On the wings of angels

Business angels and venture capitalists are used to the young and enthusiastic knocking on their door with some great new idea but capital is a precious commodity and most encounters end with a polite rebuttal.

Not many would have the patience to hear out a 15-year-old schoolboy prattle on about virtual storage environments or as we know it today “cloud” technology. But seven years ago BRW Young Rich lister and heli-sking enthusiast Mark McConnell did give schoolboy Michael McGoogan a hearing.

McGoogan was already running a web hosting business from his garage and had some 3000 clients. McConnell was pretty tech savvy and was so impressed he got a few mates to chip in and they pumped $1 million of equity into the business to form Aussie HQ.

Today the company has three divisions, of which Aussie HQ is one. The group trades as UberGlobal and is one of the largest local web hosting and managed service providers. Importantly it has also reached a critical mass with revenue now exceeding $10 million.

As McConnell says, reaching that point is the challenge but doubling in size once a level of scale is reached is relatively easy.

The challenge for the entrepreneur is how to chart a path to the point of critical mass. It’s an extraordinary individual that has the management skills to go from start-up to a medium-sized enterprise without both capital injections and business management advice. But in the process the entrepreneur has to come to terms with the reality of dilution.

McGoogan has 20 per cent of UberGlobal after a recent dilution when McConnell brought in some Chinese investors to take a 20 per cent stake so it could continue on its aggressive path.

Pie Face chief executive Wayne Homschek and his original backers are down to 25 per cent of their rapidly expanding coffee and pastry franchise chain, but he says they never had a problem with dilution.

He started the business with the help of friends and family, which is a popular method along with credit cards and bank finance. Fortunately the most popular method is relying on savings, which at least allows a business to start without the burden of debt and need for the management expertise that comes with handling a leveraged balance sheet.

That is not always possible. Art Index is on the BRW Fast 100 list for its second consecutive year but the concept of sourcing art as investment to individuals required an angel investor to get off the ground.

Founder Sacha Clemens was fortunate to find “a passionate angel investor who loved the product and wanted to remain involved and provide advice”. The company brings art works to retail investors at prices starting from $3000. Investors can hang, store or lease out their investment and it has proved popular at a time when a number of other asset classes are straining. The art market is showing yearly growth of 75 per cent in funds invested for the past five years.

The investor, Adam Smith, still acts as a consultant to the company and for now his seed capital has been enough to make the business sustainable. However, he says “should we find a venture capital group who had the right mix of finance and operational-marketing experience that can add value and opportunity, it would be considered.”

Venture capital activity in the SME space has boomed in recent years as bank finance has dried up or become more difficult to access.

Although there is significant competition among the banks to provide finance to SMEs with a demonstrated growth path and track record, new businesses and those that may be underperforming for a variety of reasons face high hurdles to securing bank finance.

Having the right governance is also an indication of a well-managed company and makes accessing capital from any source easier. Key elements include having an advisory board or board of directors, intellectual property protection and comprehensive occupational health and safety procedures.

While a board may not be involved in day-to-day operations, it’s more about having a diversity of ideas and business knowledge to help stop the sole operator making what in hindsight may be basic business mistakes, such as bleeding cash from a successful part of a business to sustain a troubled division.

And even Fast 100 companies face challenges. Pie Face has opened 50 new stores over the past two years but it required moving from company owned stores to franchising.

While franchising had always been part of the business model, the capital intensity of the company owned model could not have been sustained with traditional debt funding in the post-GFC, capital constrained environment.

Pie Face recently brought in a private equity fund and Macquarie Group as investors in preparation for a public listing next year or in 2013, depending how equity markets perform.

Yet Selmar Institute of Education, another company with both a track record and a strong growth path, had no difficulty accessing traditional bank debt during the year.

UberGlobal’s experience is typical of the new forms of finance that are becoming more popular with promising SMEs. It is bypassing bank finance in favour of private equity, particularly as it is the only local cloud provider with federal government accreditation and is gaining a lot of new business. McConnell says there were many hurdles but it is proving well worth the effort.

It’s also important to decide what type of capital you want. A number of Fast 100 companies in hindsight would have done things differently. Typically issues surround not having diversity of debt.

Like an investment portfolio, a debt portfolio should be diversified. Having just one source of debt finance can cause major problems if the financier has its own issues.

Others regret involving friends and family but had no choice as bank finance and other start-up options such as savings were not available.

One company started by raising equity, but then realised debt finance was the better option as it preserved shareholder value.

The commonest mistake was not raising enough capital to meet the business’s needs, including the hiring of quality people to match growth expectations.

And despite the incredible intrusion of the internet into daily life, the lack of bricks and mortar is also often an impediment to accessing both debt and equity finance.

A common question from budding entrepreneurs is where to find business angels and other financial backers.

Typically it’s the entrepreneur that seeks out the angel, relying on industry and other business contacts to locate a candidate. The large accounting firms such as PwC, Deloitte and Ernst & Young also have comprehensive match making services , while venture capital firms watch the spaces they are interested in closely and network strongly to find appropriate businesses for investment.

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