Philippe Gluntz explains that the average annual return of 23% is generally not attractive enough to make investors consider startups as an investment opportunity. He was invited to Slovenia by the ESIL (Early-Stage Investing Launchpad) initiative, and he believes that Europe, and particularly Slovenia, still has a long way to go in terms of angel investment.
Q: Over the last few years, there seems to be an enormous amount of money available for investment opportunities. Are these the golden years for startups?
Not really. It is not about the amount of money that is available, what is important is how well you manage to persuade investors to believe that startups are, in fact, a meaningful investment and that stock markets or other similar investments are not the only options. Startups are an alternative investment and so they are not something that investors are particularly fond of.
I advise those who opt for such an investment to make sure that they are aware of the risks and that they do not invest more than 5, perhaps 10% of their money. It is a field which brings many risks and not many are prepared to go down this road. In France, this is especially pronounced, people do not even want to invest in stock markets, which are much less risky than startups. They prefer to keep their money in banks, where they receive 0.5% interest.
Q: The same is true in the case of Slovenia, people are risk-averse here as well.
You need to find a way to convince investors to take some more risk and with that, receive more in return. This should primarily be encouraged by the government, perhaps by sharing a part of the risk with the individual investor. If there is no incentive from the government, there is slim chance that the wealthy will invest in this sector, and not in more verified investments. Only a small incentive is required to make this system work well.
Q: What kind of returns are we talking about when investing in startups? What is a good return for an angel investor?
Statistics in countries where our network of angel investors operate shows that the average return is 23% per year. At first glance, this figure looks extremely attractive, but the matter is more complicated. First, you need to have a full portfolio of such investments, say at least twenty different individual investments. If you invest in only one or two, it is not surprising when you come back completely empty-handed. Within your portfolio, you also need to have a good balance between the different levels of risk that you take on and that is hard to achieve. The aforementioned 23% is only the average of a highly diversified group. The data also shows us that as many as 53% of such investments are a complete failure; that is, not only do you fail to earn anything, but in fact you lose the entire stake.
Approximately one-third of investments bring a minimum return compared to investment in real estate, while only 15% of investments are those that bring the highest yields. The latter greatly improve the average of your investments – they not only cover losses from other companies but notably surpass the returns from different, less risky portfolios as well. But these are just the averages; if there is not one investment in your portfolio that belongs to the above 15%, there is not much you can do.
There is another thing that you need to be aware of when it comes to such an investment: you cannot just get out of it anytime you want. It usually takes years before the startup is ready for an investor to reimburse his or her stake. I usually exit the startup after eight or nine years. In this intermediate time, you do not have any secondary market where you could sell your investment to another investor.
Q: As a business angel, how much are you involved in the business of a startup that you invest in? I suppose you probably offer them more than just money?
Of course, I offer a lot more. However, this largely depends on each individual investor. I personally have a portfolio of 35 companies and I cannot be actively involved in the business of each one of them. That is why I connect with friends who I really trust. These friends then take the lead with some investments, while with others I am the leading investor who directs the company. You need to balance the portfolio of the companies in which you are actively involved and those where you are merely a passive investor, leaving the control of the company to others.
When you are the leading investor, you spend a lot of time advising and directing the founders, opening up doors for them to connect with partners and potential customers, helping them with a range of legal and accounting matters, as well as a collection of other business affairs. You are their professional consultant for many areas, but you do this all free of charge.
And that is also one of the reasons why so many who have money refrain from investing in startups – you have to be a mentor and thus devote much of your free time to that investment and not many are prepared to do so.
Q: We regularly attend various startup competitions where, for example, there are three- or five-minute pitches for potential investors. Is a couple of minutes truly enough to judge the viability of an investment in such a company?
I have seen such competitions where only ideas were presented, and this is for me quite pointless. For me, such presentations have no value. For the investor, it makes sense to listen only to the presentations of those who have already thrown themselves into the business. In five minutes (plus a few minutes for questions and answers) you do not get to know enough to opt for an investment, but it is usually quite enough to exclude most of them from the list of potentially interesting investments. Sometimes because of the business aspect of the presentation, but more often because of people in the team. People are crucial, so it is also important to make sure that those who represent your startup are also the key people in the company and that we are not only listening to their professional advisors. You have to then seriously ask these people a lot of questions to check them. Seventy percent of the decision is based on the assessment of people, not of ideas and business. After 35 investments in startups, I am already well aware that the idea they present will not be the one with which they succeed. If they are smart, they will often notice, while building their business, that they have to modify the business model, perhaps completely reimagine their concept. And that is why you need a team that is able to formalise their plan in six months or one year and not a team that will blindly insist on the guidelines initially outlined, not able to adapt them to changed circumstances and new knowledge (and, of course, with that lose all my money!) That is why the key to success is the team, not the idea.
