Why I have invested 20% of my portfolio in UK start-ups

I’m a typical London professional. I have a small portfolio in stocks, mutual funds and start-ups, not unlike many other London professionals.

After launching my own fintech start-up, CityFALCON, I’ve had less cash on hand to invest in any assets. Despite this, every year I invest in a few start-ups. I don’t do this through crowd funding sites like Kickstarter, because Kickstarter doesn’t compensate me enough for the risk I take. Equity crowdfunding, where the funders get a small piece of the company, is what I prefer.

Investing in start-ups is much riskier than investing an established legacy company, and it should be, because the rewards are also much greater. Uber, Airbnb, and Snapchat are valued highly, even compared to traditional companies, and in many ways are still start-ups. Obviously, not every start-up grows up to be a unicorn, but these very young, very valuable companies give a glimpse into a changing world where there’s more reason to invest in start-ups than ever before.

(Disclosure: My FinTech start-up CityFALCON and its stakeholders may have business relationships with some of the companies listed in the article, and may even receive affiliate revenue in some cases.)

Tax benefits (EIS, SEIS)

If you haven’t heard about EIS and SEIS tax schemes before you’ll probably have trouble believing them. Let me assure you; I’ve claimed the benefits as an investor and as an entrepreneur. You may still want to check with your tax advisor.

Picture a tax liability of £5k, you could pay no tax, or get a tax refund if you invested £10-15k in start-ups, depending on whether the start-up is eligible for either programme. If the company successfully exits, all your capital gains will be tax free, and if the company fails, you could offset the loss against your taxable income. I can’t think of a better tax scheme than this in the UK or even globally.

The benefits seem quite lavish to try and promote investment, but as an investor, I’m not complaining and taking full advantage. Learn more about the benefits of EIS and SEIS here.

Diversification 

Diversity is important in any portfolio. Start-ups can be a new asset class for many people, albeit with a risk to reward ratio.

Buy and hold strategy no longer works

Technology is changing the world faster than it ever has before. This constant and increasing rate of change means that buying a huge company’s stock and holding onto it for as long as possible and hoping for a steady climb just doesn’t work anymore in many cases.

Many major companies may not exist a decade or two from now. The problem is major institutions don’t age well, and will have trouble keeping up with the pace of change. The team at many of these places has stagnated, the incentives have become muddled, and the drive for innovation has been replaced by bureaucracy. For the huge companies among us, the innovations on the horizon, like blockchain, AI, and biotech, will be too much to deal with, and they’ll collapse. Investing in start-ups diligently and actively is the way to invest in the future.   

Backing the innovators

It’s not always about the money, it’s about backing those who can change our lives and take humanity forward. This means thinking long-term and betting on some turtles, no matter how attractive the hare may be. For several of us, life may be difficult without the likes of Uber, Airbnb, etc.

Valuations are cheap

In Silicon Valley and New York, start-ups typically raise $1 million at a $4 million valuation, often with just a business plan. The big numbers often raise the ire of skeptics, but smart investors know that when you find someone or something worth investing in, they have the best chance if they have enough capital to realise their goal.

Compare that to the UK, where most entrepreneurs manage to raise just a few hundred thousand pounds at very low valuations. Earlier in the year, I explained why most start-ups worth investing in are worth at least £1m, and that still holds true.

The reason we don’t have Facebook, Uber, or Airbnb coming out of the UK is because of such stingy early stage investment. In fact, most of the unicorns that have come out of the UK raised serious capital at the seed stage. Over time, as more companies invest in or acquire start-ups, valuations should rise in line with what we have seen in Silicon Valley and New York.   

Secondary trading in a start-up’s stock when launched should boost exits and valuations

Investing in a public company lets you buy and sell shares. When you invest in a start-up, your money is locked in until the company exits. With secondary trading, you can buy and sell stocks when you want, so more people will be likely to invest in start-ups. It’s only a matter of time before we see more of this.

The excitement, the journey, the learning

When you buy a listed company, there is nothing you can do to impact the prices, but when it comes to start-ups, you can work with the company and be a small part of the team, rather than just another shareholder.

How to spot potential problems

As investors, we need to always be open to innovative ideas, expect to be surprised, and be quick to change our minds. That said, there are certain problems a company can have that will make me stay away:

Not well funded – For a company to scale fast, they need serious capital, especially in London. The key part of a company’s early success is being able to hire the best people to keep the show on the road. Poorly funded companies can’t do either of these things, so it’s wise to stay away from underfunded start-ups.

Undervalued businesses – If an entrepreneur can’t value his businesses correctly at the fundraising stage, how could we trust he’ll do a good job when selling to clients or exiting the business? For start-ups to be successful they need to have a solid understanding of what their business is worth, and their investors need that too.

Entrepreneurs who are not full-time on the project – A part-time start-up is a waste of time. All start-ups have a high failure rate, but for part-time start-ups it’s higher still. Don’t invest in people who don’t fully commit to investing in themselves.

Copy cats – I like to back innovators and not copy cats. For example, I’d back the old Apple under Steve Jobs. There might be room for fast seconds, like Samsung. But there’s no room in my portfolio for the other players in the market screaming: “me too!” Keeping up with the pace of change mentioned above leaves no time for companies that come in third place.

Even with the tell-tale signs that many start-ups exhibit, there are still many wonderful companies that need investment, and many more people who could benefit from investing in them.

The UK has many unique problems when it comes to investing and fostering a start-up culture, but slowly those are fading away and we’re getting a chance for our start-ups to have a bigger impact, with the result that we now have more avenues to invest in innovative start-ups than ever before. If investing in and supporting innovative startups is something that you’re interested in, I recommend looking into equity crowdfunding sites, like Seedrs, Crowdcube, and Syndicate Room. Most of these sites will give a chance to invest in hundreds of different companies starting from £100.