angels to say how much money they had availablefor future investments. The potential amounts available for investment are subject tofluctuation, depending on an individuals liquidity, the opportunity itself and the stateof their other investments.

The Investor Pulse (2003) survey, which was undertaken by C2 Ventures, was basedon a web based questionnaire that the angel investment community was invited tocomplete. A key deficiency is that the report does not indicate the actual number of

responses. However, the survey broadly confirmed the picture of business angels in

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the UK that had been emerging over the ten years since publication of Mason andHarrisons initial study.

Predominantly a business ownership and management background.

Range of investment experience from yet to invest to more than five years of

angel investment experience. Motivations dominated by financial considerations but fun is an important

subsidiary reason.

The majority (60%) prefer to invest on their own.

Emphasis on investing in start-up and pre-revenue businesses.

Key factors considered at the initial screen: clear financials; scaleable businessmodel with a clear marketing and sales plan; must have (rather than nice tohave) product/service; clear exit and realistic valuation; understanding that itis the team that gets the funding, not the plan.

Two-thirds of transactions in the period 2000-2002 were for less than 50,000

(average of 27,500), but a small proportion of investments were in excess of500,000.

2.4 Adding Detail to the Operation of the Market

In addition to these large scale studies have been a number of more narrowly focussedenquiries. These have been of two types. First, there have been some studies whichhave examined specific types of business angels. Second, there have been severalstudies on specific stages in the investment process.

2.4.1 Studies of specific types of business angel

There are four studies in this category.

Anderson (1998) studied high income workers in the City of London on behalf ofLINC for his MBA dissertation at London Business School. It found that only 40%had invested in unquoted companies, with lack of information, lack of time and lackof trusted advice being barriers to investment.

Kelly and Hay have published two studies which have examined active businessangels. Their first study reported on what they termed serial investors their samplecomprised eight investors who they interviewed in detail and who had made an

average of five investments. The sample split into two groups: those who alwaysinvested on their own and those who invested as part of a syndicate. The keyconclusion of the study was that such investors typically make investments inindustries, markets and technologies where they have some familiarity and know theentrepreneur, or have the deal referred by an individual who has this knowledge.However, angels in syndicates had a greater scope for investing in unfamiliarsituations or where they did not know the entrepreneur because they were able toleverage of the knowledge of their co-investors (Kelly and Hay, 1996).

Their second study involved an investigation of the most active business angels, whatthey termed deal-makers, and others have called super angels, to examine theirsources of information on investment opportunities. They concluded that these angels

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(defined as having completed six or more investments) rely less on publicly availablesources of information and more on their own private sources from an extensive baseof contacts developed as a result of building up their own portfolios (Kelly and Hay,2000).

Harrison and Mason (2007) have provided the first-ever profile of women businessangels in the UK. There are some differences in characteristics and background butthe numbers are too small to test for statistical significance. Women appear to beslightly more likely to invest in women-owned businesses, but this is not because theyfactor gender into their investment decision. Indeed, the findings tentatively suggestthat gender is not a major issue in determining the supply of business angel finance,and that the informal venture capital market is not differentiated along gender lines.However, further investigation of this topic would be worthwhile in view of thetentative nature of these conclusions.

2.4.2 Studies of specific stages in the investment process

(i) The personal portfolio allocation decisionMason and Harrison (2000b) have explored in a very preliminary fashion the factorswhich influence how much of their wealth business angels will allocate to investmentsin unquoted businesses. One of the key distinguishing features of informal venturecapital is that it is discretionary: business angels are investing their own money andso, unlike venture capital funds which have raised money for the purpose of investing,

business angels do not have to invest. Based on responses from 56 investors attendinga LINC Scotland conference18, Mason and Harrison show first of all that moneywhich is not invested in unquoted businesses would instead be invested primarily inthe stock market, property and interest-bearing cash accounts. Respondents were

presented with a list of potential influences that were thought to potentially influencetheir willingness to invest (e.g. tax environment, economic conditions, stock marketconditions). The evidence indicated that business angels were particularly sensitive totax the availability of tax relief on their investments was the most important factorencouraging them to invest, with lower capital gains tax being the second most

positive factor, while higher rates of capital gains tax was the top factor which woulddiscourage investment. Lower tax on dividend payments was the third mostsignificant factor encouraging investment while higher tax on dividends was thesecond most important factor to discourage investment. By contrast, economicconditions are much less influential on the willingness to invest, although by no

means insignificant. Stock market conditions have the least influence on investmentactivity. These conclusions are supported by evidence from two other studies, one ofwhich is the Mason and Harrison DTI study (discussed earlier) (Mason and Harrison,1999; Mason and Harrison, 2002a).

