Past performance is no guarantee of future results. Any historical returns or unrealized returns may not reflect actual returns or future performance. All securities involve risk and may result in loss, and startup investing is particularly risky and may result in total loss.
At the time of writing, over 50,000 new businesses are started in the UK each month. The vast majority of these will be a failure. Yet some of them could be the next WhatsApp or Amazon.
If you are an investor, you therefore want to ask: “How can you tell which ones will be the next big thing? How do I get a piece of the action?”
The fact is, it isn’t always easy to tell which startups will become a huge success and earn you lots of profit. Inevitably, there will always be a high degree of risk involved with this kind of investment compared with other asset classes.
Yet in the same breath, with higher risk comes to possibility of higher return. Moreover, with government schemes such as SEIS, you can mitigate these risks by offsetting some of your losses against your Income Tax. (More on this below).
In light of the above, here are some principles you can use to make wiser investment choices when it comes to startup funding.
#1 Understand why Startups Fail
There have been many studies detailing the obituaries of different startups across the UK. Some details hundreds of reasons for startup failure, yet there are some very common ones.
Many prominent investors observe that startups with a single founder are very likely to fail. Steve Hogan of Tech-Rx, for instance, argues that having a co-founder can help startups address many of the causes of early failure, such as poor recruitment and marketing choices.
After that, some other important reasons startups flounder include the absence of market need. If no-one needs the product or service they’re offering, then the company will not sell.
Other causes of startup failure include running out of money, having the wrong team, conflict between this team and the investors, and being outperformed by a competitor.
At Bure Valley Group, we “stress test” all of the startups who want to approach our investor network for funding. We comb over each of the above – and more – to ensure the proposal is as robust as possible prior to presenting their proposal to our Angels and Consortiums.
Although this does not eliminate the risk of investing in startups, it does increase the chances of you getting a return on your investment.
By focusing on SEIS-eligible UK startups as well, this adds an additional layer of protection for your investment, since you can offset some of your losses against your Income Tax. Yet we’re jumping ahead slightly – we’ll cover that in a bit more depth shortly!
#2 Only Invest What You Can Tolerate to Lose
Since investing in startups is inherently risky, you should never commit more money than you can afford to lose.
Yes, you could win big if the company you invest in becomes huge. Yet you could also lose most or all of it. For ordinary folk in the UK, therefore, you should only ever invest a small amount of your investment funds into startup funding.
For Sophisticated Investors, the situation is slightly different. These are people with significant sums to invest, who can afford to take more risks with their money, and who can demonstrate they are aware of the risks in startup investing.
#3 Diversify Your Investments
Advice you almost certainly will have hear before as an investor, but it always holds true.
Try and spread your money out wisely amongst a range of “stress tested” startups, rather than putting all of your eggs in one basket.
It helps mitigate your risks. If one of your investments fail, and one or more of the others succeed, then the former will sting a lot less.
#4 Take Advantage of Tax Reliefs
One of the little-known tax reliefs offered by the UK government is SEIS – the Seed Enterprise Investment Scheme. This offers a great way for people to invest in startups, reducing your losses when you lose and improving your winnings when you succeed.
Essentially, SEIS allows you to invest up to £100,000 in SEIS-eligible UK startups per financial year. You can then offset 50% of your investment against your income tax.
So, suppose you invest £1,000 in a SEIS-eligible startup. You’d actually be investing £500, because you will effectively be taxed £500 less.
You have to hold your shares in the company for at least 3 years. If at that time the company fails, then £500 is at risk. This is where your Income Tax bracket comes into play.
If your tax band is 45%, then you could get back 45% of that £500 (£225). So, even though you invested £1000 you do not lose it all if the company fails. You lose about a quarter of it.
Yet this is the worst-case scenario. Suppose the company doubles in value after 3 years. What happens then?
Well, invested £1000 so you get £2000 back. Under SEIS this is not subject to Income Tax, and neither is it subject to Capital Gains Tax. So this is £1000 of pure profit.
Yet remember, the initial £1000 you invested was offset against your Income Tax by 50% – that is, £500. So actually, you’ve made £1500; a 150% return on your investment!