Investing in a start-up

Mark Lyttleton is an experienced angel investor and business mentor who helps founders and business owners to negotiate the considerable challenges involved in establishing and growing a successful business. This article will look at start-ups and how investing in them is no longer the preserve of the ultrawealthy thanks to the crowdfunding boom over the last decade.

In recent years, crowdfunding has established itself as a mainstream funding source for businesses in the UK according to research from start-up specialist Beauhurst, growing from less than eight fundraisings in 2011 to almost 600 in 2021. Lured by the potential for substantial returns, investors have taken to crowdfunding platforms in their droves, helping innovative entrepreneurs to access the financing they need to transform their promising idea into a profitable business. Take for example BrewDog, the Scottish craft brewery that provided crowdfunding investors with a staggering 2,765% return on their equity investment.

That said, crowdfunding investors also face a high risk of sustaining losses, with almost 50% of start-ups failing in the first three years, according to the Office of National Statistics. Nevertheless, even if a start-up folds, investing in early-stage businesses helps to provide jobs and support the economy.

In addition to potentially providing attractive returns for investors, start-ups contribute significantly to the wider economy, with SMEs accounting for 61% of total employment in the UK today according to Syndicate Room. Alex Davies is the founder and chief executive of Wealth Club, an investment advisory firm. He points out that start-ups grow ‘three times faster than the traditional economy’, explaining that they have been responsible for 10% of job growth worldwide since 2017.

For those who are interested in investing in start-ups, there are several potential routes.

A business angel is a private individual – typically someone of high net worth – who invests directly in start-up ventures, either alone or with others.

A venture capital fund is a form of private equity where investors’ money is pooled together in a private capital firm that invests in small businesses and start-ups.

Crowdfunding is a model where small amounts of money are invested by many investors, often via crowdfunding websites or social media. In the UK today, crowdfunding is the third largest funding source behind venture capital firms and business angels. Some of the biggest names in crowdfunding today include Revolut, Monzo, Nutmeg and Freetrade.

From the investors’ perspective, investing in start-ups offers several key benefits, chief among them the opportunity to diversify their portfolios while benefiting from a suite of generous tax reliefs. Investing in new businesses benefits society, contributing to an ecosystem of innovation and the creation of new companies seeking out ways of solving real-world problems. With many new start-ups geared towards developing world-changing technologies and systems, investing in early-stage businesses helps to achieve positive change in the world, as well as driving technological and economic growth and advancement.

Start-ups go through several stages. The first stage in a start-up’s lifecycle is when it has become operational but is not generating a revenue. At this point, the business is typically funded with the founders’ own savings or loans from friends and family.

Once the business is up and running, it enters the second stage of its lifecycle. At this point, company founders may pitch their ideas to an angel investor, who is typically the first source of funding outside of friends and family. By the third stage, the founders should have a credible and tested business plan, if not already be generating revenues, and it is at this point that growth capital investors often step in.

For those interested in investing in small businesses and start-ups, angel networks and online platforms present investors with the scope to pick and choose which start-ups they invest in rather than leaving that decision to a third party. Investors can opt to back companies operating in different industries or focus on just one, homing in on companies in their formative stages or businesses that are more established. Many forward-looking investors are increasingly seeking out investment opportunities with an ESG focus, with the goal of driving positive change in the world while simultaneously growing their own wealth.

Prior to investing in a business, it is crucial for the investor to undertake due diligence on the company. Angel investors typically conduct more than 20 hours of due diligence on a prospective investment before making a decision.

When an investor acquires shares in a company, they generally acquire voting rights too. It is important for investors to vote diligently, as their vote could impact both the outcome of the company and the yield they achieve on their investment.

Investing in new start-ups can be a risky yet rewarding business. Most new ideas, products and companies do not make it, and the risk of losing an entire investment runs high, but those that do make it can provide an impressive ROI.

According to Investopedia (as a rule of thumb), for every 10 start-up businesses, three or four fold; three or four return the original investment; and just one or two succeed. However, for companies that go public, returns percentages can run into the thousands, potentially making investors who get in early very wealthy.