18 Although profiling the respondents was not an objective of the study it is worth noting that theyconformed to the highly skewed distribution that had been identified in previous studies. At oneextreme, 26% of investors had not made any investments in the previous two years and 28% had made

one or two investments whereas at the other extreme 24% had made more than five investments. Theamounts invested ranged from less than 50,000 (19% of respondents who had made investments) to250,000 and over (32%).

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(ii) Investment decision-making criteria

The landmark studies by Mason and Harrison (1994), Coveney and Moore (1997) andvan Osnabrugge and Robinson (2000) all examined the criteria used by businessangels in making investment decisions. However, this evidence was generalised and

retrospective. Specifically, it ignored the different stages in the investment processand the scope for different criteria to assume greater or lesser importance as theinvestment process proceeded. Subsequent studies have probed the investmentdecision-making process in much more detail.

Mason and Harrison (1996b) undertook a case study of deals rejected by a privateinvestment syndicate. This revealed that the decision-making process involves twostages: an initial review and a more detailed appraisal for those opportunities that

passed the initial screening stage. Three factors dominated as reasons for rejection:characteristics of the management team, marketing and market-related considerations,and financial considerations. Most opportunities were rejected for just one or two

reasons although deals rejected at the initial review stage were more likely to berejected on the basis of the culmination of several deficiencies rather than a singleconsideration.

Mason and Rogers (1997) undertook a study in real time of the factors that businessangels take into account in their initial screening of investment opportunities thestage at which most investment proposals are rejected.19 This particular study was

based on the reactions of 10 business angels to a particular investment proposal thatappeared in Venture Capital Report. The larger unpublished study reported on thereactions of 19 business angels to three investment proposals, providing a total of 30decisions (Mason and Rogers, 1996). Investors responses were taped, transcribed,coded and subjected to content analysis. The findings indicated that investors placedthe most attention on market and financial considerations and theentrepreneur/management team. The study also highlighted several distinctivefeatures in the approach of investors to the initial screen:

Investor fit: the first response of investors was to ask themselves whether thisopportunity was a good fit with their personal investment criteria in

particular, did they know anything about the industry or market, how muchmoney were they looking for, where is it located and was their scope to makea contribution?

Investor preconceptions: the previous experiences and preconceptions ofinvestors influence their attitude to the opportunity this was particularlyinfluential when considering their view of the market.

Focus: investors placed a strong emphasis on the need for businesses to have aclear market and business focus.

Investor attitude: the approach of investors at the initial screening of aninvestment opportunity was to look for reasons to reject it. They weresuspicious and cynical and looking to be convinced.

19 The research in this study was used to make the video You Are The Product (1997) which has been

successfully used as a means of interactively teaching entrepreneurs how to become investment readyby giving them an insight into what business angels look for when they read a business plan orinvestment proposal.

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Subsequent analysis of this data by Harrison et al (1997) interpreted the businessangels reaction to investment proposals in a swift trust framework, identifyingsome of the key inter-personal dynamics involved in the investment process.

Mason and Harrison (2003a) adopted a similar real time methodology to capture the

reactions of business angels to a presentation by an entrepreneur seeking finance. Thishighlighted the importance of presentation in shaping investor attitudes and how a

poor presentation will quickly turn potential investors off.

