What Makes a Terrible Business Idea? The Seven Deadly Sins

November 13, 2007

I get sent between 10 and 20 business ideas every day. Some are actually functioning businesses (allegedly). I delete almost all of them having read just the ‘Subject’ line. Why I open and read a handful a week will be the subject of a later blog, but I thought it might be interesting (and fun in a rather brutal and nasty way) to discuss why 19 out of 20 don’t even get opened. Having seen literally thousands of proposals now I am pretty good at putting them in categories. There are as many different kinds of VC and angel (dragon) as there are entrepreneurs, and so I am sure not everyone is going to agree with me, but for this Dragon if you fall into the following seven categories you can collect your coat now:

1. Obviously ‘Me Too’ Ideas. This is the biggest category - of the proposals I get sent at least. I see a lot of ideas that are simply jumping on a bandwagon in an already crowded space. Hence out go ideas for: online travel agencies (amazing how many people think this will still work), dating agencies (come on guys … if you ever went on a date yourself you might realise that this is a seriously over-broked space ), most social networking sites (these are getting hilarious now - in order to try to look different they are ever more specialised - no I don’t want to invest in a network for geography teachers who once worked in Sheffield). These are no good unless someone has really interesting angle, which they almost never do.

2. Unscaleable Ideas and Lifestyle Companies. This is the second biggest killer for me. I have absolutely no interest in lifestyle companies – and if you are a smart dragon you won’t either. You will find yourself effectively sponsoring someone else to put their feet up. So if you are four accountants who have 100 years experience between you and you want to ’spin out’ on your own and live closer to home you are not getting my cash for ‘marketing purposes’. All you really want is £100k to buy some chairs to sit your lazy, corpulent arses on so you can then grow revenues at precisely zero % for ten years with a wage bill that miraculously always exactly equates to the gross revenue number. Entrepreneurs who are going to make you a lot of money don’t sit at one big company for 20 years and then suddenly emerge butterfly-like as dynamic, rule-breaking, whirlwinds. Avoid like the plague.

3. Impossible to Evaluate Ideas. Now this is more of problem for dragons and angels than for larger VC houses. I am amazed at how many proposals I get for biotechnology products, for new types of power generation and things of that kind. These may be brilliant, they may be garbaggio. I will not find out, because I simply have no cost effective way of doing the due diligence. Next …

4. Bars, Clubs, Restaurants and Films. This isn’t because a lot of them fail - although I think that they do - or because I dislike bars and restaurants (although I don’t like films much). Its because in business you want to be competing with people who are playing the same game as you. If other people are not really interested in maximising profit because it is more important that all their friends come to their club on a Friday night or that their restaurant gets a good Zagat score then they are going to do crazy things like price below their costs. They make it impossible for me as a financial sponsor to make an acceptable return. The same goes for football clubs and other sports teams.

5. Any Kind of Property Development. This is a different kind of objection. My problem here is that property development is not necessarily hard to get funding for. It is actually the ONLY thing the retards at UK banks will back (on a secured basis of course). So my objection here goes back to what I wrote about Blackstone in yesterday’s post. WHY haven’t these guys been able to secure any funding elsewhere? If they have bank financing and are looking for mezzanine debt or a slither of equity then I might look at it. But generally I would rather buy Blackstone at IPO than touch this stuff. So keep your Bulgarian ski resorts and your ‘brownfield’ sites in Cumbria. I am not a buyer of last resort (or any resort for that matter).

6. Anything from an Entrepreneur who looks like He/She Cannot Control Costs. For this reason anything to do with design or advertising and featuring an office in central London goes to cyber heaven immediately. I am pretty cautious generally. I like to put a small amount of money to work to test concepts in the market. If someone has already proved their idea in the market then it is a bit different, but any start up that wants to buy a lot of hardware and wants to engage a PR company (more on them later - the worst rip off in the UK economy) immediately raises my suspicious. I am personally pretty generous (really), but in business I find myself constantly asking: ‘what is the least amount of money we have to invest to test whether this idea works or not?’ If you don’t think like that, then you and I are not going to tango.

7. Social Enterprises. I wasn’t sure whether to include this one - but then I remembered that my blog is anonymous. The basic problem here is that when ‘entrepreneurs’ are detached from the profit motive bad things happen. Bad things like, they forget to make any money. My only business failure (to date - there will be more) was in this area so perhaps I am negatively biased. But after giving this quite a bit of thought I now believe that if you want to support a charity you should do so (and I do) and if you want to support a business you should do so too. But don’t try to the achieve both objectives in one investment. You won’t actually help anyone. There is a big social enterprise industry out there now and their methods of hooking you are subtle. Be very wary. I would suggest investing in the myriad of ‘consultancies’ which ‘advise’ social entrepreneurs but, despite the fact that they take exorbitant fees and do almost nothing, most of them are ruled out under Rule 2. Shame.

