Why does anyone invest in startups?
Investing in startups is not as glamorous as one might think. Why would anyone want to invest in an asset with a high risk of failure, a long holding period for the few that do make it, and lots of ups and downs along the way?
Well, for starters, there’s the allure of potentially significant rewards should one, or several, of the companies in your portfolio turn into a successful startup. Just think of the nearly £9bn valuation achieved by Transferwise (Wise Plc) when it floated on the LSE in 2021 and the many 100x multiple return to the angels and VCs who backed it when it was a startup valued at just a couple of million pounds.
Add to this the positive impact that many of these startups are looking to achieve, the jobs created by these SMEs (in the UK, SMEs account for 61% of employment) and the insight, experience and for many, excitement, that goes hand in hand with playing a role in the development and funding of innovative new businesses and you’ve got an allure that few other assets can offer.
SyndicateRoom commissioned an independent research agency to examine the performance of 519 UK startups that raised seed round funding in 2011. Between 2011 and 2017 the cohort grew at a compound annual growth rate of 30%, and was worth more than 5x its original value by 2017.
Data from Beauhurt used in SyndicateRoom's Early-Stage Equities report suggests that if you had invested £10,000 into this group of 519 startups in 2011, by 2017 you would have an overall portfolio worth over £63,848.
This figure does not include Enterprise Investment Scheme tax relief. Qualifying investors could be eligible for 30% income tax relief on their investment, up to a cap of £1m per tax year (or £2m per tax year if at least £1m of this is invested into knowledge-intensive companies).
How do I invest in startups?
There are many ways you can invest in startups ranging from online platforms through to in person angel networks. No matter how you ultimately decide to invest in startups, one of the most important steps is to create a startup portfolio that is sufficiently diverse in terms of its size, and that your investments in startups are themselves part of a diversified portfolio of different asset classes. Don’t put all your eggs in one basket or you may end up with a large loss of capital.
Your free guide to investing in startups
Risk Warning: Investing in startups and early-stage businesses involves risks, including illiquidity, lack of dividends, loss of investment and dilution, and it should be done only as part of a diversified portfolio. SyndicateRoom is targeted exclusively at sophisticated investors who understand these risks and make their own investment decisions.
Investing directly into startups
Investing directly into startups allows you to pick and choose which startups you want to invest in instead of leaving that decision to a fund manager. You can choose to back companies across various industries or focus on just one, you can back companies very early on or when they are slightly more established, and you can choose to back companies that do or do not have an ESG focus, or not. However, if you choose to invest in startups directly you will have to do your due diligence thoroughly on each company before making an investment and, as a direct shareholder, you will have to continue to be diligent and vote wisely when companies put out resolutions. More on the due diligence later in this article. For now, here are a few ways you can invest directly:
Equity crowdfunding platforms allow people (the ‘crowd') to invest in unlisted companies in exchange for shares through an online portal. Companies create and market their pitches to potential investors who can often invest as little as £10 into the business. These platforms will have several investment opportunities available at any given time and some even attract more traditional angel investors to invest through them.
Angel Networks and Syndicates
Angel networks are groups of individuals who work together to source, review, and invest together into early stage companies. Through this shared due diligence the angels hope to improve their odds of investing into potentially successful companies. Some angel networks are more formalised and structured than others. If you live in the UK you can find a list of the operating angel networks through the UK Business Angel Association.
Startup accelerators run set courses aimed at helping early stage ventures accelerate their growth. In exchange for attending the programme, startups often receive a small amount of investment from the programme operators in exchange for a share of the business. At the end of the programme the startups are presented to investors as part of a “Demo day”. Famous accelerators include y-combinator and entrepreneurFirst.
For those that prefer to let someone else choose which companies to back, Venture capital funds are pooled investment funds that manage the money of investors who want access to the startup asset class but do not have the time or experience to select opportunities to invest in for themselves. VC Funds, which sit within the broader Private Equity asset class, are typically operated by experienced investors who conduct due diligence on the companies before choosing to invest in them.
In exchange for doing the hard work of selecting the companies, VC fund managers charge investors fees, namely a set-up fee, annual management fees, and a performance based “carry” fee that they collect when one of the portfolio companies exits - usually via a trade sale or IPO.
In the UK there are special types of venture capital funds that allow eligible investors to receive tax reliefs from the government: SEIS funds and EIS funds.
The Access EIS fund
SyndicateRoom's Access EIS fund tracks the performance data of over 5,000 active startup investors. It then selects and co-invests with some of the best-performing “super angels” with the aim of replicating their collective success. Our super angels' notable investments include:
Horizon Discovery (£221m market cap). Magic Pony Technology (sold to Twitter for a reported $150m). Swiftkey (sold to Microsoft for $250m). Household names like Secret Escapes, Bloom & Wild, and Simba Sleep.
The fund diversifies investment across at least 50 super-angel-backed startups to minimise risk and capture as many potential “blockbusters” as possible. The minimum subscription for Access EIS is £5,000.
What due diligence should I conduct on a startup?
It's essential to conduct rigorous due diligence on any opportunity before making any investment decision. Studies have shown those who do so experience fewer failed investments.
Research has shown that angel investors who conduct at least 20 hours due diligence considerably increase the chances of a more positive outcome from an investment.
Don’t take our word for it, you can hear what some of the super angels look for in companies by listening to our Angel Insights podcast
Which startups are best to invest in?
Trying to select the “best” startups to invest in early on is a very difficult task, which is why co-investing with smart, successful angels is key to our investment philosophy. Our angels investr across a vast array of industries into startups of many type. If you’d like to read more about some of the types of startup our angels are currently interested in click on any of the links below to read more about that type of startup.
- AI & Machine Learning
- EdTech (Educational Technology)
- Green Technology
- Life Science
- Medical Technology
- Renewable Energy
Does Warren Buffett invest in startups?
Warren Buffet, the sage of Omaha, has not traditionally invested in startups. However, in recent years he has made exceptions to this by investing in Brazilian financial technology firm Nubank, and Paytm, the largest mobile payment app in India.
While illiquidity and lack of dividends play some role in this, Warren is not a fan of any business, startup or other, that is not firmly established in its industry.
“Experience, however, indicates that the best business returns are usually achieved by companies that are doing something quite similar today to what they were doing five or ten years ago.
But a business that constantly encounters major change also encounters many chances for major error. Furthermore, economic terrain that is forever shifting violently is ground on which it is difficult to build a fortress-like business franchise. Such a franchise is usually the key to sustained high returns. “ - Warren Buffett
So, is investing in startups a good idea?
Ultimately it comes down to what you want to achieve. Investing in startups should never be done purely for the potential returns as it is such a risky asset class.
However, if you would like to truly invest in innovation, job creation, sustainability, and potentially play a small part in backing what could be the next life-changing innovation, then it could be for you.
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Useful links & further reading
If you're interested to learn more about investing in UK startups, you may be interested in the following resources. These are provided on an informational basis only. SyndicateRoom is not responsible for the content of any external websites linked to from this page.