With the purpose of giving a business angel conceptual framework, we can start by referring that Business Angels, like the name itself says, are individual Venture capitalists that fill up the financing necessities that the institutional funds can’t answer to, like seed capital projects and startups as we can see in the next chart:
See chart
However, and to differentiate the image of this kind of investors, it’s usual to separate them in four groups: “guardian angels” (the industry veterans), professional experienced angels (former executives of big companies), financial income angels (wealthy individuals) and entrepreneurial angels (entrepreneurs that had success in their businesses).
Entrepreneurial business angels have a broad conception of their role as investors, since they invest in the activity sectors they know better, allowing not only to put capital in the chosen projects but also to have their contacts through their relations network and their own business experience, i.e. give precious orientation so that entrepreneurs can gain time, which is a true accelerator to a young company.
Most BA are former business man from SME who sold their business and want to reinvest part of their capital in companies which allow them to continue to participate in the business “game” and obtain further attractive results.
In summary we can say that a BA is a private investor that invests his own money in businesses of big growth unquoted and that shares his experiences, contact network and time with entrepreneurs.
That’s where the BA motivations come from and that is reflected in their profile: as investors they intend to have a surplus value in a medium term, at the sell moment or the company’s entrance in the stock exchange market. As former entrepreneurs they want to relive – or live – the enthusiasm and excitement related to a company creation, especially when related to new technologies, where the development can be both spectacular and fast.
At the present, the Portuguese marketplace has a business angels club – www.businessangelsclub.com – lead by Gesventure, which is an active member of European Business Angel Network (EBAN) and has 20 investors.
In France is estimated to exist nowadays from 3.000 to 4.000 Business Angels when compared to the 50.000 existing in the United Kingdom and to the 500.000 in the United States.
To have a broader notion of BA networks’ evolution in Europe we can look at the next chart:
See chart
Approaching another important aspect – the legal-tax framework of the business angels’ activity in some Member States, especially in France and the United Kingdom – we should begin to underline that being involved in Business Angels’ activities represents an high risk level. Several empirical studies showed that in 10 businesses, one has huge success, 2 or 3 are near the break even point, and the last 6/7 have to be completely supported by business angels.
To encourage business angels activity, some Member States introduced tax incentives to stimulate the investment by BA in a more favorable environment to a bigger risk activity. This is even more important to compensate the lack of entrepreneurial spirit and risk aversion in the European societies.
Before making a particular analysis of the tax framework in France and in the United Kingdom, we should refer that the tax incentives can be introduced in 2 different stages of the investment cycle:
(i) when the investment is done;
(ii) when the exit happens.
We should refer that in this second stage, the tax incentives can cover both success and failure cases.
Next we will enumerate the several main aspects that characterize the legal-tax framework in France and the United Kingdom.
1. France Model:
Starting by analyzing the existing legal-tax framework in France, we should distinguish the following investment modalities:
1.1. Direct investment made by a private investor
This investment has the following characteristics:
a) Allows a 25% tax break of the total amount invested, with a 20000€ limit (by passive individual) or 40000€ (by couple);
b) Implies maintaining participations for 5 years (in case of disposal of the equity investment before 5 years time: repayment of the tax reduction, however, giving the right to the referred tax break;
c) Applies to unquoted companies;
d) There are either minimum nor maximum in the invested amount.
1.2. Investment through Unit-Personal Company of risk investment (SUIR)
This investment has the following characteristics:
a) the company itself has no corporate tax and capital gain tax for 10 years;
b) In case of dividend distribution the partner pais no tax for it;
c) Each parnter mus thave between 5% to 20% of the capital;
d) The members and his family cannot hold more than the 25% of the rights of the company and cannot be hold any management position;
e) Company must not be more than 5 years old at the time of the investment;
f) Minimum Capital is 37.000€.
1.3. Investment through institutional operators
The investors who do not want to invest directly in unquoted companies, but who want to use their savings in the direction of this type of enterprises, may invest through institutional operators responsible for the management of Venture
Capital Funds. By using these funds, investors can, actually, invest in companies with the characteristics referred before.
