How important is it that we invest in startups?

Any sophisticated investor eyeing a move into startups this year has an abundance of options to choose from.

Between 2013 and 2017, around 1.9 million new businesses were formed in the UK, making it Europe’s third most entrepreneurial country, perhaps surprisingly behind Turkey and France. Britain, however, had more tech startups than elsewhere in Europe, with 392,000 firms launched in the period, Companies House data shows.

More recent studies point to various potential hotspots for UK startup investors in 2019.

Throughout 2018, investors put a record £200m into UK-based enterprises in the cryptocurrency and blockchain space.

The Design Museum, meanwhile, recently reported a 70% increase in the number of design businesses in Britain between 2010 to 2018. Its research suggests that Britain’s population of design-focused startups has grown 2.5 times more quickly than the average sector.

Other startup bright spots this year include mindfulness and mental health enterprises, food and drink, and sustainable fashion, according to the New Entrepreneurs Foundation.

With so many exciting markets giving rise to high volumes of startups, investors have an array of opportunities before them.

And their investment could be pivotal to the success of enterprises they choose to back.

Economically vital

Startup investors provide the vital funds needed for entrepreneurs to unlock potential and achieve goals. The startups that overcome the tough first few years in business are the employers of tomorrow. Angel investment, therefore, is not just hugely important for the enterprise community, but also the wider economy.

Jobs creation is an obvious by-product of investing in startup management teams, with the ability to turn their ideas into profits.

And this positive impact of startup success is increasingly being felt across the country in the UK, and not just in the global investment epicentre of London.

Benefitting the whole country

A national network of startup hubs is maturing, helping all regions to benefit from enterprise activity. While London remains the focal point of startup investment, would-be investors anywhere in the country theoretically have a wealth of opportunities on their doorstep - or at least an hour or two’s drive away.

Oxford, for example, has given birth to nine US$1bn ‘unicorns’ – more than double that of Berlin and four more than Paris.

In fact, Cambridge, Manchester, Edinburgh and Leeds have all produced at least two unicorns, while London has produced 36, according to the government’s Technation initiative.

Most of these successes would not have been possible without investment in their early stages - startup investment, then, is clearly crucial for a growing and diverse economy.

Enabling innovation to flourish

Startup investors can also play an integral role in supporting innovation.

In the UK, research and development (R&D) funding as a proportion of GDP is eclipsed by many other major economies.

As a result, the government is currently on a drive to increase total R&D spend from around 1.7% of GDP in 2016 to 2.4% by 2027; and startup investors have a key role to play here.

Their investment may be the only funding source available to an innovative enterprise with a game-changing idea – and an essential force in realising its plans.

Tackling global issues

By supporting innovation, angel investors can also have a hand in solving the world’s problems.

Solutions to environmental or social challenges are often only possible with the support of an angel investor, and their funds are in high demand.

Plastic pollution, unsustainable food production and the impact of climate change are among the big challenges many startups are taking on. Startup investors are a vital ally in their fight.

Preserving expertise

Startup investment is also a vehicle for passing down valuable industry expertise between generations.

For hands-on investors, backing early-stage businesses enables them to directly influence the outcome of their investments. Their vast career experience in a particular sector can be put to good use helping others to succeed in that field.

Startup investors often choose to back entrepreneurs looking to disrupt markets in which they worked. Not only could the investor have useful insights on how to outfox the incumbents, but they may also be passionately in favour of the disruption they are shooting for.

Perhaps they have long recognised flaws in products, services and approaches in the sector and yearned for a new way forward.

The startup’s management team may well have found it, and proven to the investor that they can make it work.

Strengthening portfolios

Of course, startup investment is also important for the individual’s own finances.

It enables investors to better protect their wealth from the many dangers lurking around their existing interests.

Those with only traditionally popular asset classes - like stocks and shares - in their portfolio may be at risk of market-wide downturns and crashes.

By turning to startup investment, they are able to mitigate this risk by diversifying their portfolio.

Startup investment is an opportunity to secure interests in industries not represented elsewhere in their portfolio. When other asset classes dip, these interests may rise.

Lucrative returns

Meanwhile, there is also the enticing prospect of a soaring success emerging from their startup portfolio, towards a lucrative exit.

This is the ‘what if’ factor captured by only a select few investors - like Peter Thiel, an early backer of Facebook, who saw the value of his stake grow by over 2,300 times before the social network’s IPO.

Outcomes like this are rare, but offer much inspiration to investors. The average return rate enjoyed by angel investors is around 2.6 times the original investment, according to a 2012 study in the US led by Professor Robert Wiltbank. This is the equivalent of annualised returns of 21.1%, reports Inc.com, based on the average five-year path to exit.

Many investors will choose to back 20 or 30 enterprises, or even more, to both spread their risk and increase their chances of one of their stakes delivering stellar returns.

Where to start investing in startups?

Often their search for a backable startup involves the so-called ‘5 Ms of startup investment’, a handful of fundamental pre-investment considerations. They include management team, business model, market opportunity, money and momentum.

Investors able to master this approach (covered in more detail here) may well enjoy strong returns from a highly diverse portfolio for years to come.

In doing so they could contribute to creating jobs, speeding innovation, solving problems - and more - all whilst targeting strong financial returns.