Why does anyone invest in startups?
Investing in startups brings investors together around new ventures they consider worthwhile, managed by a team of founders they deem effective enough to deliver, and funding that company through one or more rounds of fundraising, either directly, or through a fund. In some cases, investors prefer to be completely hands-off, putting down their money and waiting to see what happens. In others, investors take a more active role, providing insights, experience, and connections.
It can be lucrative, but it's not for the faint of heart. The majority of small businesses fail, so the risk of investors losing some or all of their money is high. Those businesses that do succeed can take a long time to do so – think 10+ years – and it can be a rollercoaster ride of ups and downs along the way.
So why do so many investors take the plunge and invest into early stage companies?
Well, for starters, there’s the potential for significant returns should a portfolio company succeed. In 2021, Transferwise listed on the LSE at a £9bn valuation. The angel investors who backed it ten years prior made several hundred times their original investment. Quite the return, though of course, this situation is relatively rare.
We commissioned a 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 28%. By 2017 it was worth more than 5x its original value.
Had you invested £10,000 into the 519 companies in 2011, by 2017 your portfolio would be worth over £63,848. But, this figure does not include the Enterprise Investment Scheme tax relief your investment would have received. With EIS, qualifying investors may claim 30% income tax relief on their investment.
You can read more on this in our Early-Stage Equities report.
Increase in valuation of 2011 startup portfolio
As you can see, it's not just the potential returns that attract investors to this asset class. If it was only that, given the risk, they'd be better off with safer alternatives.
Investing in startups has a number of additional benefits for the investor including portfolio diversification and in most cases, a suite of generous tax reliefs. It benefits society, contributing to an ecosystem of innovation constantly seeking new ways to solve problems. These companies are often working to develop world-changing technologies, medicines and systems to make a positive impact, and push society forward.
Even if companies don't succeed, investing in startups creates jobs and supports the economy. UK SMEs account for 61% of employment and for each company our fund backs there are five jobs created on average.
Returns, tax benefits, and portfolio diversification are certainly major attractions, but few other investments offer the excitement of backing startups, or offer investors insight and involvement in the next generation of teams and technologies.
How do I invest in startups?
There are many ways you can buy shares in startups, from investing through online platforms to investing in person via angel networks. Keep in mind, as with any asset, it is important to build a diverse portfolio of startups. Startups are incredibly risky and the most likely outcome is that they fail. 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 many risks. These include illiquidity, lack of dividends, loss of investment and dilution. Investing in startups should be done as part of a diversified portfolio.
SyndicateRoom is targeted exclusively at sophisticated investors and High Net Worth individuals. All investors must understand the risks and make their own investment decisions.
Platforms and networks allow 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 more established. You can choose to back companies that do or do not have an ESG focus. The decisions are yours and yours alone.
However, if you choose to invest in startups directly you must do your due diligence on each company. Keep in mind that angel investors conduct 20+ hours of due diligence before making a decision. This takes time and skill and we will cover it more later.
Post investing, as a direct shareholder you are entitled to vote. You must continue to be diligent as your vote may impact the outcome of the company and your investment. Vote wisely.
Here are a few ways you can make direct investments:
Equity crowdfunding platforms allow individuals to invest in unlisted companies online. The companies create and market their pitches to potential investors who in turn choose to invest or not. Platforms have low minimum investment requirements, some set at just £10. Platforms list several investment opportunities at any given time. After reading the pitch investors may ask the founders questions and engage with other investors.
Angel Networks and Syndicates
Angel networks are groups of individuals who work together to source, review, and invest together. Through sharing due diligence the angels hope to improve their odds of selecting winners. 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.
Accelerators run set courses aimed at helping early stage ventures accelerate their growth. In exchange for running the programmes, accelerators often receive shares in the business. At the end of the programme the startups pitch to investors as part of a “Demo day”. Famous accelerators include y-combinator and entrepreneurFirst.
For those that prefer to invest into a portfolio, a Venture Capital fund will build one for you. Venture capital funds (VC) pool capital from many investors to invest in early-stage companies.
VC Funds form a part of the broader Private Equity asset class. Fund managers and their teams conduct due diligence on the companies, invest, and manage the post investment admin.
In exchange for their hard work, funds charge investors fees. These fees include a set-up fee, annual management fees, and a performance based “carry” fee. The carry is charged 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. These include SEIS and EIS funds and Venture Capital Trusts.
The Access EIS fund
Our Access EIS fund tracks the performance data of over 10,000 active angel investors, then identifies and co-invests with some of the best. We call these our super angels. This process ensures we have access to the most promising deals around. We then build portfolios of 50+ startups, aiming to replicate the annual growth of the UK startup market, which is around 28%.
The 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 minimum investment 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 potential investment opportunity. Studies have shown that those who do so experience fewer failed investments.
With startups, angel investors who conduct at least 20+ hours of due diligence considerably increase their chances of positive outcomes.
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?
Selecting the “best” startups to invest in early on is a very difficult task. That's why co-investing with smart, successful angels is key to our investment philosophy. Our angels invest across a vast array of industries into startups of many types. Here are some of the sectors that interest them:
- 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 rule. Warren invested 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 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?
The answer 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 invest in innovation, job creation, sustainability, and 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.