This may seem a boring subject to most experienced entrepreneurs so I thought it appropriate to start with a question – a question most get wrong.
Q: What industry sector classification do you think Google should fall under?
- Search engine? (trick question, search engine is not an industry sector!)
Google is in fact in advertising (media) as 97% of their revenues are derived from online advertising, not from search engine activity which is surprising to most. If you happened to know the correct answer, then this article is not for you.
If it is so easy to potentially place such a reputed organisation in the incorrect industry sector, then how easy is it for a small business to place their business under the wrong industry classification and what are the consequences of such an error.
Placing your business in an industry sector will not only define what type of business you operate to potential investors, but it will also attract different types of business investors with differing investment agendas.
Using the example above Google, investors in the computers sector, software industry and media are three clearly very different groups.
Angel Investors invest in businesses that are NOT capital intensive
Angel Investors invest in businesses that are NOT capital intensive. So placing and presenting your business in the correct industry sector will immediately assure an investor that your business is not capital intensive. Getting this right will ensure that the right investor will carry on to read and study your business plan and hopefully decide to move forward.
Getting the industry classification wrong could mean that the wrong type of investors will be reviewing your investment summary and proposal. It is a well know fact that business angels tend to invest in industries that they know best.
The golden rule here is that the more investment capital you seek to raise from an investor, the more money you need to turnover to generate a return. This means that your business will be higher risk to an Investor – hence the term Risk Capital.
Choosing the right Industry sector will immediately inform an investor whether your business is capital intensive or NOT capital intensive before the investor has even read the title of your business plan. So it is important for entrepreneurs to know:
What Industry sectors Business Angel Investors tend to avoid…
… and try to avoid placing your business in these industries. They will tend to avoid capital intensive businesses that require vast amounts of Risk Capital e.g. a hydroelectric power station, wind farm or a new car engine. If you are however looking to create a single rotary part that will fit into the motor of a wind turbine that will increase its longevity by 60%, then placing your business plan in the energy sector will lose you potential investors. You would have had greater success listing your investment proposal under intellectual property or manufacturing.
If you do happen to be an entrepreneur planning to set up a hydroelectric plant, then you are better off approaching Venture Capitalists (or similar groups).
The more capital you ask for, the greater the return you are going to have to generate, and the greater the risk the whole project will become. Therefore, it is important to demonstrate and highlight that your business is NOT capital-intensive.
This is why you will find media, leisure, or marketing start-ups much more receptive to Angel Investor attention as they typically require a lot less capital.
In a 2009 research poll of over 500 entrepreneurs, Venture Giants asked entrepreneurs whether they knew and understood what sector their business was trading in and why they thought it was important for the purposes of raising investment for their business.
Not surprisingly, almost 100% ticked the box that they knew what industry sector they were trading in. However, when asked the follow-up question, why they thought a broad sector classification was important for the purposes of raising investment for their business, almost 40% of entrepreneurs elected to answer: ‘not relevant to me’ or ‘not really important’ to that question.
But, the fact of the matter remains that it is crucial in raising investment as business investors will have very specific skills and experience in areas they know and understand. They will very rarely invest in businesses that work outside their area of expertise.
As a result, choosing the wrong sector in haste can cut out a large group of investors that may have been interested in your investment proposal.
It is therefore important for an entrepreneur to understand what their business does and how it can be classified sector-wise so that most Business Angels will understand instantly.
A handy guide to developing this aspect of your business specification can be found by looking at the London Stock Exchange which provides a useful list of sectors and industries.
Aerospace and Defence
Automobiles & Parts
Construction & Materials
Electronic & Electrical Equipment
Equity Investment Instruments
Fixed Line Telecommunications
Food & Drug Retailers
Food Producers & Processors
Forestry & Paper
Gas, Water & Multi-utilities
Healthcare Equipment and Services
Travel & Leisure
Non-equity Investment Instruments
Oil and Gas Producers
Oil Equipment Services & Distribution
Pharmaceuticals & Biotechnology
Software & Computer Services
Technology Hardware & Equipment
Travel & Leisure
When an investor reads the Financial Times everything is broken down by industry sector. This is because investors do not have the time to research each company listed to find out what they do – investors instead usually know all of the companies listed in a particular industry sector.
Likewise, business angel investors that are looking to invest in UK SMEs will know what type of business and industry that they are seeking to invest in and they will have to potentially review hundreds of business plans before they choose to invest.
As a result, the chances are that before opening the first page of your business plan or hearing your elevator pitch, the angel investor will first check the industry sector you are involved with. It is wise to keep your industry sector in alignment with one of the sectors that angel investors will tend to invest in.
Never use creative or technical words to describe your industry sector, even if you have a very specific product or niche solution that is not easily defined. Remember Business Investors will not necessarily have had your specific education or experience and will always look at industries that they easily understand.
(X) You are NOT an SEO company that optimises your business clients’ PPC campaigns and organic search results;
- Instead you are in Media.
(X) You are NOT a designer coffee outlet;
- Instead you are in Retail.
(X) You are NOT an online CRM solution that is seeking investment to take it to the next level;
- Instead you are in Software.
A good way to double check the industry sector your business should be in is to look in the FT and the London stock exchange and to locate the competitors and then to directly align your industry sector to them. Even if the listed companies are not totally identical to what you are doing, it would still give you a clear indication of where your company should be. The companies are listed and so they would have already raised funding via an IPO and attracted investors.
Aligning your company to your competition’s industry sector will also ensure that you attract similar Angel Investors. They may even already own shares in those listed companies.
What about IP (Intellectual Property), Commercial Licensing, and Research and Development?
Q: What broad sector classification do you think Intel is listed in?
– Computers and Software?
It may surprise you that Intel is in fact in intellectual property (IP) as they research and develop chips and subcontract manufacturing to third party manufacturers!
Always think carefully about the sector your business should be in. Getting this right will ensure that the right investors will read and study your proposal – and more importantly, invest!