When it comes to investing in startups, it can be challenging to know where to start as an individual investor. This guide will take you through what you need to know, whether you’re an experienced investor, or just getting started.
Our guide to investing in startups includes:
- What your options are when investing in startups
- The different types of shares typically available when investing in startups
- Where you can find startups to invest in
- How to go about choosing the right startups for your investment
- What to expect on a campaign page
- How to invest
So, without further ado, let’s get started.
How Can I Invest In Startups?
As an individual investor there are a number of ways you can invest in startups. Unlike larger companies, very few startups will be listed on public stock exchanges — as they’re still private companies — which can make the process of investing a little more complicated. While the risk of investing in early stage companies is greater, there can be considerable upside if the business you invest in early performs well.
When startups are first created, founders will typically need money to get the business off the ground. Some will finance the business themselves, building the business alongside another job. Others may choose to loan money from the bank if they’re able to get approved for a loan. Many entrepreneurs choose to sell shares in the business in exchange for capital, often from angel investors.
Angel investors typically invest directly into businesses, interacting and negotiating with the founders personally and handling their own due diligence and legals. For founders, finding and agreeing angel investment is a time intensive process, so they will normally only accept investments of £10k and above. For angel investors, investing directly can be very high risk as the businesses are often at an early stage, and all due diligence needs to be completed by the investor. Hiring lawyers makes the process expensive, so typically angel investors will only invest directly if they want to be directly involved with the business, and are investing a large amount of money.
So, where can you find startups looking for Direct Investment? High Net Worth and Sophisticated Investors can meet businesses to invest in directly on Seedrs Private Deal Room.
Individuals may want to invest in a business because they love that brand, they are a customer of that business or because they believe in the idea or mission that the business is on. If these brands look to raise funds, then these individuals may be able to buy shares through a community fundraise on a platform like Seedrs. When you invest in a community fundraise, the platform’s (in this case Seedrs’) legal entity is the shareholder in the investee business, and full beneficial ownership of the shares is given to the underlying investor. Investors exchange money for equity in the business via Seedrs, and so share in the potential success of the business in the future.
How do community fundraises differ from buying shares directly?
As the platform you choose pools investment from lots of individual investors, you can buy shares for as little as £10. The platform ensures that everything the company shares in its pitch is ‘fair, clear and not misleading’ — and runs basic background checks to ensure that the founders and business are above board. We encourage all investors to do their own research and complete their own due diligence before making any investment decisions. This ensures that the investment decision you make is well-informed.
Community fundraises are a way that you, as an individual investor, can invest in businesses that you know and love, and have the opportunity to share in their potential success, from as little as £10.
Eligible individuals can invest in a business’ community round, once they have set up a Seedrs account. If you’re interested in learning more about the types of businesses who are looking for investment from their communities, you can see live investment opportunities here.
Venture capital funds
Some businesses will choose to raise funding from institutional investors, like Venture Capital (VC) firms. VC firms raise capital from investors to invest in a portfolio of early stage startups that they believe will succeed, and work with the businesses to help them do so. The money VC firms raise is pooled into funds that are invested as per each fund’s investment strategy.
Investing in a VC fund is different to investing in an individual business through a community round or directly, as investors are investing in the full portfolio of companies that the fund invests in. One benefit of this is that an investment in a VC fund is diversified across multiple businesses, rather than all invested in one. While VC firms aim to identify the best opportunities and minimise risk, investing in startups and early-stage companies is inherently risky, and there is always the potential for loss of capital.
VC funds have a fixed time within which the firm must invest all its capital and return initial investments and any returns to investors. This is typically 10 years, so VC fund investments should be considered just as long term as investments into individual private businesses.
There are a number of different types of venture capital funds, with varying degrees of accessibility for different types of investors — read more in this article – The Venture Capital Acronym Decryptor.
These opportunities are exclusively available to investors who self-certify as ‘High Net Worth’ or ‘Sophisticated’. Following their self-certification with Seedrs, they will be able to access a range of opportunities on Seedrs Private Deal Room, that restricted retail investors cannot.
Investing In Startups — What You Need To Know
The world of start ups can often be littered with confusing terminology and concepts, and at Seedrs we’re committed to demystifying that world, opening up more investment opportunities to more investors. There are a number of nuances and phrases that it’s worth getting familiar with when investing in startups. Here’s what you need to know:
What are primary and secondary shares?
“Primary shares” are new shares being issued by a company in exchange for equity, to finance growth. In a community fundraise, investors typically purchase primary shares.
“Secondary shares” are existing shares that are being sold by an existing shareholder to realise a return. The money paid for secondary shares allows the buyer to invest in a business and receive the same exposure as they would from primary shares, but the funds go to an existing shareholder, rather than to the business to fuel growth.
