Investing Capital

Why do so many investors invest in startups?

Investing is something we've all done. Every single one of us will have allocated something - be that finances, time or otherwise - to a project or opportunity with the view of it producing a positive return.

This doesn't necessarily have to be in a financial product - it could have been something completely unrelated, such as investing time to learn a new language to further your career - but the base principle is that we all have some level of exposure to investing.

As a result, there'll be an understanding of the level of risk involved, the potential returns and the overall process of giving X to potentially receive Y. And with this understanding, it's felt most would agree that investment is a positive.

Looking at the first point above, the level of risk you are open to obviously varies depending on what investment it is you're making. This could go from being extremely low risk - think a personal investment of your time into learning to draw for your own personal pleasure, perhaps - right through to particularly high risk - growing companies in emerging markets have traditionally been seen as some of the most risk-focused investments, for instance.

Keeping the focus on the latter, investments into early-stage startups as a whole, regardless of where they're located, are often heading towards the high side of the risk scale.

Why, then, do so many investors choose to back startups?

Everyone has their own reasons, and individually there'll be hundreds of different reasons, but on the highest of levels they can often be grouped into one of three areas:

1. It gives you the opportunity to diversify and try something new

Most people's first exposure to investing is in an ISA or other government-backed savings account. You put money in, don't need to do anything with it and achieve a couple of percent return every year. At the time of writing, the best cash ISA was providing a return of 1.3%. Look at high street savings accounts and it's possible to see a 5% return each year.

The cash ISA interest rate in particular is low, but so is the level of risk. Not only is your money returned tax free, but it's guaranteed (currently up to £85,000). You quite literally don't have to do anything, including worry about whether you'll lose it or not, and you'll see a return, albeit a small one, each year.

Safe and secure, it can be a great way to start investing and if you speak to most financial advisers, they will always recommend having a good percentage of your investments into such low risk asset classes.

But diversification should play a key role in any investor's portfolio. Putting all of your eggs in the one basket is very rarely a wise choice, and for those investors who become more confident with their investments, adding some more risk-focused investments can prove particularly attractive.

And early-stage companies can be the perfect way to do just this, as the variety of companies at this level is so vast that there's something for most. For example, in the past 12 months we've raised investment for QikServe, a company that provides restaurants with self-service solutions, right through to Intelligence Fusion, whose focus is on providing data intelligence to companies to help them protect their people and assets right around the world.

Two very different companies, it's important to point out that both of these raised investment under the Enterprise Investment Scheme (EIS), an established scheme that provides investors with a range of tax reliefs to help mitigate some of the risk associated with investing in companies at this stage.

By no means is the EIS the only way to invest in early-stage companies, but it's definitely one of the most popular - since its inception in 1994, over £16 billion has been invested via it, directly allowing investors to add diversity to their portfolio whilst backing the next generation of British businesses.

2. You can take a much more active approach to investing

As an investor, one of the high level decisions you have to make is whether you want to be active or passive. We've talked about this previously in relation to property investing, but the basic principles are the same regardless of the asset class you choose - you can either be a passive investor and want to do very little once you've invested your money, or you can be an active investor and want to be fully hands on with the opportunity.

And there are few better ways to be an active investor than with a startup, particularly if you have knowledge or experience that the company would directly benefit from.

As an active investor in a startup, you can essentially turn into an angel investor; someone who is providing an entrepreneur with both finances and professional advice. Generally speaking this is because you believe in the individual and their idea; the concept they've shown works and they now need the help and support to grow and scale.

Read more: 5 investing insights from a female angel investor

How active you are is normally open for discussion, but could quite easily include day-to-day coaching and mentoring, but conversely it can be much more hands-off - making the occasional introduction to people within your network, for instance. For the most part it's all negotiable at the point of investment and there's no set framework.

Especially in regards to the startup raising money, any advice and support they can receive from knowledgeable and experienced individuals is always going to be welcomed with open arms, so if you have the ability to give it - and the desire to do so - being an active investor with a growing startup can be extremely rewarding.

3. You can become an impact investor

Arguably one of the fastest-growing phrases in terms of popularity in the investing world, becoming an impact investor - one whose focus is on making a genuine difference - is so important to so many. In fact, the millennial and Generation Z generations both have notable traits of wanting to make a difference, whilst GCV's Jordan Dargue has talked a lot about how, to encourage more women to invest, we need to further open up the world of impact investing.

Today more than ever we can see the impact of our actions, be that in terms of a local social initiative or a global economic one. We have news and insights at our fingertips, and hear daily about how we need to do more to ensure future generations can get on the housing ladder easier, or how we need to reduce plastic waste to save sea animals.

These topics have been around for years, and investors have always tried to tackle them, but as younger generations become more focused on making a difference, these types of issues rise to the surface and gain more prominence.

What's particularly interesting to me is alongside them, we're seeing the rise of impact-driven investment opportunities with companies that may not have traditionally been seen as one to invest in if you are trying to make a difference.

Read more: can you invest for impact and still see a financial return?

Take Intelligence Fusion again. On the face of it, they're a Software As A Service (SaaS) company that provides data to companies, data that they can then action however they see fit.

But dig a little deeper and you find a company that is truly keeping people safe. It's used by other companies who are trying to grow and expand to new territories, but in a way that is as safe as it can be. We know we don't live in a perfect world, but that doesn't mean those areas that have suffered from crime of all varieties need to be ignored - and Intelligence Fusion gives businesses the opportunity to expand and make a difference to the local economy, all the while keeping their people and assets as safe as possible.

Just one example of how you can invest into a startup that's making a difference - and therefore make a difference yourself - it's understanding that 'impact' goes well beyond the most obvious opportunities that first come to mind. Yes, we all need to play a part in reducing the effects of global warming, but there are so many more ways we can make an impact with our investments.

Investing into startups

Adding investments into early stage startups to your portfolio can be exciting. Their volatility makes them riskier than other investments, and it's important you understand the risks of such investments, which is why taking the advice of an independent financial advisor is always recommended.

But if you are aware of the risks and still want to move forward, there's a very good chance you're seeing what many others who invest into startups are seeing - an opportunity to diversify your portfolio, be actively involved and ultimately, make a difference in the world around you.

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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.