12 Apr 2006   |   Viewpoint

Editor's chair: On the care and breeding of angels

Europe needs more "angel" investors to finance its start-ups. A Prague conference highlights why it isn't getting them.

Richard L. Hudson

Europe needs more “angel” investors to finance its start-ups. A Prague conference highlights why it isn’t getting them.

Beer glasses – squat, tall, snifter-shaped or chalice – are the passion of Pavel Bobošik’s life. At 42, the Czech entrepreneur has built from scratch what is now the biggest manufacturer of specialty beer glasses in the region. His firm, SAHM s.r.o., has grown in 16 years to 250 employees and sales of about €18 million. And now he is beginning his next career move: to be an “angel” investor funding other entrepreneurs.

Problem: He’s lonely. There aren’t many big investors like him in Prague – perhaps 10 or 20, he estimates. That means it’s hard to find advisers, investment leads or camaraderie in what is, by anyone’s measure, an ultra-risky business of betting on start-ups.

He has tried to remedy the isolation by joining Prague’s first (little) club for angel investors, and he recently earned an MBA from the European outposts of the Thunderbird business school. But of his two investments so far, both in his own industry, he counts one a success and one not. Now he wants to branch outside his field of expertise, where the risks will rise.

Advising, encouraging and breeding investors like him is what Europe badly needs. Angels – so-called because they watch over as well as fund start-ups – are a critical link in the chain of financing that pulls an idea into the marketplace.

It’s a chain that typically starts with the founders of a company and their immediate friends; continues with angels as the company develops its idea; moves on to venture capital funds as a company expands; and can go on from there to a company sale – either to another firm, or on the public stock market.

The chain can break at any stage; but the weakness of the angel link is a special problem in Europe.

“There are small companies who simply cannot find the money they need. The shortage of start-up capital is chronic” in Europe, said David White, director for innovation policy at the European Commission, speaking on 11 April at the annual conference of the European Business Angel Network, a group that encourages the growth of investing clubs.

Puny Europe

By any measure, the early-stage financing market in Europe is puny – a tenth to a third the size of the US market. “We need to fix the provision of risk capital” in Europe, White said.

Any fix starts with angel investors. In the US, they are even more important than VCs. In 2005, according to Jeffrey E. Sohl, of the Center for Venture Research at the University of New Hampshire, angels ploughed $23.2 billion into 48,000 ventures. By comparison, later-stage VCs invested $22.1 billion in 23,000 ventures.

Who is the typical angel? In the US, Sohl’s research has found, he (only 5 to 6 per cent are women) is rich, of course: net worth of $10 million to $15 million. He is almost always (more than 80 per cent) an entrepreneur himself, eager to use his hard-won knowledge of starting and building a company to help others do the same. His most common sectors: life sciences and biomedical devices (20 per cent of deals) and software (18 to 19per cent). More than 85 per cent of his investments are in local companies. (“Good deals don’t have legs,” goes an old adage of investing.) And he travels in company. In the typical funding of $450,000, four to six angels are involved.

Data on European angels are extremely sketchy – in part because of the European genius at hiding from the tax man. Their population, some estimate, is perhaps 50,000 to 100,000 – at best, a fifth the size of the US angel network.

How to encourage an angel

So how to encourage more of them? Here are three ideas discussed at the angel conference in Prague:

  • Cut capital gains taxes. Fiscal policy varies wildly around Europe, from a zero rate in Belgium to 40% in Finland and (for some investments) Britain. The argument to cut taxes: investing in start-ups is so risky that, to encourage it, the state should refrain from taking any cut of the winnings. The argument against a cut: the capital gains tax alone isn’t important to an investor’s perception of risk and reward – especially in countries, like Britain, where profits from one venture can be rolled tax-free into another venture.
  • Provide up-front tax breaks. The argument for: rather than cut the final tax rate, goes the argument, it’s smarter for the state to let investors shelter some of their income immediately in a venture – that is, grant them some kind of tax deduction when they invest in a qualified venture. Again, Britain – with by far the largest angel community in Europe – is a model, with several tax-deduction schemes for small-company investing. The argument against: social equity – that is, why give rich people more tax breaks?
  • “Co-invest” state with private funds. There’s a huge range of government schemes already around Europe that, in one way or another, provide matching public money to a qualified young company when it attracts angels.  Some are university programmes for spin-outs; some are direct government investment funds, such as the €100 million a year that the EU channels into tech-transfer organisations and start-up investment funds through the European Investment Fund. The argument for: it expands the capital pool available for start-ups, while still letting the market decide into which ventures the money should go. The argument against: a potential waste of public money – especially as the data are so sketchy on which programmes actually work.

But the fundamental problem isn’t one of policy; it’s of attitude.

In most European countries, wealth is suspect. The whole notion that a successful entrepreneur should be able to keep his winnings – even if reinvested in other ventures – is politically incorrect. So governments, in search of jobs, squander their tax breaks on trying to bribe multinational companies to invest in their countries, rather than on encouraging a vibrant local enterprise culture. Through that political lens, angels can look like devils. And so long as that’s the case, Europe will remain in economic limbo.

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