Share on Facebook

Can a Beast Ever be Too Beastly?

A dragon is expected to be a hard-hearted animal - we have stomachs which produce flames after all! But I was wondering today about the limits I would be prepared to go to to make money in my chosen profession.

The catalyst for my soul (stomach?) searching is the extraordinary story of the IPO of the Blackstone Group this summer. Yesterday the US company produced predictably woeful results which sent an already depressed stock down over 8% (by the close). It is now down 28% from the IPO price and almost 40% from the high set on the first day of trading. I am sure everyone reading this will know that Blackstone is one of the truly ‘big beasts’ of the private equity industry. It was reportedly started by Stephen Schwarzman and Peter Peterson with just $400,000 in 1985 (now manages a whopping US$ 88.4 billion) and as such provides a wonderful example to a little dragon like myself of what can be achieved with determination and a rigorous application of the principle of ‘buy low / sell high’.

Now I believe that market matchers will argue forever about which of two signals defined the top of the credit bubble. The massively hyped Blackstone IPO, which occured on 21st June 2007 is clearly suspect A. But then the hilarious comment by the (then) CEO of Citigroup Chuck Prince that he was “still dancing” at the credit party (reported on 10th July) runs a close second.

For me there is a hands down winner. Chuck Prince was out of touch with the realities of credit trading. He allowed his traders and bankers to amass positions in the mortgage backed and leveraged loan market which have already been written down by $11 billion. Even with the dollar disappearing around the U bend this is a pretty chunky loss. And if Deutsche Bank’s analysts are right that the total market losses will stretch to $300-400 billion, then there is surely much more to come from Citi. So the Prince of Citi is exonerated on grounds of diminished responsibility.But messrs. Schwarzman and Peterson have no such defence. They were there on the ground and could see the writing on the wall. So their ability to get an IPO down as the market was boarding up its doors and windows ready for the hurricane to come was breathtakingly audacious. And now the stock is down 40% (since 22nd June).

If you watch CNBC you are told to think that Mr Schwarzman and his friends are aghast at what has happened (I heard someone say it yesterday). This is because CNBC has a role to play in the Wall Street / City carnival which requires them never to question the basic premise that companies like Blackstone are there to make money for their shareholders. This is, of course, often the case - but it clearly wasn’t in this instance.

Now apart from pure, unadulterated, admiration that I feel for Schwarzman and Peterson for one of the most wonderful pieces of market timing in recent financial history, what other lessons are there from this (lets face it) pretty laughable story? For me there are three. The first is simple: if you consistently buy low and sell high (and that means realised P/L for all you traders out there not unrealised) you will pretty much always win. The second is that you should never let an active asset manager run your money for you if you can possibly do it yourself. These are the real guilty men and women in this story. There were loads of ’stay away’ blogs from independent thinkers at the time (see www.thestreet.com/newsanalysis/investing/10348377.html) and yet the muppets running your pension fund still piled in right at the top.

But the third is the most important. Even as a little dragon you have got to consider WHY someone is selling what you are buying. S and P were not selling their equity because they wanted to make you richer. They were selling because they thought their stock was over valued in an inflated market. They used marketing tools, CNBC and the like to get you to take the other side of their bet. And guess who was right?

For me, there is only one way this story could get funnier. Blackstone should use some of its vast un-spend equity to LBO …. you guessed it - the Blackstone Group! If they do I might even invest in the fund myself.

Share on Facebook

Five Angel Investment Myths - and the Truth Behind Them

November 11, 2007

Myth 1 - You have to be a Zillionaire to be an Angel Investor. This really couldn’t be further from the truth. The truly rich, which Felix Dennis describes as those with assets above (I believe) £250 million, are not usually interested in angel investing. They run their money in family trusts (offshore) and invest in property, hedge funds and private equity. They need capacity that angel investing cannot give them. But if you have £10,000 to invest you can be an angel investor. In fact, the vast majority of angel investments in the UK are in the regional of £10,000 to £50,000. It is customary at this point to get all po-faced and opine about this type of investment is not for the elderly, or the risk adverse and stuff like that. Well I think that is garbage. Angel investment can be part of anyone’s portfolio. If you follow my advice on how to structure your investment (see Guides) then you will have a darn sight more control over your angel investment than you will over the decisions of BP or HSBC or any of the other investments you might be tempted to make. I will show you how to draft a shareholder’s agreement such that your investment company cannot even by a new pencil without you agreeing (if you want to). You will see that angel investments can be a lot safer than you might think.

