What’s wrong with making a profit?

I have been involved in raising funds for businesses now for over 10 years, either for projects of my own or on behalf of clients, and I am still surprised at the perceived ‘greed’ of some investors!

Maybe ‘greed’ is too strong a word, I should perhaps say expectation as it is the perceived expectation of the proposed or desired performance of an investment that seems to cause great consternation among Angel investors and VCT’s.  Let me explain….

Personally as someone who has started many projects, failed sometimes and won enough to keep me interested I believe I understand the need for a business to turn a profit.  I am pragmatic enough however not to expect a profit in the first year, or even first two years, but if I can’t see a move toward profitability in year three, then I begin to think that profitability may well be elusive and it could well be time for a change of direction/pivot within the business plan.  Because I remain involved in vested businesses and keep an eye on performance against the business plan, I tend to live the reality of the coalface and can see the constant chipping away at costs and propping up of revenues that will lead, eventually, to profit or not as the case may be.

However, what I do not do is to assume prior to investing that the business will perform at 5, 10, 20 or even 30 x ROI as many investors do, in fact I know investors who will not even get out of bed for less than a forecast 30 x ROI.  I think this is pure folly and damages the entire Angel sector.

In my opinion it is feasible to assume that a service or product has a place in the market, that the product is sufficiently well developed and that we know what price the product should sell at.  We then have to consider the promotion of the product in an effective manner so that the market is responsive and sales are generated.  All of this relies on people and process (there are a lot of P’s here!!) and as an investor you have to look at the entire mix (of P’s) and consider the potential of the business.

I do this using a number of models and often play down the potential or forecast upside revenues in favour of increased costs.  As well as adding a minimum of 20% on costs and -20% on revenues, I include a customer churn model every x months to take into account the fickle nature of early adopters as well as the normal NPV type financial modelling.

This process will show me when I can expect a profit on the business and from which I can ascertain a value and invest safe in the knowledge that the worst case scenario (as far as I can plan for) is covered.  Often this does not show me a profit that will allow for a significant ROI and so I try to look across my portfolio to ensure a broad 22% IRR and whenever this can be defined (within the limits stated above), even when taking into account the worst case scenario planning an investment can be made.

However, this does not rely on the founder of the business to ‘sell’ to me a 30 x ROI or to adapt his/her business plan to suggest massive returns and exits.  I am frankly not interested.  It’s easy to sell the upside, just look at the opposition in parliament, they can say whatever they like, promise whatever they want and people can choose to believe it and vote for them.  But within the first year, you watch them back pedal on all those promises and this is the same for the founder of a business, and why would I want that?

I don’t want the founders of business in which I and/or Flaming is vested to feel pressured to make promises they can’t keep, or for us to face month after month of failing numbers because that’s what we bought into.  I don’t believe that does anyone any favours at all and can cause significant lack of focus on the core purpose we are in business.

I/we much prefer to take a pragmatic, medium to long term view of returns based on known risks, downsides and potential upsides and not some arbitrary measure that makes us feel good.  This is what Angels should be doing, investing in good people with good businesses and from which good dividends and profits can be derived in time.  Not suffering from poor expectation management or letting greed be their driver!

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