The notion of angel investment in Turkey is even more recent than the concept of entrepreneurship. It is worth noting that it has been hardly two years since the introduction of the angel investment license in Turkey and currently the number of persons interested in angel investment remains at a couple of hundred. In light of this information and given that angel investment is still at the development stage, my article aims to offer advice to those who are currently investing in entrepreneurs and also to those who intend to become angel investors.
The following are some examples of the kind of mistakes that angel investors in Turkey make without even realising it:
Making an investment decision based on insufficient research and failure to make a comparison between different entrepreneurships
You have been in the business world for many years. You have got business experience and some capital. You invested in various fields and you see entrepreneurship as an exciting business line. You became or wish to become an angel investor because you appreciate successful, young entrepreneurs; you want to share your experience, add new dimensions to your investments or you wish to become a part of new business circles. You acquired an angel investor license, which will, under certain circumstances, allow you to deduct from your personal income tax the investment you make in a joint stock company (A.Ş.) through an angel investment network. You attended a number of angel network meetings and registered with one or more that you thought best suited you. You heard entrepreneur presentations at the first meeting and among them you found one that you really liked. The entrepreneur has good command of his subject and is a good presenter. S/he also looks like a reliable person. There are others who take interest in them and your share of 30,000 to 40,000 Turkish Liras at first stage sounds like a risk that you can afford to take. On top of all that, it is a very “trendy” business, which you think is “your thing” so you hit the button. Trust me, many “first investment” decisions in Turkey are made exactly like this, which unfortunately increases the possibility of failure. The most important prerequisites for good investment are sound research and asking the right questions. The business may seem very promising and the entrepreneur may come forward as having good command of his or her business. However failing to have a thorough understanding of the business, to consider alternative businesses, to do research on similar lines of businesses, to think about competition conditions, and to go for one of the first businesses one is presented with is definitely not the right way to go about making an investment decision. There are a couple of questions I normally ask entrepreneurs and I cannot possibly see myself warming up to any project unless I get reasonable answers to my questions. Some examples to those questions are as follows:
- Why did you choose this business?
- What are you success criteria with this enterprise?
- Where do you see your business in 3, 5 and 10 years?
- When you receive financial support what will be your top three priorities?
- What precaution did you take against competition?
- What is your exit plan?
Investing in a company that operates in a field where you will have difficulty providing added value in addition to financial support
Surely the project must not be seen as a financial investment tool only –the entrepreneur’s expectation is for you to be able to offer business experience, know-how and a network in addition to financial support. This means that the investor must choose what suits best their knowledge, experience, circle of friends, disposition and interests. For example, as someone who wrote his dissertation on sustainability following many years of research, I always look for an emphasis on social and/or environmental impact in the entrepreneurial projects I am presented with. I tend to believe that my general command over sustainability, my interest in sustainable development and my network of people working in the field offer a significant advantage to entrepreneurs who are interested in these fields.
Failure to conduct due diligence before you invest
Would you choose to become a partner in a company that has previously taken certain risks that can affect you in the future? Frankly, I would not. How do we find out whether such problems exist? The only way of doing this is to conduct a due diligence (DD). Due diligence consists of three areas: financial, tax and legal. The former concentrates on a company’s financial risks – e.g. the ageing of receivables and payables (determining which accounting periods outstanding receivable and payables were due) or the comparison of a company’s income and expenses as per accounting periods to see if they are consistent. A comparison between previous periods and focusing on periodic variations is a very important part of financial due diligence. One problem that may make such a financial comparison impossible is if a company was founded very recently. This often results in tax due diligence being more popular when it comes to due diligences conducted for startups.
Here is an example: an angel investor who becomes a partner and/or legal representative of a company with outstanding tax or any other public debt is jointly and severally liable for the payment of such debt. Partners and legal representatives may not be discharged of any tax liability by way of converting a limited liability company to a joint stock company (A.Ş.) or through setting up a new company and transferring the old company to the new one including all its assets and liabilities. This, of course, should not mean that one must not invest in a company with a tax liability risk. What is important here is to ensure that the total monetary amount of any tax liability identified during due diligence is presented in the form of a table. This would allow the investor to i) decide whether the existing tax risk may be tolerated and ii) set a cap for the tax risk and draft an agreement to confirm the amount risk belonging to the entrepreneur. Legal due diligence, on the other hand, reviews a company’s legal issues that may present risks. A common legal due diligence question: Has the entrepreneur previously signed any agreements that can potentially render the investor liable in the future? Due diligences not only determine a company’s risks that may affect the investor in the future but also gives an idea about the way the entrepreneur does business. The latter is extremely important in establishing harmony in the future partnership.
Failure to be sufficiently informed about the company’s accounting/ performing periodic audits
Due diligence also gives information about how the accounting of a company are kept. This is yet another very important issue. Personally I would not want to become a partner without having acquired thorough knowledge about its accounting. If this is the case, the investor will then have two options: 1- playing an active part in the keeping of the company’s accounts or 2- conducting periodic audits and reviewing monthly profit & loss and, more importantly, cash flow statements. Surely, whether or not the investor takes a direct part in account-keeping, it is best to work with an accountant whom you know and trust.
Failure to determine an accurate value before you invest
Determining the value of an enterprise is a difficult task. This is how it generally works: the entrepreneur utters a price and the angel investor tries to negotiate on that price. Although company valuation may pose some difficulty particularly with companies younger than one year, I would rather create a logical model using well-prepared business plans to base my decisions on than to negotiate on vague figures. Therefore my advice to angel investors is to conduct a valuation performed by professionals. Otherwise, there will be a risk of entering into a partnership at a much higher or lower price than the actual price which will at least be mutually unfair for both parties.
Not being prepared for additional financing
One other matter that investors generally tend to overlook is the possibility of having to repeat investment once or even twice in the near future. Are you aware that your budget should take into account a possible need to offer additional financial support to the company in the future? I have seen many investors who have had to face a decreased share percentage threat due to stock dilution in capital raising when additional financing, which was even bigger than the original investment, became necessary only six months after the investment.
I should start by saying that neither expecting immediate return on one’s investment nor making a three-year exit plan is realistic. Investing on an entrepreneur requires devotion, and more importantly, patience. When a business is established it takes time for it to settle down, to start running smoothly, to brand and attract new investors. This is why, in my opinion, it is best for investors to try to help entrepreneurs when they fall behind in the goals they set out in the original business plan rather than to give them a hard time and to cause despair.
Although just like any other business angel investment has no one single approach, if the goal of the investor is to invest with minimum risk possible, learning from the universal mistakes I briefly explained above should prove to be helpful.