With the dramatic drop in the cost of web design, web hosting, online advertising etc. etc. it is also now quite feasible to set up and at least test the feasibility of a B2C business idea very thoroughly for less than £50,000. Now it may be the case that to turn it into an EBay or Amazon there may be further investment required, but that is where bigger angels or venture capital funds come in. We’ll talk more about that is subsequent blogs.

Myth 2 - Angel Investing is very Time Consuming. This is not true either. Once you have found your investment(s) you can usually devote as much or as little time to them as you like. I tend to be quite ‘hands on’ with my portfolio; but that is because I want to learn and also (if I am honest) I don’t usually trust people to spend my money wisely if I am not watching over them (like an angel right?). It is also the case that many entrepreneurs like to have angel investors who bring a skill set that they themselves don’t have (often financial, legal or marketing expertise are sought). But this doesn’t have to mean an onerous time commitment. Be clear at the outset how much time you are able to give, put clear requirements in the shareholder’s agreement regarding the production of financial information to you, and you should not have any problems.

Myth 3 - You will be very lucky to make a lot of Money Angel Investing. This one is a little harder for me to shoot down because I have not yet successfully exited an angel position (I’ve only be going a year). But I can only tell you about my own experience. Out of around 10 businesses I have backed over the past year, only one has actually folded. But even with this one I was able to buy the assets from the liquidator for a song and I intend to resurrect it in a slightly different guise in 2008. It is by no means dead. All the other businesses are in a healthier position now than they were when I invested (although three of them have required a small amount of additional financing). So am I going to make a ton of money? Even a mythical dragon can’t see into the future, but I do believe that my portfolio is worth very substantially more now when at the time of investment.

Myth 4 - Good Angel Investments are extremely Hard to Find. I am sure this used to be the case. But today the internet has revolutionised the process. There are now a large number of online angel investment networks. All you do is register your details (with absolutely no obligation to provide finance or financial information) and you will received daily emails of business plans. You will be amazed how many there are. With very little effort, at the peak of my investment period in mid 2006 I was receiving 20-30 a day! Many of these networks are not restricted to the UK, but offer opportunities all around the world. And you can save filters so you only receive proposals in sectors which interest you. Entrepreneurs are usually looking for between £50k and £150k. Now of course a lot of the ‘opportunities’ are not great investments, but the deal flow is substantial and is increasing all the time. My favourite angel investment network is: www.angelinvestmentnetwork.co.uk. Get yourself registered on that today and start evaluating ideas tomorrow.

Myth 5 - Angel Investing is very Complex Legally. This is bunk as well. Angel investment can be, and I suspect often is, conducted without any documentation whatsoever. Now I wouldn’t recommend this, and I would actually spend just a little time thinking about the form of your investment. The two choices are to simply lend the company money (a Directors Loan) or to purchase shares. I intend to write a very simple guide to these two forms of investing in the very near future so please hang on for a couple of days and I’ll publish something you can download. But suffice to say, neither route is at all difficult, time consuming or mentally taxing. But a little effort in this department does go a long way later on. I have NEVER had to pay for legal advice on how to structure an investment.

Share on Facebook

Absent With Official Leave

November 7, 2007

Read a fantastic article by Michael Lewis on www.bloomberg.com today (I believe the same guy who wrote the excellent Liar’s Poker on Salomon Bros.) about the final days of Stan O’Neill as Merrill Lynch lurched towards a US$ 8.4 billion write down of mortgage and other assets. I am always fascinated by stories of people losing lots of money (got to be more than $1 billion otherwise it doesn’t count as ‘lots’ these days). As a former trader myself, I do know just a little of the loneliness and despair he must have felt. Most people don’t have much sympathy for people in O’Neill’s position (he did get $160 million for losing $8.4 billion after all!), but I am inclined to be more generous. In my experience it is not the people at the very top of banks who are the most greedy and plundering, it is the tier one rung beneath. And I do also play golf myself, so O’Neill’s musings recorded on the back of score cards as Merrill plunged into the dramatic losses that cost him his job were doubly fascinating.

