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Are you looking to diversify your investment portfolio? If so, investing in startups or early stage businesses might be of interest.
Whether you choose to make a one-time investment to help an entrepreneur’s business get off the ground or provide ongoing financial support to help the company through its difficult early stages, a startup investment can be incredibly rewarding both professionally and financially.
Our guide to investing in startups and early stage companies will help you make your own investment decisions. At InvestUK, we help you kickstart your journey to invest in startups through expert business advisory services and mentoring for international entrepreneurs.
Jump to section:
Is investing in UK startups the right step for me?
Why are startups such a great addition to my investment portfolio?
Can I invest alongside other investors?
How can I recognise a good startup investment?
What should I be looking for from a team of entrepreneurs?
What should I look for in the business idea of a startup?
How am I protected financially as an investor?
Startups, or ‘early stage businesses’, refer to ideas in the beginning stages of development or ones that have only recently been developed. They are suitable for the market but still undergoing marketing research and product development. These companies may be generating revenue and have a developed business plan but might not be profitable yet.
Typically, private investors invest in startups and early-stage businesses. They are often referred to as angel investors.
Angel investors are usually entrepreneurs themselves or those with experience in the business world. They invest in startups with their own money for a minority stake – usually between 10% and 20% – often focusing on the process of mentoring and supporting the business. These investors take a hands-on approach, spending much time with the entrepreneur and helping to develop and grow the business. The angel and the entrepreneur will typically spend at least five years working closely together, so it is essential to have a strong relationship.
Although the educational and supportive side of startup investment may not mean that an investor is focused solely on their financial goals, the return target can be high but also carries higher risk.
These types of investments can also be referred to as seed investments, although some consider there to be differences between the two based on the investor’s relationship with the startup. They suggest that an angel investor takes on a more significant role as a mentor in startup investing, using their experience to guide entrepreneurs. In contrast, seed investors are more likely to focus solely on supporting the entrepreneur, possibly as a friend or family member. The two terms are, however, usually interchangeable.
Angel investors can compare with venture capital investors – another type of early-stage investment. This is a form of private equity investment whereby a business receives funding in exchange for a share of its equity. By making investments in early and mid-stage companies, the investor’s aim is to profitably exit the investment at a later stage in the future, usually within 5-10 years, Those involved in venture capital investments are generally a mix of entrepreneurs and bankers, and the scale is much larger than an angel investor, ranging from a few million to tens of millions of pounds. These investments usually happen within a venture capital firm whose work is concentrated mainly in one specific sector.
If the hands-on, educational side of investing in startups doesn’t suit you and your area of expertise is more finance than entrepreneurship, it might be worth looking into something closer to a venture capital investment rather than a hands-on startup investment.
While startup investing tends to have a bad reputation as an investment opportunity due to being a high risk investment, they have a range of benefits unique to early-stage companies.
Entrepreneurs, investors, and researchers alike generally state the early stages of a business to be the most critical in developing a business. Having all your assets concentrated in one company or even one sector could be risky when investing. This is where a diversified portfolio can be helpful.
A diversified portfolio is one where your investments are spread over different asset categories with multiple exciting businesses. Startups provide a solution to this: with new investment opportunities in every sector, they could help ensure stability in the event of an industry-wide downturn affecting a large part of your portfolio.
Experienced investors might back more than twenty ventures at any time, allowing them a stake in a range of growth opportunities.
Startups can also give you an almost unrivalled sense of satisfaction. Investing in startups is believing in a new idea, supporting an entrepreneur’s dreams, and standing behind the development of something you want to see in the world – whether a step forward for sustainability or a new craft beer company.
It might even be a chance for you to make your own investment decisions to support the projects of someone you know personally who has a good idea that you want to back.
Yes. If investing in a startup seems too precarious a step to take alone, it is worth noting that angel investors can come together to invest.
Investing alongside other investors is known as syndication and has a range of benefits, including but not limited to:
There will usually be one investor in the syndicate identified as the ‘lead investor’, who will play a more active role than the other co-investors in terms of their input in the business and funding. They will typically take a board position in the company as the syndicate representative.