Next, lets see the several investment modalities existing in the French market place:
1.3.1. Investment in Venture Capital Mutual Funds
This investment has the following characteristics:
1. For the subscriber, the revenues and the portfolio capital gain, benefit from tax exemption;
2. For the referred motives it is not an active investment: the investment decision is made by the funds portfolio managers;
3. The fund must invest 50% of its capital in unquoted companies;
4. In order to benefit from the tax incentives, the investor must retain its fund participation for 5 years.
1.3.2. Investment in Innovation Mutual Funds
This investment has the following characteristics:
1. Cash subscription of shares in the Innovation Mutual Funds give the right of a tax reduction: 25% of the amount invested in the limit of 12.000 € (private individuals) or 24.000 € (couple);
2. Subscribers benefit of a tax exemption from revenues and portfolio capital gains;
3. The fund must have 60% of its capital invested in innovative companies under conditions certified by Anvar in France (ADI in Portugal);
4. Investment must be frozen for 5 years in order to benefit from the fiscal advantages.
1.3.3. Investment in Local Investment Funds
This investment has the following characteristics:
1. Cash subscription of these funds give the right of a tax reduction: 25% of
the amount invested in the limit of 12.000 € (private individuals) or 24.000 € (couple);
2. For the subscriber, the revenues and the portfolio capital gain, benefit from a tax exemption;
3. Fund portfolio must have:
- A minimum of 10 % of the funds invested in unquoted companies less than 5 years old.
-Investments in limited and determined geographical zones;
4. Investment must be frozen for 5 years in order to benefit from the fiscal advantages.
2. United Kingdom Model:
Proceeding with the analyses of existing legal-tax framework in U.K., we should distinguish the following investment:
2.1. Direct investments by a private investor
a) in the tax year of 2004/2005 the investments made by unquoted companies may give the investor a tax break of 20%, calculated above the invested amount up to 200.000£ (around 295.000€);
b) The referred tax break will be up to 40% in losses cases;
c) Any gains on the disposal of shares after 3 yrs are free from capital gains tax;
d) The investors must be UK residents;
e) Shares must be held at least 3 years;
f) An investor cannot own more than 30% of the shares, directly or not;
g) The investments which mention in their parasocial deals models a repayment based in grants or other types of deals of exit do not allow benefiting of the referred tax break.
Although the legal-tax framework that I have been referring to is considered crucial to mobilize the show up of informal investors, compensating this way the lack of an entrepreneurial culture in European Union, several Member states consider essential the support of public institutes to Regional Business Angels networks so to raise the awareness level of business angels activities.
Actually, Dutch Ministry of Economic Affairs promoted recently a new study on business angels in the Netherlands and concluded that it would be necessary to stimulate the business angel networks in the Netherlands, through the continued emission of information flow about BA activity that may aware the potential investors to the advantages that are associated by this way of investment.
As a curiosity we can say that in this year 2005, 64 meetings have been organized by different BANs following the same format and financed by the Ministry. In France, where the issues of financing through informal investors has been in the concerns of Official Entities for a long time, the dynamics of Regional Business Angel Networks deserved a concrete action plan, formalized between France Angels – main nework of BA in France and ANVAR – French agency of innovation – through which it assumed the responsibility of creating a Business Angels School. Through this initiative, France Angels has been developing territorial marketing actions, to create awareness but also to give information
and trainning to potential investors that have a business angel profile.
In practical terms, this initiative is realized in an association between ANVAR and France Angels, through regional actions that involve local partners (like technological parks, polytechnic institutes, businessmen associations, financial entities), by activity sectors (like biotechnology, agro-nourishing, information and communication technologies), turning to Former Students Associations – like INSEAD’ former students – or even former directors of big French groups like France Telecom.
In summary, the importance of state co-finance of activities developed by business angels networks in spreading information that allow to leverage the unexploited of this activity in Portugal must deserve all the attention from the official entities in a way that it can contribute to the growth of the informal venture capital market in our country.
I refer to initiatives that essentially:
- inform how this BA market works (parassocial deals, exit strategies, syndication operations…);
- involve BA that invest in projects in seed and start-up phases taking advantage of their demonstration effect;
- obtain abilities that allow BA a better preparation for their decision making process in investments;
- mentor the BA in the adoption of development ways for their activity with the diversity of available solutions in the present legal and tax framework.
In conclusion I would say that in a time where there is the creation of favorable conditions to technological and organizational innovation in the Portuguese companies, reinforcing the clusters’ dynamics and its knowledge and competence base, at the same time that there is an initiative to company constitution in the information technologies, life sciences, clean energy, materials, micro energies and nanotechnology areas, it is important to create conditions, like an adequate legal-tax framework, that allows to convince a raising number of people, with financial resources and entrepreneurial ability, to become active business angels. This will be, inevitably, the most adequate the may occur in a near future, in our country, cases of success businesses financed in their start-up by informal investors, like amazon.com as we can see in the next chart that I want to leave like a final brainstorm.
See chart