The crowning irony was the revelation that while Merrill was rushing headlong towards the buffers, O’Neill was out playing golf on his own. Aside from the fact that you would think that someone who must easily be worth $300 - $500 million would always be able to get a golf partner, the image of this guy walking up and down the fairways as millions of dollars were flushed down the sub-prime toilet is surely almost as tragically heroic as Captain Ahab or Hamlet (at least to financiers). As a venture capitalist I am amazed that the heads of large organisations can be so detached at times of crisis. The story is that Jimmy Cayne (head of Bear Stearns - or “beer stains” as we always use to call it), was away at bridge tournaments without a cell phone or pager while the two internal Bear hedge funds blew up. I think what this shows you is that investment banks today are really indistinguishable from the hedge and private equity funds they claim are their ‘customers’, and that the CEOs of these organisations are now wholly the prisoners of the main position (risk) takers who generally sit one or two rungs down from the CEO level. Not saying this is a bad thing, necessarily, but it does mean that for shareholders it almost doesn’t matter what the CEOs do, they are figureheads only. Your capital is being punted in massive bets made by much lower profile people just where the shadows start.

Anyway, I am off to play golf now, so please don’t call me or expect any more blogs today - and yes you are right … I am playing on my own.

Share on Facebook

A Capital Offence

John Kay has a piece in the UK edition Financial Times (www.johnkay.com) today on UK capital gains tax and the proposal for a flat rate of 18% for all capital gains. He actually does make a number of reasonable points. I do suspect he is right when he asserts that true entrepreneurs are driven by a kind of mental illness (I should know, as I am a partial sufferer myself), and do not coldly calculate after tax returns when establishing businesses.

But he badly misses the main point, which for me is that he doesn’t properly take into account the attitude of the providers of finance. I am both and entrepreneur and a finance provider (through my VC company). This blog will frequently (I hope) document the laughable and inept responses of financial organizations in the UK to supporting new enterprises. Most UK-based VC funds are no better (as we will see), preferring to move ‘up the curve’ to invest mostly in companies that are already well established. For investors like me - the real ‘angels’ investing £100k to £500k in genuine start ups - the post tax return on investment is crucial. An 80% hike (from 10% to 18%) in the capital gains tax rate will make a very significant impact on my willingness to support entrepreneurs in the future. I share the dreams of my entrepreneurs to an extent, of course, but only to an extent. I must apply portfolio theory and consider my investments as a whole because I know that at least 50% of them will not make it through to trade or private equity sale. So the after tax return on the portfolio is crucial, and therefore this proposed change will definately alter my behaviour.

I think there will probably end up being some kind of U turn from A Darling (love that name - always makes me think of the 4th Black Adder series). But my fear is that he will ‘compromise’ by exempting gains up to a certain level (I think £100,000 has been mentioned). This is no good at all. People like me need to make £2,000,000 on a £100,000 investment to compensate for all the ones that go wrong (which will be the subject of future blogs). Just giving a paltry allowance like that might help the plumber pass on his business to a colleague but will not help those supporting genuinely entrepreneurial enterprises.

The only hope really is that G Brown re-reads some of his old speeches on what entrepreneurs do for an economy and how important it is to nurture them (which is why he introduced the 10% rate in 1998 in the first place). For 9 years he said and did all the right things, and then in one moment of madness he risks undoing it all.

Share on Facebook

Why Start Dragon’s-Pen.com?

November 5, 2007

Several reasons really. The first is purely because I am too lazy to keep a proper hand-written journal and I would actually like to keep a record of this period of my life. You see I have only been a dragon for a little while, a year or so, and I don’t intend to remain a small dragon for long. I want to become a really BIG dragon. But in order to do that I need to record the mistakes I make along the way so I can look back later and try not to repeat them. It is said that those who do not learn from history are forced to re-live it. I intend to follow the ‘learning’ path.

The second reason for starting Dragon’s Pen is to try to provide encouragement and inspiration for other people to become supporters of entrepreneurs. Although at times I am sure this blog will descend into frivolity (is that a word?), in this I am deadly serious. I work with about ten genuine start ups at the moment and the problems they have all had attracting financial support have been tortuous. More people need to sign up to the excellent angel investment networks like www.angelinvestmentnetwork.co.uk and www.bbaa.org.uk and get involved in angel and VC investing. In this blog I hope to offer advice on how to do it, on what mistakes to avoid and on how you really can make a lot of money if you approach it properly.

The final reason for the blog is to try to provide some entertainment. I spent many years in investment banking at a senior level. I know lots of people in hedge funds and private equity. I don’t want to be a dick and over-dramatize things, but there a lot of funny things that people tell me or send me that never make it into the newspapers. I have no scores to settle and I am not a ‘disgruntled’ employee in any way. But I do think there is scope for more people writing what is ‘really’ happening in some of the situations reported in the WSJ and FT. I hope I can provide some commentary which will be a little more irreverent and insightful than a lot of the dross the media provides.

I hope you enjoy it.

Share on Facebook