Is startup investing only for experienced angel investors?
Every established angel investor has been through it; that rite of passage when they made their first decision to back a startup.
For many, the experience will have been the impetus for a series of further investments as they sought to build up a diverse and balanced portfolio.
Research headed up by the British Business Bank in 2017 found that 17% of UK angels have upwards of 21 investments – although most (64%) have no more than 10.
Startup investment is certainly not the preserve of experienced angel investors; every angel must overcome the challenge of their first investment.
But some level of relevant experience can undoubtedly help - both in selecting a startup investment and steering it towards success.
One of the largest studies into the profile of US business angels suggests that the majority of startup investors do have a wealth of experience to draw upon.
The study, commissioned by the Angel Capital Association and published in 2017, involved responses from over 1,600 angels. It found that 55% of angel investors were previously a founder or CEO of their own startup.
The report also suggested that 60% of angels with entrepreneurial success under their belt take on advisory roles within the firms they invest in, while 52% take a board seat. Among startup investors without that entrepreneurial experience, only 38% assume an advisory role and 26% take a board seat.
Having the entrepreneurial experience to guide founders nearer to a lucrative exit may well give seasoned angels an advantage.
Industry or career experience can be equally valuable, however, even if the investor is a novice in terms of angel investment.
For example, a mission to disrupt the status quo underpins many startup business plans. Investment newcomers who have worked in the industry earmarked for disruption may have much to offer the enterprise, despite their lack of angel experience. They may recognise the market’s pressing need for a new approach and have inside knowledge on how to deliver it.
Connections in a target market or a high profile that might open doors are other examples of valuable currencies that the investor may offer the startup, regardless of how few startup investments they have in their portfolio.
But while experience and background may help to achieve strong returns in startup investment, in-depth specialist knowledge of the investment process itself is not necessarily required. Unlike stocks and shares which, as an asset class, may seem daunting to the beginner, startup investment is relatively accessible.
Agencies which serve as a conduit between startup and investor are common, while the government is actively encouraging more people into startup investment.
Tax breaks designed to reward those that support the growth plans of early-stage firms are a major pull into angel investing.
The Enterprise Investment Scheme (EIS) offers a tax relief of 30% of the cost of the shares purchased in the company, set against income tax. A maximum tax reduction of £300,000 is possible, given that up to £1m of investment is eligible for the relief (although the tax reduction and investment levels can be increased for knowledge intensive companies).
UK investors can also take advantage of the Seed Enterprise Investment Scheme, which relates to enterprises in the early stages of their journey. Investors can obtain 50% relief for income tax on the cost of shares via the SEIS, on a maximum annual investment of £100,000.
While such schemes are motivating more to get involved in startup investment, we also see barriers to entry being lowered.
The rise of crowdfunding has opened entrepreneurial endeavours up to fast and flexible online investment. Having started out as something of an anti-establishment, financial quirk, it is now truly accepted and validated by the mainstream. This was illustrated in the US by the 2016 decision of the Securities and Exchange Commission (SEC) to change the rules to enable companies to raise money through crowdfunding.
Since then over 1,000 firms have filed with SEC to sell securities to the crowd, collectively raising more than US$137m.
Many crowdfunding platforms, including UK-specific ones, offer an array of startup opportunities, often with a low minimum investment threshold. They enable users to quickly build up a diverse portfolio of interests.
What crowdfunding does not offer, however, is the hands-on experience that comes with angel investment. As one investor in a crowd of many, you have no influence in how the startup works towards its exit goals.
Also, not all crowdfunded opportunities are equity based – sometimes investors are lured through a rewards-based incentive, such as receiving a specific product that their investment has helped to develop.
Somewhere around the halfway point between crowdfunding and traditional angel investment is the syndication model. This involves a group of angels investing together in a syndicate, enabling individuals to enhance their investment capacity, pooling funds and expertise. A lead angel is usually appointed as a conduit between the startup and the syndicate.
This model may be appealing to less experienced angels looking to develop their investment knowledge and skills. Taking a backseat may not be on your agenda, however.
If you are an investment novice keen to fashion a career as an angel investor, where you can play a role in helping the enterprise to scale up, and hopefully receive a healthy return once its exit plan is realised, there are some well-worn steps to follow.
Firstly, you must be prepared to embrace risk. Angel investing opens up the possibility of one of your startup interests becoming a turbo-powered success, exceeding all expectations and delivering exponential growth.
But startup failure rates are generally high. An often-repeated stat is that 90% of startups fail, but detailed research suggests that this is probably not wholly accurate. Certainly, it is not true to say that any startup investment you make has only a 10% chance of success.
The broad-brush figure does not factor in the startup’s specific target sector and growth opportunity or the calibre and track record of the personnel behind it. Also, evidence suggests that, as startups mature, their failure odds continue to drop. An investment two years into a business plan may be significantly less risky than one at the very start with no market traction or live customer data.
The level of risk you take on depends on various factors, many of which you can analyse thoroughly before parting with funds.
Absolutely critical to the performance of your startup portfolio is the level of due diligence carried out prior to any investments.
While no startup investment is entirely risk-free, the research you do at the outset is instrumental in mitigating that risk and maximising your chances of a positive outcome.
A useful starting point is ‘the 5Ms of startup investment’, an approach which covers five main areas of investigation once you have an opportunity in your sights.
The 5Ms are - management team, model (as in business model), money, market opportunity and momentum - but the general idea is to leave no stone unturned. Question every aspect of the business and look for signs or flaws that could either be fixed with your guidance, or perhaps, are a red flag signalling that you should not invest.
And whilst all of the ‘5Ms’ are key to exploring, many investors believe hitting it off with the management team is particularly critical, given that you could be on board as an investor for several years. Similarly, a fundamental, unrepairable hole in the business model could be a turnoff as an investor.
In your careful consideration of the opportunity there may well be lots of positive signs emanating from the startup.
There is no reason why your first startup investment can’t be a hit. And even if things don’t result in you becoming an overnight millionaire, your adventure into the fascinating and potentially lucrative world of angel investment has to start somewhere - every investment is an opportunity to hone your investor instinct and learn vital lessons along the way.