Identify business angels and create networks for them and entrepreneurs
Introduce tax incentives, but be prepared to tweak
MALAYSIA should look into creating business angel networks and introducing tax incentives to help develop the entrepreneurial and start-up space, says a professor who has spent 25 years researching the subject in the United Kingdom.
The problem with creating business angel networks is finding them first, says Professor Richard Harrison, immediate past Dean of Queen’s University Management School, where he holds a Chair in Management. He was previously Dixons Professor of Entrepreneurship and Innovation at the University of Edinburgh.
“I don’t have deep knowledge of the South-East Asian region, but I suspect there are similarities with what was happening in the UK when I first started researching the issue: That there is a lot of investment activity going on that is not being seen, that is not on anyone’s radar screen.
“What you need to do is identify and find these investors, then forge networks between them and bring them together with entrepreneurs,” he adds.
And that would not be an easy job, he admits, speaking to Digital News Asia at the recent Asian Business Angels Forum 2012 (ABAF) in Kuala Lumpur.
“One thing we discovered early in our research in the 1980s was that it is a pretty invisible market. Business angels are not listed in directories and they do not advertise their services. They are very private individuals and do not group together.
“On the other side, you have entrepreneurs who are not plugged into the business world, who because they are young, aren’t part of any business network.
“So essentially you have a bunch of invisible entrepreneurs seeking funds from invisible investors. It’s two groups of people dancing in the dark. Like someone once told me, it was like finding a black cat in a coal cellar – and the cat may not even be there,” he adds.
What Harrison (pic) and his fellow researchers did was to first find out who these business angels were, and to profile them.
“It was the ABCs of profiling – we wanted to know their Attitudes, Behaviors and Characteristics. Who were they? What were their backgrounds? How did they make money and investment decisions? Did they invest by sector or according to market space? What were their demographics?
“We wanted to get a good sense of who these people were, what they did and how,” he says.
What Harrison and his group did, and where most of his work has been, was to identify this market. They then worked with UK government agencies in the early 1990s to set up business angel networks and put them in touch with entrepreneurs.
“We moved from 1993 when there were two angel networks, to 45 such networks by the end of the 1990s,” he says.
Changes in government and the resultant changes in policies, with some of the networks closing down or merging, have brought the number of business angel networks in the UK to about 25.
“What we saw on the back of that however was the establishment of less formal networks – initiated by the angel investors themselves,” he adds.
Government plays an important role here, but must know when to step back.
For example, setting up and running these networks require funds, and the government can underwrite this.
“However, the rationale for government participation would be in helping support the flow of information, rather than intervening directly,” says Harrison.
“One thing we learned in the UK, in the mid-90s when we reviewed the first truncheon of networks, was that appointing the right network manager was very important. The success of the network directly correlated to the ability of the network manager.
“If you had someone who knew the business world, who had networks, who was prepared to act entrepreneurially himself, then the network worked. Appointing a public servant or bureaucrat who just wanted to push paper around his desk was not very helpful,” he adds.
To ease and encourage the creation of such networks, it is also necessary to remove that shield of invisibility, and this is an important role the media can play.
“There needs to be increased visibility of business angel activity,” says Harrison.
“The media can do stories on business angels who are willing to be profiled, and it shouldn’t just be about the superstars. If somebody reads a success story of somebody like Tony Fernandes (the founder of AirAsia), he would just say, ‘Well, that’s Tony.’
“Do stories on the moderately successful angels, the ones who spent perhaps only a hundred thousand to see a start-up through its early stages and then made a nice sum cashing out. People would read that and think, ‘Hey, that guy is like me. If he can do it, so can I’.”
The business media could also do case studies and profiles of start-ups, from their early stages onwards, how a business angel came in saw them through the difficult stages, and their eventual success, he suggests.
“Business angels get involved in the business and bring more to the table than just money. They bring their experience and their networks. These stories need to be told,” he adds.
It would be a learning experience for the media and its audience, Harrison notes.
“I remember that about five years after we started, there was increased coverage in the business and financial press, but the term ‘business angels’ was always used in quotations marks and the stories would have to carry a definition somewhere.
“This is no longer the case. Now it’s part of everyday conversation – but it took between five and 10 years to make that transition,” he adds.
Tax incentives, not shelters
Tax incentives for investors can be another powerful driver to develop the business angel market, but it is a move that would be open to abuse and would need greater scrutiny and tweaks down the road.
“The basic model is that an investor making, say, a 100,000 ringgit investment in a qualified business, can offset that against his tax liability. We have had something like this in the UK for about 30 years now,” Harrison says.
Citing a keynote speaker at ABAF 2010, Anthony Clarke, co-founder and chief executive officer of the Angel Capital Group, Harrison says that about one billion pounds sterling is being invested in the UK every year.
“And Clarke says that about 250 million pounds of this comes from the taxes offset by the Government,” he says.
He however adds a word of caution, saying that France introduced a similar scheme several years ago but had to switch it off because it was overly generous and open to abuse.
“The UK has also experimented with an exit relief in capital gains tax. If investors rolled over their gains into another investment, they could avoid paying tax on it. If they gained from the exit, they still paid taxes, but at a reduced rate.
“The Capital Gains Rollover Relief has been tweaked many times, however. One of the downsides was that it was very often mis-marketed as a tax shelter for high-net-worth individuals, so a lot of it went into property investments. Some people got very creative in how they made use of the system,” he adds.
Still, Harrison maintains that the scheme has been largely successful. “Our research shows that the effect of this tax relief was that investors not only invested in more businesses, but they also did so with larger sums than they otherwise would have.”
He says that the overall effect in economic terms has been very positive, but admits he cannot quantify this.
“That is the big question, but by my estimates, it roughly doubled the investment market,” he adds.
He says it is also hard to estimate the business angel contribution to the UK’s GDP (Gross Domestic Product).
“However, we estimate that business angel investment in early-stage start-ups is as much as that coming from venture capital and private equity funding.
“Seeing that the individual sums are smaller from business angels, we believe that they are supporting three to four times as many businesses as the venture capital and private equity industries.
“And that’s conservative estimate – in the United States, they estimate the ratio is 10 to 1,” Harrison adds.
So, create networks and provide tax incentives -- and in that order too.
“Having tax incentives in place without some established mechanism to put entrepreneurs and investors is going to be a futile exercise. There is no point incentivizing investors if they can’t find the deals,” says Harrison.
“The starting point for a country like Malaysia is to increase the connectivity first, and getting the media coverage and case studies up. Get people into the room together first,” he adds.