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Making a profit from investing in early-stage companies

Making a profit from investing in early-stage companies

22nd December 2017 by Steve Bates

Equity-crowdfunding connects startups and early-stage companies that need financing with people who want the opportunity to invest in them. But how do you make a profit by investing in what you feel sure will be the next big thing?

We look at the potential ways that you could receive a profit from your investment.

Take the next exit ahead

When used in a financial context, an exit is when an investor or entrepreneur sells their stake in a business. There is more than one exit method:

Acquisition

Although an entrepreneur may start a company with the dream of building something big and sticking with it until they retire, a larger organisation may spot the potential it represents and decides to acquire it. For example, Wealthify raised on Seedrs, then technically within a year, Aviva acquired a majority stake. This provided an exit opportunity for investors.

The company that’s making the acquisition takes over the startup using cash, stock or a mixture of both as compensation. It will propose a deal to make an acquisition or buyout, usually involving a windfall for anyone holding shares in the company being bought out, usually in cash but sometimes in new stock.

Known as a tender offer, these usually involve proposing buying shares at a higher than the price they were sold during funding rounds. This gives the shareholders a financial incentive to sell them.

The offer could be far higher than what was paid for the shares when the company was at a very early stage – creating a profit.

Initial Public Offering (IPO)

The first time that shares in a company are put up for sale to the general public on a stock market is called an Initial Public Offering.

The very first UK firm to launch an IPO   after previously raising growth capital through equity-crowdfunding was Freeagent, a cloud-based accounting software company. Freeagent had previously raised £1.2 million from 700 investors on Seedrs, back in July 2015, but required more funds to get to the next stage.

Just 16 months after raising on Seedrs, they began trading on the Alternative Investment Market (AIM). The float raised £10.7 million, valuing Freeagent at £34.1 million.

Shortly after the float, Jeff Lynn, co-founder of Seedrs said, “It’s great that the shares owned by our investors will now have liquidity on the stock exchange. As the early stage investment space matures in the coming years, we look forward to seeing many more Seedrs companies floating or exiting.”

Secondary markets

 Without a liquid secondary market, investors would need to hold onto their shares in a startup until it listed on the stock market or the company was bought up.

However, sometimes investors just don’t want to wait for any of these options to become available in order to try and make a profit from their shares. So, in yet another innovative move, Seedrs became the first crowdfunding platform to create a secondary market, making it possible for investors to buy and sell shares from each other.

As you can see, there are a number of ways to make a profit from investing in the equity of ambitious, growth-focused businesses.  It’s a long-term proposition, with returns unlikely for years, if at all. But for those who are looking for a long-term investment, investing in private companies certainly offers the potential for profits.

Investing involves risks, including loss of capital, illiquidity, lack of dividends and dilution, and should be done only as part of a diversified portfolio. Investments should only be made by investors who understand these risks. Note that not all shares will be eligible for the secondary market and, even if they are, the ability to buy and sell shares will depend on demand. It can be difficult to find a buyer or seller, and investors should not assume that an early exit will be available just because a secondary market exists.  Past performance is not a reliable indicator of future results

Steve Bates

Steve Bates

Content Team at Seedrs

Digital Agency Kent