How can equity crowdfunding help you to diversify your investment portfolio?
At first there were just two ways...
Until comparatively recently, there were just two ways that wealthy individuals could invest in early-stage companies and benefit from the tax reliefs. The passive approach involved simply investing in an EIS or SEIS fund. The more active approach was to become a business angel. In both cases you enjoyed a level of tax-sheltering that was the envy of investors all across the globe. Both approaches allow you to diversify your portfolio but neither is entirely plain sailing however.
Become a business angel
Being a business angel can be tremendously rewarding; super-angel Jonathan Milner says it gives you “all the fun without any of the admin of running the company”. The returns can also be incredible – according to a report published by NESTA, business angels make an average return of 22% year-on-year. However the downside of being an angel is that you must be in a position to invest significant amounts – the starting point for lead investors is often measured in multiples of £100,000.
Invest in a fund
The alternative to becoming a business angel is to let someone else take care of managing your investments via an EIS or SEIS fund. In this case, the fund manager does the hard work of finding good investments, managing them and securing a good exit for his investors. This comes at a cost though and you’ll usually pay significant management fees - in some cases these have been known to equate to almost 40% of the capital invested.
Now there’s a third way
In addition to the two approaches already mentioned, there is now a completely new way to invest and take advantage of the Enterprise Investment Scheme’s generous tax reliefs. It’s equity crowdfunding and amongst other things it allows you to build a diversified portfolio of investments across a range of different sectors and geographies.
So, how do you go about using equity crowdfunding to build yourself a diversified investment portfolio?
- Plan your strategy and play the long game
Don’t simply invest in every opportunity that presents itself. Consider each one carefully, do your due diligence and hold back some of your allocated capital so that you don’t miss out on any good deals which may come along in the future.
Be prepared to invest for at least five years. Companies can and do fail so it’s possible your first investment may go awry before you have even finished building your portfolio. If that happens, don’t give up - just remember that bad companies usually fail many years before the good ones exit.
- Understand the platforms you use to invest
One of the first questions you should ask is whether the equity crowdfunding platform is investor-led or company-led. In other words, are the investment terms set by negotiation between lead investors and the company, or are they mainly set by the company.
Also ask what investor protections you get from the platforms and learn whether they let almost any deal list - exposing you to a higher risk of bad ones, or whether they take a highly curated approach.
- Invest with those in the know
To build a properly diversified portfolio of investments you may have to venture into sectors that you are unfamiliar with. If that’s the case, check to see if the lead investors who are putting their own money into the deal have experience of the sector. If they don’t then walk away.
- Don’t put all your eggs in one basket
You should aim to create a fully diversified portfolio by making 5 to 10 investments a year in different sectors. One way to do this is to take your allocated investment amount for the year and divide it by ten. This then gives you your average investment amount which you can then invest across a range of sectors.
- Make your investment capital go further
If you do your own due diligence and invest via an equity crowdfunding platform rather than an EIS fund you avoid having to spend up to 30 or 40% of your investment capital on fund management fees. This money can instead be invested.
- Be ready to follow your money
Remember that most angel investments require further funding, so be prepared to follow your money in future rounds. So, if the company in which you have invested is going well be prepared to follow with additional investment in order to maximise your returns.
By using equity crowdfunding for investment portfolio diversification you get to choose which businesses to invest in. If you choose to do so using an investor-led platform you are investing alongside experienced lead investors who are bringing favourable terms and investing their own money giving you reassurance.
In many ways, the due diligence needed to build an investment portfolio using an investor-led equity crowdfunding platform is not too dissimilar to direct angel investing although without investing the same amount an angel would.
Risk Warning: Tax relief depends on an individual's circumstances and may change in the future. In addition, the availability of tax relief depends on the company invested in maintaining its qualifying status.