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How to invest in startups as a first time investor

Startups and Venture Capital have become an increasingly attractive asset class for investors thanks to strong historical returns and liquidity in recent years.

The many success stories of venture-backed startups that have gone public have also brought in more and more attention from private investors. The asset class has now outperformed every other primary class in the last three years and is expected to continue its solid performance.

Investing in startups allows investors to buy shares at the early stages of the company's growth journey and at an attractive price. There are a number of ways you can invest in startups;

  1. Direct Investment - buy shares directly in the company.
  2. Online Investment - typically through a co-investment platform or equity crowdfunding platform.
  3. Indirect Investment - through a professionally managed fund.  For private investors in the UK, these are usually SEIS, EIS funds or VCTs.

After UK startups generated a record £29.4 billion of investment in 2021 as venture capital remained a key asset class among sophisticated and high net worth investors.

Find out more: Invest in Startups - View live Investment Opportunities.

For those considering taking the step into startup investing, understanding the methods and techniques for mitigating risk and maximising potential returns is crucial.

Diversify your portfolio

One of the key considerations for those eyeing up the startup path is to ensure you diversify your portfolio. This can help you to ride out any macro-economic waves which may affect sector-specific businesses over the length of your investment timeline.

Investing exclusively in particular markets, sectors or companies can result in an exposure to unforeseen issues occurring in one particular field and potentially detrimental impacts on your portfolio.

Therefore investing across different asset classes, regions and sectors is, therefore, a common approach among seasoned investors, and one newcomers should also follow when and where possible, simply put, this is known as developing a portfolio diversification strategy


Consider your options carefully

While it's common to experience an innate desire for chasing that speculative tip and that next investment trend, the more sophisticated investor will ensure there is value to be had across a range of considered choices.

Warren Buffett, chairman and CEO of Berkshire Hathaway, is one of the most influential investors in history. His sage advice is:

“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”

Stellar stocks, with their perceived potential for high returns, say, for example in new medical breakthroughs or a polished hi-tech revolution, may be very enticing - but considering the endpoint and what the long-term future value of the company will be, can often be a much more sustainable approach.

Plotting the future of a potentially high-growth startup may be far trickier than that of an established blue chip, with some degree of guesswork. This is when your in-depth research, looking at the startup from every angle, will come into play.

Find out more: Invest in Startups and View Live Investment Opportunities

Methods for startup selection

A trusted starting point is the ‘5Ms of startup investment’. This urges investors to analyse the startup opportunity through the lens of these five key areas;

  1. Management Team - how experienced and entrepreneurial are the Founders. Can the Founders build a team capable of executing the growth strategy and creating shareholder value
  2. Model - Business Model and Revenue Model.  Does the startup have an innovative and disruptive business model? How does the company make money?
  3. Market - Opportunity, size, and overall market growth potential.
  4. Money - how much capital does the business need and how will management deploy funds to create value?
  5. Momentum - what has the company achieved to date. Does it have a strong pipeline of customers or any early commercial traction?

While no ‘M-factor’ is more important than others, many feel your assessment of the management team is pivotal to the ultimate decision of whether to invest or not.

Some experienced business angels urge others to invest in brilliant people, not necessarily what is perceived to be a brilliant product.

Read More: 11 reasons why angel investors choose to invest in startups

Leading US startup investor and actor Ashton Kutcher, co-creator of venture fund A-Grade Investments, has invested in multiple tech companies. Among them is Airbnb, Spotify, Uber, Flexport, Oscar Health, Warby Parker, Nextdoor and Houzz.

His tried and tested methodology highlights a number of key metrics for any interested startup player.

One of his key pieces of advice is to ensure the investment target is a leading player in their chosen field.

This will involve determining their ability to demonstrate a deeper understanding of consumer behaviour, a historical insight into the market and the ability to provide the supporting data demonstrating that they possess a leading edge.

He believes that by doing this, potential investors can secure a level of confidence that their targeted investee has the domain expertise for whatever problem they’re trying to solve.

He also highlights the personal qualities of grit and determination; the capacity to persevere through really tough situations. He says this one is difficult to assess, and generally goes "by gut instinct on meeting the founder”.

Then there is the perceived level of ‘charisma’. He says:

“When I meet with a founder with true charisma, I usually come away feeling like I want to quit my job and go work for them. Because if I don’t get that sense…the best person for the job that they are hiring for isn’t going to have that feeling either.”

Mitigating risks

There are many benefits to investing in startups, which may reap returns far and away above a safer, more conservative market play.

But bear in mind that investing in startups and early-stage businesses involves risks, including lack of dividends and illiquidity, and is best done as part of a diversified portfolio.

The choice of potential startups in which to invest is continually increasing, with 2021's 5.4 million UK startup applications being the highest on record since 2005.  

And when many new startups will be setting their eyes purely on growth over the first few years, as a result, there is likely to be a lack of liquidity in their stock in that time - with the prospect of a significant payout upon exit several years down the line.

The upside of the patience required as an investor can be startling. A payback of ten to twenty times the initial investment is a feasible target with the right investment, and whilst a higher risk/higher return strategy, a key consideration for a UK equity startup investor is the beneficial treatment they will receive from the domestic tax regime.

A number of innovative venture capital schemes exist in the UK that offers significant tax breaks to individuals and incentivise investment into unlisted companies in return for the risk minimising and return maximising benefits they promote. Two of the most popular examples of such schemes are the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS).

Read More: Income tax relief and the EIS: what you need to know as an investor

Offering generous tax reliefs that range from everything from 50% income tax relief to capital gains tax exemption and loss relief, the aforementioned schemes, in particular, have proven particularly popular in recent years, together raising more than since their introduction.

And whilst the EIS and SEIS are two of the more well-known, government-backed methods for maximising startup investments, other effective routes still do exist. VCTs, alternatively, involve investing in an HMRC-approved company which uses the investor's capital to pool and invest in a group of startups on their behalf, in a less autonomous, but more automatically diversified fashion.


Making a decision

Whichever route into startup investment you choose, though, thorough research and careful analysis are advised before you invest in any opportunity. Due diligence is such a key element to any investment, and this doesn't differ with startup investing.

Granted, it can be tempting to back, on a hunch, what seems like a team who are about to set the world alight with a revolutionary idea or to try and invest in what looks like the next Facebook or Google. But your research needs to take precedence. Your investments should be based on what they find.

Understand your portfolio requirements, carry out your research and only invest when you feel as confident as you can. Taking this approach can't 100% guarantee returns, but whether you're a new or experienced startup investor, it can help to ensure you're investing in the right opportunity for you.

Driving Growth.
Creating Value.
Delivering Impact.

Backed by

Growth Capital Ventures (GCV) is backed by funds managed by Maven Capital Partners, one of the UK’s leading private equity and alternative asset managers.