11/03/2011

Why 4% inflation matters to angel investors (and the businesses they back)

By Modweena Rees-Mogg, CEO And Founder Of AngelNews

The news this week of both a 4% CPI (Consumer Price Indices) inflation rate in the UK, plus a 44,000 increase in unemployment is serious. And it is going to matter, a lot, to the angel investment market.

Since graduating in 1990 this is the first time, I have really experienced an inflationary economy, so I cannot tell you any war stories about the terrible times of the 1970/80s, but the have been recounted to me by my older wiser friends. Tales of prices going up every week etc etc.

Here is a chart from the ONS (Office for National Statistics) showing inflation over the last 11 years. I think the most telling thing for me is that the last time rates were at 4% it was just before the Credit Crunch and the economy felt very different to how it feels today.

I think Mervyn King is making a fair point about the impact of interest rates in controlling inflation, given his reasons in the article: Inflation will rise sharply, says Meryn King, and there is going to more pain to come with the rises in Employees NI and fuel duties, let alone the public sector redundancy earthquake and the real bonfire of the quangos which will burn long and slow as all the "not for profits" struggle to turn their businesses into commercial enterprises. Maybe in 3 months time concerns about inflation will seem like a storm in a tea-cup.

But I fear not.

So should angels and entrepreneurs worry about significant and long term inflation? The simple answer is yes. And here are some things to think about:

The angel perspective

1. You don't want to be in cash in inflationary times. So angels need to get investing into assets that will inflate in line with or ahead of the RPI (Retail Prices Index) and CPI. There is a good case to be made for investing in business that will build solid asset value, not just businesses which own a property, but also businesses which have assets that can quickly turnover cash — social media sites for example.

2. Think also about those high turnover low margin business that may not have a lot of IP (Intellectual Property), but sure as hell know how to work the cash and can move swiftly to meet current market conditions. Or those businesses which will appeal to customers in hard times: I suspect hybrid & electric car makers will thrive in the 20teenies.

3. Grab EIS (Enterprise Investment Scheme) relief while you can and remember to think hard about where you are going to hold that cash until your 3 year time limit is up. Just in case it is reclaimed by the tax man!

4. Remember equities are typically a good hedge against inflation, but if you are investing now, make sure you think hard about valuation. Remember if those financial projections are not adjusted for inflation, they may be giving you a very false impression indeed.

5. Accounting policies can change. Don't underestimate a return to current cost accounting of stock!

6. Think about funding structures. Is this really the time to load a company with debt when the capital value of that loan will depreciate by 4% or more each year?

7. And if you are lending to a business you are going to have to rethink the interest rate you want to charge and what the business will be able to afford to pay in what timescale given that they are going to be facing ever increasing pressure on cash.

8. This might just the be stage in the cycle when it is better for you to put some man hours in at your favourite portfolio company rather than taking on a member of staff on salary.

9. Check the minutiae in the numbers. The travel costs of that dynamic salesman driving around in his Ford Mondeo may grow all of a sudden — perhaps now is the time to get him a hybrid car?! Think if the business can find an online way to do something, especially selling!

10. Review employees, their contracts and the employment strategy of your portfolio companies. With a glut of talented people coming onto the market you will have to weigh demands from good staff for pay rises vs the opportunity cost of letting them leave, but finding a better replacement.

11. Put in place more checks and measures — turn that monthly board meeting into a weekly conference call, for example.

BUT

12. Don't stop investing. The best SMEs (Small and Medium Enterprises) outperform in their sectors disproportionately well during difficult economic times (remember Microsoft was founded in the 1970s!). And investing in the class of 2011 will give you some real bargains. Your wealth now needs to be put to work by entrepreneurs to drive the economy forward. You just need to take better care that it is put into the best quality pots.

The Entrepreneur perspective

13. At this time more than any other you need to hang onto as much cash as possible so you can meet those unexpected demands for higher wages and growing demands for price rises from suppliers.

14. Borrow if you can as inflation will eat away the capital value of your loan.

15. Watch out for new and more aggressive "inflation protecting" terms in investors' terms sheets when fundraising.

16. Plan for your exit — what terms will you want — e.g. would you rather be paid in £, $ or The Renminbi or shares or even physical property?

17. Keep on top of the management accounts. Know at the close of every day what money you have in the bank, what you are expecting and what you owe. Keep your investors informed too — weekly conference calls, more rapid preparation and distribution of management accounts and the rest.

18. Reshape your business if possible to make your cash turn over quicker; reshape it again to make cash turn over even quicker than that.

19. When preparing your financial projections, remember to account for inflation in the forecasts;

20. Adjust your cash flows to take account for late payers and slower buyers.

21. When doing well store the company's wealth in inflation protected, but liquid assets (maybe not gold, but it could well be worth putting some of your spare cash into A grade quoted equities, rather than on deposit at the bank).

22. Plan for staff turnover of good people as your competitors try to nab them off you, but staff retention of poor people; alongside regular requests for pay rises. Think about your policy now — can you give them perks, not cash for example? Maybe that staff canteen you have been planning should move up the importance agenda if it means everyone gets a free hot meal each day.

23. Watch out for cost inflation in unexpected areas — travel for example; put your prices up ahead of the costs. (Yes. I know this will feed inflation but you cannot stand alone in a Tsunami and not expect to drown).

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