Finally, Mason and Stark (2004) adopted the approach used by Mason and Rogers butwith the difference that the same investment proposals were shown to business angels,venture capitalists and bankers in order to reveal differences in their approaches toinvestment evaluation. Bankers were shown to have a very different approach to thatof business angels and venture capitalists, placing much greater emphasis on thefinancial aspects of the proposal to the exclusion of most other issues. Venturecapitalists place equal emphasis on market and financial issues while business angels

give greatest emphasis to the entrepreneur and investor fit.

(iii) Negotiation and Contracting

The first evidence on how investments were negotiated and structured was provided by Mason and Harrison (1996c) in a study based on a telephone survey of 31investors and 28 entrepreneurs involved in investments that had been made throughLINC. The majority (71%) of investors had made only one or two investments. Keyfindings were as follows:

Only a minority of investors (38%) and entrepreneurs (44%) identified anyissues that were difficult to negotiate the most difficult issues were the sizeof the investors shareholding and related issues of ratchet clauses and pricing.

The approach of investors to valuation was very imprecise, with the actualvaluation reached by processes that were variously described as arbitrary,informal or negotiated.

Over three-quarters of entrepreneurs sought professional advice, mainly fromlawyers, in the negotiation process. The costs were fairly modest. In contrastonly just over one-third of investors used professional advisers, again mainlylawyers to draw up or review the investment agreement.

The decision time was relatively short, in most cases extending over less than

three months. In only 70% of investments was a formal investment agreement drawn up.

Two-thirds of investors and entrepreneurs agreed that the investmentagreement was equally favourable to both sides; 20% of investors and 15% ofentrepreneurs felt that it favoured the entrepreneur while 12% of investors and18% of entrepreneurs felt that it favoured the investor in other words, mostentrepreneurs did not feel that the process of raising finance from businessangels was exploitative.

Only 40% of investments involved straight equity, with a further 29%involving only loans. However, equity dominated in those deals that involved

both equity and loan finance.

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The investor or investors took a minority position in 56% of the investmentsand a 50% stake in 19% of investments.

Most of the equity investments were in ordinary shares only 16% involvedcomplex instruments (e.g. preference shares).

LINC sponsored a follow-up survey of investments made in the period 1994-96 usingthe same survey instrument (Lengyel and Gulliford, 1997).

A much more detailed investigation of business angel contracts was undertaken byPeter Kelly for his PhD at London Business School which attracted responses from106 business angels who had largely been contracted through business angel networks(Kelly and Hay, 2003). Compared with previous studies these investors would appearto be unusually active, with an average of eight investments each. The study foundthat, contrary to previous studies business angels draw up contracts as a matter ofcourse. They want to spell out quite clearly the rights, roles and responsibilities ofmanagement and investors. Five non-negotiable items are identified:

Veto rights over acquisitions/divestures;

Prior approval for strategic plans and budgets;

Restrictions of managements ability to issue share options;

Non-compete contracts required from entrepreneurs upon termination ofemployment in the venture;

Restrictions on the ability to raise additional debt or equity finance.

These non-negotiable give investors a say in material decisions that could impact thenature of the business and the level of their equity holding. There are also a number of

contractual provisions to which investors attach relatively low importance and so maybe considered to be negotiable:

Forced exit provisions;

Investor approval required for senior personnel hiring/firing decisions;

The need for investors to countersign bank cheques;

Management ratchet provisions;

The specification of a dispute resolution mechanism in writing up front.

These items were included in fewer than 40% of the contracts studied. Less

experienced angels include a wider array of protective contractual safeguards. Butwith experience angels become more focused on elements that can impact theirfinancial returns. Finally, Kelly and Hay (2003) observe that important to include isnot the same as willingness to invoke, and suggest that angels prefer to use theirrelationship with the entrepreneur to manage setbacks and problems rather than usingthe contract to invoke their rights.