But that's not enough. If, therefore, you conclude that you do not exclude the opportunity presented, the second phase comes into play - a more serious overview of the company that goes into many details and lasts up to three months. We then organise another presentation in front of an expanded team of potential investors, and then each of us will make an investment decision. Then we try to collect together as much money as the startup needs for successful development.
Q: Do you have any advice on how to start a presentation?
It is a good idea to present the team. Also, when you explain your idea or business you should explain exactly how you are different from your competitors. This is something that many people forget in their presentation when in fact this is the most crucial part of the presentation. They need to show how well they are familiar with their competitors and explain exactly what their competitive advantage is. As for the figures in the business plan they represent – let me just say that I do not believe in them. However, they must, of course, prepare them to show how they think and to prove that they know the numbers and are capable of correct evaluation of the market.
Above all, they need to be able to explain how they have come up with the evaluation of their company. Oftentimes they come out with only a number or an offer – "we offer 15% for that amount of money". And more and more often there are young guys who evaluate their company, let us say, at four million euros, but they have nothing to offer, they present only their idea. We immediately reject these, of course. Those who come only with an idea and a basic prototype or have just started their business cannot really expect such an evaluation of the company. Maybe a million or two if they really have something extraordinary, but no more. They must, therefore, have a team, a product, a comparison with competitors, an explanation of the company's valuation, and a plan on how they will grow (although I do not believe in it).
Q: Does the association Business Angels Europe have criteria to determine who can invest?
No special criteria, everyone can invest. We are only strict when it comes to the two largest investors in a single project; these two must have the experience and be ready to invest their time. Others, of course, can participate based on their judgment. Sometimes we try to stop someone from investing when too many of us want to invest in the same project. Or if someone invests too little – you cannot participate, for example, with a contribution of only five thousand euros.
Q: At the beginning of the conversation you mentioned that governments should offer some kind of incentive to develop the investments in startups to the fullest extent possible. Could such incentives also complicate the investment?
The simplest things for the government to offer are tax benefits. These should be very transparent. Sometimes when governments offer co-investment programs, however, there may be problems with different views of the investment and various rules. In this case, there must be very clear criteria for selecting an investment, for further monitoring and for the possibilities of further funding. For example, in the UK, further funding is automatic. If a certain proportion of the initial investment is covered by public funds, then it is already agreed that the same share of further investments is covered in any subsequent funding circuits from these same sources.
I am particularly fond of tax incentives. Otherwise, the cooperation of the state can really complicate the business. I was a public employee for ten years so I can honestly say that, in my opinion, for startups that grow out of certain proportions, it does not make sense for their fate to be decided by public officials. Startups must be steered in the right direction by private capital, which shares the risk with them.
It is often mentioned that startups in the US bloom even though the country does not offer any incentives, which is not true, of course. There might not be any subsidies, but they offer highly-developed tax benefits. Investing in startups allows you to lower your tax liabilities for 20 years. What is especially interesting is the tax system in certain countries where you can reduce your tax liabilities due to a potential loss – that is, because of the fall in the value of your startup, even though you had not yet gotten out of that investment.
Q: How can Europe stop the migration of startups to the US? It seems that many startups build and develop on European soil, but then those who are successful eventually move their headquarters to the US.
In Slovenia, it is obvious why this happens, but it is not any different with us in France. If the startup wants to expand, it needs a large market. If we demand a high annual growth rate, then it is clear that they will not be able to stay only in Slovenia for long. The European market is large but fragmented. If you expand to Austria and Germany, this is a different environment, not only fiscally, but also competitively. To grow, startups are easily tempted to escape to the US or more and more frequently to Asia – China, for example.
The only way to stop this is for Europe to offer businesses a less diverse business environment, but, of course, this takes time and cannot happen quickly. As a business angel association, we try to offer something to keep the startups in Europe. For example, if you invested in a Slovenian startup, you could then say, after some time has passed, "In Germany, we have business angels and consultants with whom we cooperate, we can easily help you to switch to their market." We then arrange for German partners to enter the company with a new round of investments and take it to a larger market – all within the same ecosystem. A club of European angel investors is thus emerging, which aims to facilitate the connections between markets. This is our contribution at a time when we are waiting for Europe to develop a more unified environment. But I realise that this is a slow process and that this will not be the environment for me, at best perhaps for my grandchildren.