Startup Investing Part 2: Venture Capital, EIS and VCT
Introduction
As we discussed in detail throughout part 1, Angel Investing is the most direct way of allocating your capital to early-stage businesses. Meet the company, do some due diligence (we hope), agree on terms and wire the funds. Done! However, after looking into the risk profile and the requirements around having a large and well-connected network, it became obvious that it isn’t an easy decision.
You basically should have enough cash to be able to make a load of different bets on companies (at least 10 is ideal) with a good enough network that you’re not just getting the ones everyone else has passed on to be able to hope for any of your money back, let alone a reasonable degree of success. You also need to have sufficient liquidity to be able to part with the cash in the knowledge that even in the best case scenario, you won’t be getting any of it back for 5–7+ years. Given that the minimum ticket size would be unlikely to be less than £10–20k even for a pre-seed round, you’re making 10+ of these and they should only make up the more aggressive portion of your portfolio, it is usually only after passing around £1m+ investable funds that angel investing becomes a serious possibility. Now, don’t shoot me — I’m sure there are plenty of examples of people who have succeeded with less, but aside from the innate survivorship bias looking only at winners, they most likely had a stellar network full of budding founders likely to build successful companies.
We discussed the alternatives a little too — rather than buying chunks of individual companies and taking on the burden of finding them yourselves, it is much easier to choose a fund. Investing in VC funds has much lower barriers to entry. Most have a minimum ticket size not much higher than that of an individual angel investment, but you are usually investing in a chunk of 10 or so companies in that particular fund. Of those, 6–7 might reasonably be expected to fail or return less than invested capital in the fund’s lifespan, 2–3 might stay flat and the remaining 1–2 could be huge successes. I have often seen examples of funds with 8 or 9 ‘losers’ and one huge winner, big enough that the fund doubles invested capital. Given that even the most successful funds in the world with the most advanced networks often still choose bad eggs, it makes sense to not try and go it alone unless you’re pretty certain of your edge.
So the obvious next question is:
“How do I choose which VC fund to invest in, and how do I choose how much to invest?”
Great question. To be honest outside of the US it becomes slightly less congested — in fact, the majority of the top performing funds in Europe are based in, or have an office in London. They also tend to invest a little later and base decisions slightly more on traction than in the US, where the capital flows more freely. Despite that, let’s not get it twisted. This is risky stuff. 75% of the Venture Capital and Private Equity in London goes to either seed or venture stage businesses. This compares to 21% for growth stage companies and 4% for established companies.
Here are some of the funds we like:
1. Molten Ventures (formerly Draper Esprit)
The UK’s largest VC fund, and arguably the most successful. Recently floated on the London Stock Exchange. Investments include Trustpilot, Cazoo, Graphcore, UIPath, Revolut
Healthcare, Fintech, Deep Tech & Consumer. Portfolio investments include Depop, Cazoo and Secret Escapes
Founder and stage agnostic, although favours fintech, SaaS, entertainment, fashion and digital infrastructure. Portfolio investments include Deliveroo, Funding Circle, Transferwise
Early stage, entrepreneur founded. Large focus on impact investments
We’ve already discussed how much to consider investing as part of a robust and prudent portfolio, but there is one more factor to consider: the tax. In the UK, early stage businesses are subject to tax relief on investment, subject to a few criteria (max no. of employees, UK registered etc). It is possible to claim back this tax (up to 30%) off your annual income tax bill. Therefore, any tax relief in excess of your annual income tax bill could be considered “wasted allowance.” It might in this case be sensible to stagger your investments across tax years to take full advantage of the tax relief. And yes, if the investments work out you might find yourself in the favourable position of getting full tax relief on an investment which netted a large positive return.
EIS & VCT
The two most common vehicles in which to make venture capital investments are Enterprise Investment Scheme (EIS) and Venture Capital Trust (VCT). Broadly speaking, both encourage trading into small unlisted companies and are capital gains tax exempt. However, the latter are traded on the secondary market too, and have slightly different requirements to claim tax relief.
It is worth considering one's individual requirements before investing, although in general we tend to prefer EIS new issue stock. You will be required to fill in forms confirming your minimum investment size as well as available investable funds and investor sophistication.
If you have any remaining confusion over this please reach out to one of our team to direct you, or your dedicated financial adviser. Happy investing!
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