What is the difference between an equity round and a convertible note?
Investing in a regular equity campaign is the simplest and most common way to invest in a startup. You decide which business you want to invest in, and if the campaign hits its funding target then you will become a shareholder in the business. As the company becomes more valuable, so do your shares; allowing you the opportunity to share in the future success of the business.
Convertible campaigns are often used by businesses when there is a large fundraising round on the horizon, but they want to raise a smaller funding round in the meantime. By offering a convertible, the business doesn’t need to put a specific valuation on their company at that moment in time, and therefore avoids potentially affecting their negotiations with the future investors.
When an investor purchases equity in a business, the purchase price of the equity implies a company valuation. For example, if an investor purchases a 10% stake in a company and pays £10,000 for that stake, this implies that the company is worth £100,000.
Convertible campaigns avoid the need to agree a specific valuation on the company and instead offer investors a discount (referred to as the “Discount”). When the convertible converts to equity in the future (usually when there is a new round of funding), it will be converted based on the discount to the valuation at the time of the new round of funding, sometimes subject to a maximum valuation (referred to as the “Valuation Cap”).
Investing in a convertible campaign allows you to invest today, with your investment converting into equity in the future, at a discount compared to other investors in the future funding round. This is a very common structure used by angels and VCs all over the world.
While this is the standard approach to convertibles, each one is unique which is why we attach a document to each convertible campaign on Seedrs outlining exactly what the specific terms are for that particular campaign. We strongly suggest that a potential investor familiarise themselves with this document before deciding to invest.
For example, if you invest £1,000 in a convertible campaign on Seedrs, and a new investor invests £1,000 at the time of the new funding, you would receive more shares than the new investor.
What are the risks of investing in startups?
All investments carry varying degrees of risk, and investing in early-stage and growth-focused businesses is no different. The main risk associated with investing in startups is that the business may simply fail, and investors won’t get their money back. Due to the potential for losses, this asset class is high risk. You can learn more about the risks of investing in startups in our guide, ‘What Are The Risks Of Investing In Startups’.
How To Choose A Business To Invest In
When selecting a business to invest in, you should consider a number of factors and do as much due diligence as possible. Platforms like Seedrs will do some of this work for you, but you should still spend time reading the documentation, familiarising yourself with the structure of the deal and understanding the type of investment you’re making. Some things to look out for include:
- Business performance: the companies’ financial and business performance to date. But keep in mind that past performance isn’t always a good indicator for future success.
- The team: the founders and the early team will be key to the success of the business.
- Investors: has the business already attracted investors? If so, who?
- Macro factors: what industry is the business in? What are the macro economic trends at play? The macro environment can have a huge influence of an early stage business.
- Investment structure and vehicle: how will your investment be setup? We have shared some more information on what look for here below.
You can learn more about selecting startups to invest in in our guide ‘How To Select Startups To Invest In’.
How to choose which crowdfunding platform is best for you
There are some key considerations when choosing a crowdfunding platform that’s right for you:
Crowdfunding platforms use different legal structures to pool funds from individuals to invest in startups. Some of the options are:
Managed Nominee Service
Seedrs’ managed nominee is a legal entity that acts as a nominee shareholder on behalf of investors in a startup, and is one of the most important features of Seedrs.
This structure is used in private investing to simplify the process of managing multiple investors in a single startup. The managed nominee holds the shares on behalf of the investors, and is responsible for managing the administrative tasks associated with the investment, such as receiving and distributing dividends. In short, this means that investors do not need to worry about administering their investments. Seedrs ensures that their investments are protected using both the statutory provisions afforded to shareholders as well as the professional, contractual protections that are in place under our subscription and shareholder agreements with each company. You can read more about our nominee structure here.
One of the key benefits of the Seedrs nominee is powering the Secondary Market. As the nominee is the legal shareholder of all investments made by Seedrs investors, we can enable trading within the structure by transferring beneficial ownership between underlying investors. The Secondary Market, powered by the nominee structure, is solving the liquidity problem of private investing. You can learn more about the Seedrs Secondary Market in our guide here.
Special Purpose Vehicles
A Special Purpose Vehicle (SPV) is a legal entity that is created for a specific investment purpose. SPVs are commonly used to pool together funds from multiple investors to invest in a single startup or group of startups. An SPV is usually structured as a limited partnership or a limited liability company (LLC), giving investors limited liability protection. This means that the investors are only liable for the amount they have invested, and not for any additional debts or obligations of the SPV.
Whilst often the cheapest and fastest option, off-the-shelf SPVs can be basic and lead to challenges for founders and investors down the road. These will typically be set up on a deal by deal basis, and will have an appointed lead investor for each deal. This appointed individual manages investor rights and administration, and as an investor you’re entrusting that individual to manage your investment effectively. Given the off-the-shelf and repeatable nature of these structures, typically legal documents are templated and customisation and additional review comes at a cost to the individuals administering the SPV.
