Increasing the return potential of your angel investment
There is no denying that angel investment is risky, startups have a high failure rate and sometimes it’s due to things out of the founder or investor’s control. Whilst building a portfolio of investments is the number one way of lowering risk and increasing the potential of your return overall, in this resource, we will zero in on what you should consider to increase return potential when investing in any particular company.
Several variables will affect your return
Whether the company succeeds (gets acquired or IPOs) or fails (potentially being valued at zero)
The level of success: not just that it gets acquired but how much does the acquirer pay
The valuation you invested at. Let’s say a company gets sold for £50M - the return on your investment will be very different if you invested when it was valued at £1M (50x) or £10M (10x)
Further funding rounds completed by the company and at what terms i.e. if later investors received preference shares and agreed to a liquidation preference, they will get paid their agreed multiple (1-3x) before you and the founder, regardless of how much the company is sold for.
As above, the terms you went in on. Did you receive ordinary shares or preference shares? Usually, a UK investor will take ordinary shares (the same terms as the founder) which then qualifies them for S/EIS tax reliefs (acting like instant cashback on your investment of up to 50%).
Ordinary or Preference shares
So, you may be thinking, which is better? Ordinary or Preference shares? Each comes with different risks and rewards. The argument for Ordinary shares is that you get S/EIS tax relief which comes with a whole host of perks and risk mitigation.
The argument for Preference shares is avoiding dilution and getting paid first, this is usually most beneficial when the company doesn’t do as well as hoped as it reduces the risk of your investment going to zero. However, you need to consider other investors coming in at later rounds who may get even better preferential terms, reducing the benefit of yours
It’s pretty clear that S/EIS has fantastic benefits, hence why it is the preferred option for most UK angel investors. However, you (and the founder) are not protected from dilution. As dilution is not really in your control, and will likely affect your shareholding, let’s take a look at the things in your control to help you increase your returns as an ordinary shareholder.
How can I increase my return as an ordinary shareholder?
Go in very early - the earlier you go in the more likely you are to get a bigger percentage, therefore ending with a decent size (even after dilution).
Make sure you negotiate a fair valuation and only invest when there is a high potential for return - as above, the lower the valuation and the higher the possibility of the exit valuation, the better deal you’re getting
Support the company to succeed - if they are one of the top winners in your portfolio i.e 100x you will likely still get a great return on investment, regardless of dilution.
Have an investment strategy to maintain your shareholding - invest a big ticket at the start, then continue investing in future rounds to maintain shareholding or go in with a smaller ticket at the start and invest more in future rounds to maintain your shareholding.
Participate in secondaries - sell your shares when a bigger investor comes in rather than waiting for exit and continuing to be diluted. This isn’t a guaranteed option, but many angels opt to take it if it occurs.
Build a portfolio - be sure to diversify your risk by investing in a portfolio of companies rather than just placing your bets on one or two.
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