(iv) The post-investment relationship

The landmark studies discussed earlier provided some evidence on the smart aspectof business angel investing. However, this aspect of angel investing has not been

explored in much detail by UK scholars. Based on a survey of investors who hadraised finance from either venture capital funds or business angels, Harrison and

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Mason (1992b) presented evidence on the roles identified by the entrepreneurs asplayed by business angels and their assessment of how helpful these contributionswere. This highlighted serving as a sounding board to the management team,monitoring financial performance and assistance with short term crisis/problems asthe most valued contributions. Mason and Harrisons study of deals that had been

facilitated through LINC (1996c) looked in more detail at the post-investmentexperience. It confirmed that the norm was for investors to become involved, andwould typically join the board. Their time input varied from at least a day a week toless than a day a month.20 Their contributions were also varied and best summarisedas passing on their business experience. However, only half of the entrepreneursregarded the angels contribution as being helpful (31%) or extremely helpful (19%).

Nevertheless, nearly half of the investors (47%) and a majority of entrepreneurs(56%) considered the relationship to be productive and majority of both investors andentrepreneurs regarded it as consensual. The Lengyel and Gulliford (1997) study

provides updated information on these issues.

Kellys PhD study also explored the motivations of angels in becoming involved withtheir investee businesses. The typical anticipated involvement by the angels in hisstudy was 16 hours per month (8 hours face-to-face and 8 hours phone calls andreading reports) and 40% of investors were employed in the business in somecapacity. Kelly concluded that rather than being a means of defending their interests(i.e. for protection) business angels get involved in response to specific needs of theirinvestee businesses. He further notes that involvement is greatest at the early stages,where the businesss need for experience is greatest (Kelly and Hay, 2003).

(v) Harvest

Mason and Harrisons (2002b) study of exits was based on data on 128 investments.Returns were highly skewed: 47% of exits involved a total (34%) or partial loss, or

broke even in nominal terms, while 23% generated an IRR in excess of 50%. Tradesales were the main exit route and were used both for successful exits and some thatonly broke even. IPOs accounted for only a small proportion of successful exits. Exitsfrom living dead investments were mainly through sales to other shareholders andnew third party shareholders. The median holding period was four years but thisvaried by investment performance. The median holding period for investments thatgenerated a good or exceptional return was four years, rising to six years forinvestments that generated low positive returns and just two years for loss-making and

break-even investments. The most successful investments shared few commoncharacteristics. A separate analysis of the returns from technology and non-technology investments found no differences in the returns profiles (Mason andHarrison, 2004b). Mason and Harrisons (1996c) earlier study of LINC deals hadnoted that some angels take returns in the form of directors fees and, less commonly,consultancy fees.

2.5 Market Based Estimates

20

Mason and Harrisons NBAN study found that on average angels commit six days a month on eachinvestment (Mason and Harrison, 2002a).

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The research summarised to date has focused on the identification of business angelinvestors, and has collected data on their investment behaviour, demographics andattitudes and intentions. Studies that explicitly attempt to measure the scale of themarket as a whole are far fewer in number. One of the few such studies is the riskcapital market analysis undertaken in Scotland, which has profiled all identifiable

equity investment in the unquoted business sector between 2000 and 2005 (Harrisonand Don 2004; 2006). These reports presents the first comprehensive account andanalysis of the early stage risk capital market in Scotland, and indeed anywhere in theUK, and with the exception of research in Sweden there are no identifiable similaranalyses elsewhere. The analysis is based on a unique specially created databasewhich records actual investments made in businesses in Scotland and identifies theinvestors making those investments (the methodological implications of this researchare discussed in Section 4 below).

The key findings of the initial report are as follows. Over the four years (2000-2003inclusive) there has been a total of 673m of identifiable risk capital investment in

581 new and young Scottish companies. The early stage equity risk capital market inScotland is very much larger than previously estimated for example, figures fromthe British Venture Capital Association suggest that over these four years there was atotal of 119m invested in start-up and early stage businesses in Scotland. There is, inother words, a large and dynamic early stage risk capital market in Scotland whichchannels investment capital from a wide range of institutional and other investors intostart-up and growing companies, and this market is significantly larger than previousestimates have suggested. In 2003, the Scottish Risk Capital Survey identified 121mof new investment in Scottish businesses; in the same year the BVCA recorded only7m in early stage investment and a total (including management buy out and buy ininvestments, which are excluded from this Survey) of 109m. In

Documents

Developing Time Series Data on the Size and Scope of the UK-2008