5 reasons angel investors choose to invest in startups

Traditionally, the term ‘angel investor’ accounted for someone who supported a startup business, both financially and with professional experience, being particularly ‘hands on’. Whilst a broader definition is accepted today, one common trait is generally still maintained - angel investors are typically the first to provide venture capital to startups.

Investing in high growth start ups can be exciting and rewarding. It is a higher risk / higher return investment strategy. Done properly, investing in venture capital style investments can add an element of diversification to a well balanced investment portfolio. 

Venture capital (VC) has now outperformed every other primary asset class in recent years and is expected to continue its strong performance, according to global SaaS company, PitchBook. The asset class has performed well and has a track record in delivering attractive returns for investors whilst supporting early-stage companies in realising their potential. Following a 2021 that saw a record £26 billion invested into UK scaleups, as an asset class, Venture Capital is attracting increasing interest from experienced private investors.

The following five points discuss why venture capital investment opportunities often play a significant role in many well-constructed angel investor portfolios:

1. Potential for significant returns

The primary reason angel investors and other experienced investors choose to invest in startups is to target better returns than those typically available from traditional mainstream investments.

Investing in startups and early-stage businesses at the right entry price is critical.  This can be achieved by investing in businesses in the early investment rounds where the valuation is attractive.  The potential for future value creation can be significant if the management team successfully executes the business plan and demonstrates positive commercial traction.

Investments in successful startups have the potential to deliver returns in excess of 10x money on money.  However, as with all investments, there's also the risk that a business does not perform as expected resulting in potential losses.

When investing in startups on a deal-by-deal basis, it's essential to build a portfolio of companies.  It's sensible to invest in 5 to 10 startups to ensure there's a solid approach to portfolio diversification. Across a portfolio of 10 investments, it's most likely two or three will perform very well, another two or three will break even and the others will fail. Overall, the gains made from the high-performing portfolio companies outweigh the downside of the non-performing assets.

2. Portfolio diversification

Investing in venture capital can act as an effective portfolio diversification strategy, in part due to the fact that VC is categorised as an alternative investment, and in turn displays little correlation with traditional market movements. This can be highly beneficial for investors aiming to spread the risk held within their portfolio.

With venture capital opportunities existing across a broad range of sectors and geographies, and each startup possessing its own level of target growth and exit plan, VC naturally lends itself as a powerful tool when crafting a diversified investment portfolio. 

Allowing for a calculated spread of capital across industry, specialisation, business maturity and management style, if executed on a deal-by-deal basis, startup investments can help to diversify an investor’s portfolio by distributing risk across multiple companies in order to balance out any potential failures with successes.

During uncertain economic times, such as the rising-rate, high-inflation climate currently affecting the UK in 2022, diversification is of paramount importance to investors looking to maintain, and hopefully grow, portfolio value.

Either to hedge against inflation or simply ensure that ‘all of your eggs are not in one basket’, expanding into alternative asset classes, including venture capital, could be a wise move for investors to reduce portfolio risk and volatility.  However, it's important to keep the diversification theme running through the venture capital portfolio too. This helps to reduce concentration risk and provides further balance to a well-constructed investment portfolio.

3. Generous tax reliefs for UK-based investors

In the UK, tax wrappers such as the Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS) can make investing into startups even more attractive for investors due to providing the opportunity to minimise risk and maximise returns.

Firstly, the EIS can provide investors with up to 30% income tax relief on a maximum annual investment of £300,000, or £600,000 in the case of Knowledge-Intensive Companies (KICs), should company shares be held for at least three years. Instantly mitigating almost a third of the risk associated with investing in early-stage companies, reliefs such as this have helped the EIS attract more than £25 billion of private investment for over 36,000 SMEs since being introduced in 1994.

