Why it’s a great time to invest in early stage start-ups…

We’re going deep into the numbers this week with expert insight from Rich Williams. Rich is an economics graduate and former investment analyst for one of the best performing investment funds in Europe and he now runs his own disruptive startup – making him the perfect person to weigh in on why now is a great time to invest in startups…

The expression “start-up” naturally invokes images of a high tech, silicon roundabout-based bean bag office half filled with hooded MacBook-carrying millennials about to release their great and obvious idea. In reality “start-ups” covers the full breadth of industries from micro-brewery (do you know any?) to the latest land-surf-board maker established in Canada, already being endorsed by pro surfers. In recent years the industry has become an increasingly hot topic for investors from angels to pension funds. Why now? Is it too late or are we only on the cusp of a long and establishing wave?

Online technology has certainly helped drive transparency and provided a stage for new ideas. There are innumerable crowd based seed platforms where anyone can upload their business and receive funding from willing investors. This has levelled the playing field for budding entrepreneurs no longer having to go cap in hand to the local land baron. More importantly, it has opened the landscape of opportunity up for investors. The myriad of ideas across industry, growth stage and investment structure allows investors to find great opportunities as well as the ability to diversify. As the industry has developed the process of investing and structure of equity have also become more consistent. It is increasingly common for platforms to carry out vetting before an opportunity is made public for example.

Fundamental to investment opportunity is expected return, calculated by multiplying the return associated with each potential outcome by the probability that the outcome occurs ER = [(P1xR1)+(P2xR2)+...+(PnxRn)]. If the probability of failure is 50% and failure means you lose your entire investment this can start to look risky. However, with the introduction of SEISinvestment rules in the UK the downside risk is dampened: Upon other things, the investor can claim back 50% of their initial investment by way of an income tax break followed by a further 25% if the company fails. This limits the loss from failure and significantly improves the Expected Return.

Low returns elsewhere also make start-up investment look increasingly attractive. Traditional investments such as fixed income have had returns at historic lows for almost a decade. If you want to lend the German government money over two years (The 2 Year German Note) you will have to pay themfor the privilege. Equities are at historic high valuations, which by definition reduces future expected returns. Even alternatives like private equity are beginning to suffer, making it difficult to find consistently attractive long term investments.

Start-ups can offer a less competitive landscape with comparatively high potential returns, especially if all goes well.

This is not to say that throwing money at anyone with a good idea will make you money. Often, it’s the investments you don’t make that are the most important. 

There is also no simple formula that works across the board given the breadth of opportunities, varying investment forms and low liquidity. But with sufficient patience and care there are huge opportunities to be had. It’s exciting, world changing and if the investor has the right blend of passion, experience and contacts – then all the better. 

Who knows – you might just find the next Instagram.

Richard Williams