Choice is good, but who’s in the pool?
When investing in startups, deal access and selection is very important. Crowdfunding brings the luxury of choice and can give investors the satisfaction of handpicking their own investments to build a portfolio of their design. But many investors forget that the crowdfunding selection pool is already limited by the medium itself. Crowdfunding doesn't necessarily give you access to the best deals around, only to those available via crowdfunding.
Which are the good, promising, high traction companies that actually want to raise via crowdfunding? In most cases, it’s the ones that have a B2C proposition who can align their fundraising with their marketing, and simultaneously demonstrate their consumer appeal while attracting investors.
There will be successes that fit the bill. But without that carrot, crowdfunding to raise capital is inefficient, a huge amount of work, and actually quite expensive. So most types of business (unless they need the money, which opens up a whole new set of issues) shy away from it. As such, crowdfunding won’t get you access to any of those potential success stories.
How well do you know these companies, and do you have the time to put the work in?
Investing in startups individually can require a considerable outlay of time and effort from the investor to ensure they’re making the right investment decisions. Experienced investors will be part of a wide network that can make the necessary introductions for them to access the most promising opportunities. Then, those investors will subject those opportunities to rigorous due diligence to make sure those companies are genuinely worthy of investment, and, crucially, that those companies are EIS qualifying and entitle the investor to tax relief.
If you’re considering investing into a crowdfunding scheme, you should consider this outlay and ensure you’re not at a disadvantage before you even begin. In many cases, it is simpler and more time and cost effective to benefit from the networks and due diligence of the experienced investors by investing into an EIS fund.
You still need to build a portfolio.
Venture capital returns follow a power law distribution (for more on this, see our white paper. Simply put, this means a small number of startups account for a very large proportion of the total returns. Because of this it makes sense to invest in a large enough group of companies to ensure that your chances of including one of the companies that generates major returns are as high as possible, and that any loss will represent a smaller proportion of your overall portfolio. However good a business might look on paper, even the most promising can fail.
Crowdfunding is great for gaining flexibility over the companies you invest in, but it can be unwieldy when you're trying to build a portfolio of ten, 20, or 50 companies (we recommend 50 to optimise your return potential). For portfolio building, investing in a fund can be more convenient, although be aware that different funds build portfolios of differing sizes.
Hype and success are not the same thing.
Crowdfunding campaigns can be exciting, especially when a company sees a surge of interest, press and investment that seems to suggest that its product has such high demand and access to money that there’s no chance the business will fail.
Sadly, it's possible to lose sight of what you're doing because of this feeling that you're joining a flood of investors who are all confident. Loads of investors and interest must mean a huge market for the product right? Sadly not. Initial hype doesn't necessarily translate into that engaged market post fundraise, and can fizzle quickly if the product isn’t quite right, if there are issues with production, distribution, or even branding, or if some other similar product comes along. Investors in crowdfunding projects should be able to see past this potential buzz of hype, and look to the long term prospects of the opportunity once the party’s over. While the average success rate of a crowdfunding campaign is 22.4%, around 90% of all startups fail. It's important to keep this in mind when you're looking at investment opportunities, and remember that a successful campaign is just the start.
Investing in startups is fundamentally a long term investment that can take at least five, and more likely closer to ten years to see results. Keep this in mind, and choose the companies you back wisely.
Consider all the options
Many people invest in crowdfunding because it is accessible and because they hear about an idea that captures their attention and interest, or that stands to make an impact. But many of these people do so before considering the range of options on offer for making investments into startups, many of which will also allow investors to back companies with great ideas that stand to impact everything from renewable energy to social development to advances in healthtech and more.
What are the other options you might want to consider?
EIS Funds
These funds build investors portfolios of startups that qualify for tax relief under the Enterprise Investment Scheme (read more about the tax reliefs). The investor makes an initial investment and the fund will deploy this over time (in most cases, 12 months or more) into startups it has selected. The manner in which funds select investment opportunities can vary; in some cases a fund manager will choose based on their appraisal of a startup's prospects for success, in other cases funds will use a more data-driven approach to selection.
Some funds will focus on a specific sector, like tech, others might focus on companies that stand to make an impact, while others will be sector agnostic.
Pros: Your portfolio is built for you, and due diligence is taken care of by the fund.
Cons: You won't get to choose the individual companies that go into your portfolio, and you can expect to wait around 5-7 years before seeing any returns.
Venture Capital Trusts
VCTs are publicly traded trusts that invest in private markets. When you invest in a VCT, you buy shares in the trust, and not in the individual companies it invests in. In theory, this leaves investors with shares that are easier to dispose of, though in practice, there's not much of a market for them.
VCTs pay out returns in the form of tax-free dividends to investors, and offer a suite of tax reliefs similar to EIS funds. Read our article comparing VCT and EIS for a more detailed appraisal.
Pros: Tax free dividends, publicly traded shares.
Cons: Fewer tax relief benefits than EIS, longer holding period required, lower maximum investment.
The Access EIS Fund
Our fund co-invests with proven angel investors to build large portfolios of hand-picked companies for our investors. It’s a high risk investment, and we can’t guarantee that every startup will be a unicorn, but we’re confident that our approach is the smartest on the market. Even better, we can show you the data to prove it.
If you’re interested and would like to find out the benefits of investing towards the start of the tax year, you can call us on 01223 478 558 and we'll be happy to answer any questions you might have.
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