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Curb on angels may leave start-ups without a prayer

FSA rules mean that early-stage investors cannot collectively risk their own money

 

A COUPLE OF YEARS AGO, I attended a technology conference in the South of France as a guest of one of the major international investment banks. I know, "it was a tough job, but somebody had to do it".

 

At a lunchtime session, one of the bank’s expert analysts was giving an overview of a telecomms technology company. “There are no metrics that we can find that justify the current high market valuation of this company”, the expert declared, “but we still rate it a strong buy”. 

 

I was a bit puzzled by this. It seemed that the magic dust in the overheated technology world had reached a point that you didn’t even need to have any kind of remotely believable business growth forecasts to hang your recommendations on. Still, this prestigious investment bank was fully regulated by all the main authorities, including in the UK and the USA so I supposed it must know what it was doing.

 

Nowadays, in post-dotcom and post-Enron times, the world is a much more sober place. It transpires that many of these prestigious analysts had not been quite as independent as we had thought them to be. We now know that many of them advised their clients to invest in companies largely because their parent bank was receiving lucrative advisory deals from the very same companies.  

 

They, the companies and the advisers, that is, were doing fine out of this arrangement – it was only the shareholders that were getting stuffed. It makes you wonder what financial regulation is actually for, if it didn’t stop this kind of nonsense.

 

Well. I’ve just found out.

 

So here we are, a long way from the French Riviera, in a cold and damp winter, and allow me to introduce you to some angels. Did I say angels? Yes indeed – business angels.

 

“Business angels” is the term used to describe people who personally invest in companies, often at the start-up phase. The term derives from the funding of theatrical productions, where the individual investors are called “angels”.

 

These days business angels often play a key role in new company formation. They put money and, more importantly, time and attention, into start-ups. They help get the business going, often finding key members of the management team, and in most cases they help the company raise further investment from venture capital sources.

 

And angels often herd in flocks. As it happens, I am a member of a group of such angels. We found that we could collectively invest larger amounts into start-up companies than could be done individually, and so more ambitious projects could be funded. By involving several angels, the company could draw on a wider range of advice from its investors.

 

A few months ago we decided that this could all be more effective if we created an investment pot to leverage our efforts. About 20 of us punted £5,000 each into a common bank account. We decided that in any situation where two or three members decided to invest £25,000 in a start-up business, the fund would contribute another £25,000, doubling our financial firepower.

 

All the members accepted that this was high-risk, and that they might well lose all their money, but were willing to take the chance because it would allow them to do more deals and get involved in a wider range of companies.

 

And then we discovered financial regulation, as imposed here by the UK Financial Services Authority (FSA).

 

Whatever it is that consenting adults are actually allowed to do in Britain today, collectively risking their own money is apparently not one of them. It transpires that any one of us could get up to seven years imprisonment for spending our own money in this way. Not only that, any company that we invested in could sue us – and again the penalty could be up to seven years in jail.

 

Not surprisingly, we’ve all decided it’s not worth it, and the fund is being broken up and the money returned to its members.

 

It seems a shame. It means that fewer Scottish start-up companies will get funded.

Still, no doubt all those people who have lost buckets of money investing in failed dotcoms, Enron, or Global Crossing, as a result of highly regulated advice from prestigious analysts in major investment banks, will be comforted to know that our financial regulation system is successfully protecting us from risking our own money by investing in Scottish start-up businesses.

 

What a relief.

 

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