Startups can be high risk, high-return investments. Still, it’s worth spending time performing due diligence on the startup you are interested in and other exciting businesses in the field to compare their past performance and success before taking the plunge and investing. Performing your own due diligence ensures that you thoroughly understand the idea you are investing in.
You should also be looking for a team who is passionate about their project. Even a revolutionary idea can be hard to pull off if the unit isn’t passionate about making it work. Complacency can hit, and competitors can knock your business out of the market.
Entrepreneurs who are passionate about their startups are also essential for communication. Passion for the business makes communication between everyone easier, and when everyone is excited to share their ideas, things can move forward quicker and more efficiently.
The founders should be experts in their field. Their product must be targeted exclusively to an audience that they understand. Even if it’s a great idea, a team that doesn’t know its niche of the market can delay the whole project as the founders learn the fundamentals, while competitors have the advantage of previous knowledge.
It’s usually a good idea to invest in startups in an industry, field or product you are already familiar with and have driven positive past performance in. Understanding what you are investing in will benefit both you and the entrepreneur and the business’s future performance.
A large and expanding market is also a must for a startup. If an idea is too niche, it may dominate its market share but remain a small business. Avoid opting for a product targeted exclusively to a very small audience to ensure the greatest return on your investment.
Finally, you should consider why the startup you are investing in is a good fit in the current market. If it has been tried before, why did it not succeed? If not, why hasn’t it been tried before? It’s unlikely that the idea you are backing is entirely original and has never before been considered, so it’s advisable to question if it will be a good fit and assure you good returns now.
The most streamlined and efficient process to invest in startups is by using crowdfunding platforms.
These are various platforms listing startup companies looking for investments. Alongside giving you all the essential information you need about a company you’re thinking of investing in, these startup websites also ensure that all transactions go through the platform, giving you an extra layer of financial protection. With an array of opportunities available, you can build a diversified portfolio without worrying!
Many successful startups, such as Monzo and Revolut, started with investments via crowdfunding platforms, and many will have international links that you can use to navigate markets and territory. Some crowdfunding platforms have other benefits, such as an internal market, which allows you to sell your shares to other investors at any time.
Crowdfunding platforms can be tailored to a particular sector, so it’s important to consider where your area of expertise is before browsing platforms. They are typically led by successful entrepreneurs who excel in their fields, meaning that you can be sure that the startups they associate themselves with have a great outlook.
However, suppose crowdfunding platforms aren’t giving you enough control or enough of a hands-on approach. In that case, you may opt for networking, making your expertise in your industry well-known, and ensuring you are self-certified as a sophisticated investor as per the FCA can all result in entrepreneurs approaching you. This may even help you build more links with other entrepreneurs, allowing you a hands-on experience of a wide range of startups.
Investment regulations work to protect all parties involved. The EIS (Enterprise Investment Scheme) and SEIS (Seed Enterprise Investment Scheme) allow angel investors generous tax breaks on their investments. This makes investing less risky, thus protecting you as an investor and encouraging growth for the business by facilitating investment. Under the EIS, angel investors are not entitled to take more than a 30% share of a business, keeping the entrepreneurs in control of their business, incentivised and passionate, making the company easier for you to work with.
UK startups and investments are regulated by the Financial Conduct Authority (FCA). The Financial Services and Markets Act 2000 states that angel investors should self-certify as having a high net worth or being sophisticated investors, meaning that they are knowledgeable and financially stable enough to receive business plans and invest in startups. This helps the entrepreneurs feel that they can rely on your advice and can lead to a stronger level of professional trust, making work smoother.
Crowdfunding through organisations is known as investment-based crowdfunding, which is also regulated under the Financial Services and Markets Act 2000. This means that your investment is protected not just by the crowdfunding platform you choose but also by UK authorities.
If you are considering to invest in startups in the UK but feel you need more guidance, InvestUK offers a wide range business planning and advisory services.
InvestUK is not regulated by the Financial Conduct Authority and the Financial Services Compensation Scheme established for the protection of investors does not apply.