Thankfully, investing in early-stage equity goes far beyond the much publicised fan-led campaigns, where for as little as £10 you get a stake in your favourite local restaurant. It now includes fundraises for some of the UK’s most promising tech startups.
I am thrilled to see that private investors can now back entrepreneurs to help them realise their business ideas, and participate in an asset class that was previously only accessible to business angels and institutional investors.
As the number of investment platforms grows, so too does your choice of investment opportunities. If you are new to this type of investing, here are a few things worth keeping in mind before committing your hard earned cash.
Why take their word for it?
Most online platforms will give you an overview of the investment opportunity, including its own growth projections and valuation. However, don’t take its investment team’s word for it. Just as you would with any financial decision, you need to take a very close look at the information provided and check it makes sense to you.
Is the information even sufficient to make a decision? Do the growth prospects justify the valuation on offer? If in doubt, do your research, ask for more information from the company and speak to people who know the industry.
As an investment director, I frequently see businesses that have fantastic ideas, but the numbers don’t stack up. As much as everyone loves ambitious entrepreneurs, the business plan should be a realistic reflection of how much and how quickly a business can grow within the context of the industry and internal resources available. In my opinion, it is the investor’s responsibility to ensure that they have done their homework and understand the numbers sufficiently before going in.
Clearly, due diligence does not stop with the numbers. What do you know about the team driving the business forward? Do they have sufficient expertise in the area and are they incentivised to see the business flourish? What is their track record and reputation in the industry? Again, if you have any doubts, try to speak directly with the team behind the raise. After all, you are trusting them with your cash and are relying on them to make your investment a success.
Are we in it together?
As well as looking at who you are investing in, you need to also look at who you’re investing with. The reality is that growing a business takes time and most likely will require additional capital further down the line. Try to understand where that money might come from, who has the ability to follow their money or help the business through tough times.
In this respect, private investors may substantially benefit from the presence of institutional investors as the latter tend to have access to larger pools of capital, allowing them to keep funding the business and also being incentivised to see an exit.
Are you getting a good deal?
In the end, the quality of a deal comes down to the investment structure, so make sure to closely examine the legal terms of your investment.
Even if you have backed a successful business and managed to get to the point of exit, you may not make a penny. This is an area that can often be overlooked. Make sure you understand the ranking of different classes of shares and respective shareholder rights.
What will happen in the event of an exit? Who gets paid out first? What will be left for you? Are there tag along rights, which allow you to join a deal and sell on the same terms as the majority shareholder, or conversely drag along rights, which enable the majority shareholder to force minority shareholders to join in the sale of a company, helping to facilitate clean and quick exits where the company has a diverse shareholder base.
It is critical for you to know where you stand on the essential legal terms, before entering in to the investment. Although the exit may seem in the distant future, the terms agreed now will potentially make or break your return.
Check whether your investment qualifies for any of the government’s tax incentive schemes such as the Enterprise Investment Scheme (EIS), which could increase your financial return or, if the worst comes to worst, reduce your financial loss.
Stick to the cliché – don’t put all your eggs in one basket
Even if you got comfortable with the investment, remember that the majority of start-ups will still struggle to achieve their growth targets and could fail. Be sure to fully understand the risks and make sure you can afford to lose your investment before you commit.
Personally, I believe the alternative investments space holds some of the most promising investment opportunities. But investing in early-stage equities demands considerable due diligence and scrutiny, and it is best to consider it as a part of a well-diversified investment portfolio.