On the other hand, the SEIS (the ‘younger sibling’ scheme to the EIS) focuses on investment into particularly early-stage startups, often at the idea stage. The SEIS requires startups to hit a more narrow eligibility criteria, but - in exchange - offers investors the opportunity to claim 50% income tax relief on up to £100,000 per year (again, should shares be held for at least three years). Any investment gains are also free from Capital Gains Tax and any losses attract further tax relief. These generous tax breaks help to mitigate downside risk and maximise investor returns.  These benefits have helped the SEIS to generate over £1.5 billion of investment for more than 15,000 UK startups since its establishment in 2012. A powerful way to support innovation and back the next generation of high-growth startups.

Furthermore, recent amendments to the SEIS could provide more scope for positive impact and potential investor upside to be maximised, mainly due to the eligibility criteria for businesses to qualify for the scheme being relaxed, and annual recipient and investor limits via the scheme being increased. 

Alongside these highly attractive initial benefits, both schemes also provide scope for additional exemptions that can help to further minimise investment risk, maximise returns, and assist in planning for later life.

Out of these additional reliefs, both schemes share inheritance tax exemption, capital gains tax exemption and loss relief, whilst EIS deferral relief and SEIS reinvestment relief are offered exclusively by each respective scheme. The entirety of these benefits are offered alongside the opportunity to support some of the UK’s most exciting startups and scaleups.

4. Supporting startups that can transform industries

Drawing on the theme of supporting game-changing businesses, venture capital attracts angel investors not only for the financial incentives, but also for the chance to help realise the potential of many promising companies. Supporting these firms, often from the idea stage, means that investors can potentially share their knowledge and expertise, striving to further their chances of success.

Highlighted by Statista, the number of angel investors performing an active role in early-stage investments in Europe reached 345,000 in 2019, up from 241,444 in 2011.

Especially when the investor role involves the active sharing of expertise and advice, the fact that young companies can grow and thrive with the support of business angels is certainly an attractive point to be considered. 

5. Generating positive impact

Venture capital can become an increasingly alluring asset class for many investors who seek not only to generate superior financial returns, but also to facilitate the delivery of significant positive impact.

In the UK, social impact investing increased from £833 million in 2011 to £6.4 billion in 2020. This showcases the growing number of investors eager to support early-stage businesses with high growth potential that also display the attitudes and ability to positively transform industries and communities.

Spanning areas of economic, environmental and social change, a multitude of businesses exist that have the potential to revolutionise the way people live and work for the benefit of the planet, as well as for the benefit of people themselves. Choosing to back impact-driven startups can be an effective method for investors to encourage and materialise this positive change.

Additionally, increasing government regulation regarding sustainability can make investing into positive environmental and social transformation more sensible, more actively encouraged, and also more rewarding. 

Furthermore, Impact investing is becoming increasingly profitable for investors, signalling that there is no longer a trade-off between positive returns and positive impact. A 2020 study conducted by the Global Impact Investing Network found that, of 294 respondents, the majority stated that their impact investments were meeting or exceeding their financial expectations.

How can I invest in startups?

Over the past ten years, it has become significantly easier for angel investors to support early-stage businesses. Primarily, this is due to the improved access to VC opportunities that online co-investment platforms have provided. Opportunities to support promising startups whilst simultaneously constructing a well-diversified investment portfolio are now widely available to many investors.

Whether this is achieved via investing directly into singular investment opportunities, researching and selecting from a host of portfolio companies through a co-investment platform, or investing into multiple startups via a fund, the breadth of opportunities for angel investors to invest in startups has never been wider.

Regardless of the chosen route, researching investment platforms and finding opportunities that align with personal investment goals and values can, on the whole, be carried out online. Whilst the process of discovering the right companies amongst a vast range of options could be time-consuming, the future gains from supporting growth-focused, impact-driven startups could prove to be highly worthwhile.

GCV Invest is an online investment platform for experienced UK-based investors. We provide access to growth-focused investment opportunities across three asset classes; venture capital, private equity and property.  Our investor members have co-invested over £35 million alongside institutional investors in transactions worth over £100 million. 

With a portfolio worth over £600 million and over 600 high-quality jobs created, our investor members are building wealth with impact.  You can find out more about GCV Invest here