If you become a regular investor through SPV structures and build a startup portfolio this way, as an investor you’ll be responsible for tracking your investments and will likely be dealing with different lead investors operating through different platforms and communication methods.
Key Considerations When Investing in Startups
Liquidity and Exit Timelines
Investing into private startups is a long term commitment. Companies are remaining private for longer, with the average time to exit (from initial funding to a public listing) increasing from three years in 2000 to eight years in 2020, according to data from ThomsonOne.
The majority of startups fail. There are many conflicting figures on the overall percentage that fail, but some quote that up to 90% of new businesses fail. You can learn more about the risks of investing in startups in our risk-focused guide here.
Of the startups that do succeed, there are 2 main methods for startups to exit and generate a return for early investors: being acquired or merging with another business through an M&A transaction, or listing on the public markets through an IPO or direct listing. In broad terms, in these situations a valuation will be agreed at the point of sale/listing, and investors will receive a return on their investment based on the valuation that they initially paid for their shares. You can learn more about how investors can make money in our guide ‘How Do Startup Investors Make Money?’
For investors that want to realise returns before a full exit event, shares can be sold through a secondary share sale. For direct investors, these share sales are complex, typically have to be approved at board level of the issuing business, and often require the services of a specialised broker (incurring considerable fees). This option is normally only feasible for large shareholders, as brokers in the market will often have a minimum transaction size.
However, thanks to clever legal structures like the Seedrs nominee, some platforms like Seedrs offer more accessible liquidity options that are available to shareholders of all sizes.
The Seedrs Secondary Market allows buyers and sellers to trade eligible shares in private companies. The market represents an opportunity for early investors in startups and other private companies to potentially realise liquidity before a formal exit opportunity, and is the only fully functioning early-stage equity secondary market in the UK. Shareholders can list their shares for sale in lots as small as £10. You can learn more about the Secondary Market here.
For larger shareholders, Seedrs Secondaries can enable an early exit through Secondary campaigns. In a Secondary campaign, shares are offered to Seedrs investors and whatever is committed to be purchased is then bought from the original investor through a secondary trade. You can learn more about shareholder secondaries here.
For platforms to offer investment opportunities to individual investors, a certain level of due diligence must be completed. Certain platforms decide to take due diligence a step further, offering investors enhanced protections, and Seedrs is among them.
Seedrs’ standard due diligence process requires the fundraising company to verify and disclose information both before the campaign launches and again before the investment transaction is completed. If a founder chooses Seedrs, it demonstrates that they believe that they have nothing to hide from our enhanced scrutiny.
Seedrs provides all types of eligible investors with the opportunity to invest in exciting early-stage and growth businesses, structuring deals to ensure that when there are returns, everyone shares in the success – including investors and founders.
Investing on Seedrs – What Is The Process?
What Happens After I Click ‘Invest’?
1 – Use the free text box to enter how much you’d like to invest
- If you don’t enter an exact multiple of the share price, you’ll be offered some options to scale up or down your investment to receive a number of whole shares
- If you invest in a convertible round you can invest the exact amount you like. When the shares convert you’ll be given an exact number of shares, including a fractional share, based on the amount you invested and the price at which the shares convert.
- If you insert a number greater than the minimum for investing directly, you’ll be given the option to invest directly, with an outline of the difference between direct and nominee investing.
2 – Read and understand the investment details and fees:
- Seedrs Nominee
- This means you’re buying shares through the nominee, and have access to all the benefits and services associated
- Investment fee: 2% on investment (Min. £0.50, Max. £250.00)
- Carry: 7.5% on any profit made for nominee services.
- This means you’re buying shares in the business directly, not through the nominee
- Investment fee: £250.00 2% on investment (Min. £0.50, Max. £250.00)
- Carry: 0% on profit
3 – Read and agree to the investment agreement
- Clicking on ‘investment agreement’ will generate a custom investment agreement between the investor and Seedrs, with respect to the specific investment. This subscribes the investor to the terms of the fundraise.
- If investing directly, read and agree to the subscription letter
- Clicking on ‘subscription letter’ will generate a custom subscription letter, applying for a direct allocation in the business raising funding.
4 – Click proceed to payment, where you can select your payment method of choice and process your payment.
We know that we’ve covered a lot of information in this introduction, and there is plenty more to explore, and so perhaps the best way to get familiar with all the information above is to have a look around for yourself. You can explore the site and then sign up for a free Seedrs account, check if you’re eligible to invest, and start your journey with Seedrs. Once you’re up to speed on how to invest in startups on Seedrs, next up we’ll talk about the risks associated with startup investing and how you can manage them as a diligent investor.