Bank Loans vs Angel Investment
Venture Giants Special report on Risk Capital
Question: What is Risk Capital?
Definition: Risk Capital is classed as investment capital placed into a speculative activity to fund high-risk, high-reward investments.
As an entrepreneur looking to raise start-up funds for your business or seeking funds to expand your business, it is important to understand that angel investment is classed as risk capital because the initial outlay in your business is very risky – no matter how sound you think your investment proposal may be.
Most entrepreneurs get far too involved with the business. Remember that you are not selling your product to an investor. What you actually need is for the investor to invest in you, so you must focus on what an angel investor can expect to earn from you and that is what you are selling.
The investor will always understand that there is a risk that his capital may dwindle to a fraction of the initial amount invested if the venture proves unsuccessful, but it is the entrepreneur’s job to convince an angel investor that the returns will justify the risk.
This is a good reason why your business plan and all supporting documents must project a minimum 30% return on investment no matter what the product or service is, if you are serious about raising investment.
Angel investors, like all of us, are consumers; they go out and buy toys for their families at Christmas – but this does not mean that they would invest in them. They would buy them – but they would not invest in them, and this distinction is important to understand when you are pitching for investment. There are no no-brainers for investors, just businesses and entrepreneurs that they believe will make them money and it is important to emphasise this point to an investor.
Venture Giants is about finding angel investors for your business that will provide funds for your business so this article mainly focuses on risk capital. The banks are primarily about lending and being paid back interest, fees, and capital. Risk capital however is about investors placing money into your business to profit from future growth prospects of your business. Ease of raising start-up capital from a bank can change drastically depending on the current economic cycle you find yourself in.
It can, perhaps, seem unfair that banks are sitting on vast sums of money – what difference would £40,000 matter in the long run when assisting an entrepreneur that has a recommendable business plan? Banks must always factor in risk however, and with a business loan, this will not be able to secure the bank against the worst-case scenario of an entrepreneur failing in their efforts.
After an analysis of your business plan, unless you have significant connections, you will be meeting with up to three different representatives of the bank over a period of time, before they can approve the loan to you or your business. It is imperative to understand this, as it will ensure you adopt a patient mindset.
There are several things a bank will take into account when deciding to offer money to a serious entrepreneur:
- Do you have any collateral to secure against their bank loan? If you are not willing to put your assets up as collateral – then as a start-up entrepreneur are you really serious about your business?
- If you do not have any assets yet, why? Have you failed or lost money before?
- Is your idea a good one with a proven business model? Having a totally unique business idea that no one has thought of (worse, in the process of creating a new sector or a new way of doing things) is a massive red flag for a bank, as you will have to educate the consumer on your new method – a costly affair.
- What is your credit worthiness? On your Experian credit report, is it all green? Be ready to explain and disclose all discrepancies.
- What is the experience of your management and executive team. It matters to banks, and you must highlight all of your team’s experience in your industry.
- Image matters! You have to demonstrate to the bank manager and others, that you are a stable, persistent, hard working and willing to do what it takes to make your company work – with or without the bank loan. This can go a long way to building and establishing your credibility.
On the flip side of this, it is important to understand that banks are fearful when they see an individual that is credit worthy and has the potential to raise this money but might just take their business elsewhere. So demonstrating that you can take your business elsewhere and that you do not really need them, can be very powerful during the initial meeting with your bank manager.
If you do get approved for a bank loan – do not celebrate just yet! As an entrepreneur, understand that the bank is in it to make money too, and you will most likely see a host of arrangement fees, balloon payments, early repayment charges, and so on (and please always bear in mind that these fees can be negotiated). I myself have negotiated 0.25% from the interest rate on a £2m loan over a 5 year period just from flashing my pretty eyes at a bank manager and saying that we would go elsewhere if it wasn’t secured at 0.5% off the rate they offered. They offered 0.25% which is worth £50k by the way – not bad for ten minutes of work.
A couple of final notes on raising external finance from banks:
Do not take out lots of credit cards before applying for your loan. Credit cards paid off in full are good for your credit worthiness – however, applying for lots of credit cards in clusters at one go is terrible! I have seen a credit rating drop from the high 900s on Experian to the low 600s only because two credit cards were taken out at the same time. Creditors may look at this at a personal bail out on your side. Even with rock solid bank statements, banks do assume a lot and always err on the side of caution.
Be careful about going to other banks for checks AFTER credit checks have been carried out on you. Every credit check leaves footprints on your credit report making you less attractive to other banks. So not taking up the loan may adversely affect your credit rating even if you had not been declined for the loan.
What happens if the money you get from a bank covers everything you need and you don’t need to get funding from an investor?
The problem is that the bank’s investment is not necessarily all you need. More than money, you need expertise on how to run a business. Banks will not have the experience of starting up and running the business you are involved with, and will neither be able to give specific advice or share expertise.
This is what a business angel can bring to the table and where their real value lies.
Always try to look at the value of what is being offered, over a purely monetary aspect. It is important to remember that an angel investor’s success, experience, career history and network of contacts can make a huge difference.
If you are not used to starting and running a business, a business angel who has had that experience will be able to help – most business angels are people that have had experience in running their own company or service before and certainly have a lot of experience; they just don’t want to do the day to day stuff. An angel investor with this experience will prove very valuable in both capital growth and preserving the bottom line.
The reason why it is important to talk about these distinctions is that a business or start-up capable of raising external investment from angel investors will always have financial institutions interested. Banks do not care whether it is your investment in the business or an angel investor’s, as they will always have first charge over your business – which means that they will always be paid back.
As an entrepreneur, if you are serious about raising investment capital for your business, you must be prepared to present and communicate your business plan to investors with their terminology. You are going to have to learn how investors think and to present you business in the right way. You will be met with scepticism, and you are going to have to convince investors that your product is capable of generating profits.
This is where Venture Giants can assist you in raising investment. Not only do we solve the problem on how your investment proposal must be presented to an investor, we also send it out to hundreds of investors that we feel would be interested in it.