For most individuals looking to start their journey as an investor, small businesses or startups provide the perfect entry point. Most angel investors start by investing small figures into a number of early-stage businesses, building up a portfolio of larger investments as they become more experienced and better able to identify businesses with potential for healthy returns.
Investment into small businesses plays a vital role in boosting the overall economy. In 2022, entrepreneurs in the UK supported almost 200,000 UK jobs, generated £28.8 billion worth of business activity in and contributed £14.3 billion in GDP impact highlighting how crucial support for startups and small business is to the financial health of the country. By funding startups and small businesses, investors not only have the chance to gain substantial returns but also support companies which drive a huge amount of positive change beyond economic growth and job creation.
Startup founders are generally driven by their entrepreneurial spirit, passion for their ideas and a commitment to achieving their goals. With this comes new mindsets, new ways of doing business, and typically greater adaptability to changing market conditions than seen in traditional corporate businesses. Small businesses may not be as influenced by macroeconomic changes as larger companies and this resilience and adaptability in an increasingly changeable world is a benefit to investors, employees and the wider ecosystem.
Some of the most innovative and influential businesses of the past 20 years have grown from tiny startups to multi-billion dollar unicorns. Startups think outside the box, drive progress, and foster creativity and competition, which can mean massive returns for investors into those companies who achieve significant growth.
Startups also tend to put more money into local economies, sourcing goods and services from their area or region, which can have a multiplier effect and positively influence the economic health of an area. Startups are also more likely to build diverse and inclusive teams and take positive action on social or environmental issues, such as ethical supply chains, community engagement and waste reduction.
While investing in small businesses carries some level of risk, it also offers the potential for high returns. If a small business experiences significant growth or is acquired by a larger company, investors can reap substantial rewards. Overall, investing in small businesses is not only financially rewarding but also supports economic development, job creation, innovation, and local communities, making it an important component of a well-functioning economy.
What is small business investment?
Investors provide capital or financial resources to a small business in exchange for ownership stakes, equity, or debt securities. This investment is typically made with the expectation of generating a return on the invested capital over time. There are two types of investment commonly made into small businesses and startups:
- Equity Investment: In an equity investment, the investor provides capital to a business in exchange for ownership shares or equity. As a result, the investor becomes a shareholder and holds a percentage of ownership in the company. The investor's potential return on investment comes from the company's profits and increased valuation over time. Equity investors may also offer advice and contribute to the decision-making process of the business, depending on the terms of the investment.
- Debt Investment: In a debt investment, the investor lends money to the small business in the form of a loan. The small business agrees to repay the loan with interest over a specified period. Unlike equity investors, debt investors do not become owners of the business and do not share in the company's profits or growth. Instead, they receive periodic interest payments and the return of the principal amount when the loan matures.
Investing in small businesses and startups can be an attractive opportunity for investors seeking potentially higher returns compared to investment into more established companies. However, it also carries higher risks due to the inherently volatile nature of these businesses, which may have limited track records and face greater challenges in the competitive market. Before making any small business investment, thorough due diligence and careful evaluation of viability, growth potential, and risk profile should be undertaken.
Who can invest into small businesses?
Small business investments can be made by angel investors, syndicates, venture capitalists (VCs), and private equity firms.
Angels typically invest anywhere between £10,000 and £50,000 in the UK, though some may invest as much as £150,000.Angels look to invest at a very early-stage, helping businesses to get off the ground through providing capital and, in many cases, offering mentoring, business advice and strategic input. Typically, angel investors will need to self-certify as either a Sophisticated or High Net Worth (HNW) or Investor, as defined by the FCA under the Financial Services and Markets Act 2000 .
Angels often create or join existing syndicates, which are groups of investors who agree to invest together in a business. A syndicate can be put together by angels or those looking for investment and they frequently comprise angels from multiple investment networks. The syndicate will have a lead investor whose role it is to conduct due diligence, negotiate terms and source more investors to bolster the syndicate if necessary. Once an investment is made, the lead will be the conduit between the investees and the syndicate and most likely be the main source of advice and support to the business.
Investing via a syndicate can reduce the risk of bad investment through the combined knowledge and experience of its members and, due to the larger sums of money available, syndicates can negotiate better terms than individual angels.
Venture Capitalists are professional investment firms that manage pooled funds from multiple investors. They typically invest in startups and early-stage companies with high growth potential; VCs usually take an equity stake in the business and play an active role in its growth and development.
Individual investors or entities (such as family offices, pension funds, and insurance companies) who provide funds to VCs have to be Limited Partners (LPs). A limited partner - often called a silent partner - invests money in exchange for shares but has restricted voting power on company business and no operational involvement in the business. A limited partner’s liability is limited to the amount that they have invested in the company. Individuals investing money via VCs tend to be experienced investors with large sums of money available to deploy.
Crowdfunding has opened up investment opportunities for those who would typically have been unable to invest into early-stage companies. Equity crowdfunding allows people to invest in unlisted companies at the start of their journey in exchange for shares, providing partial ownership of a company and the potential to make profit should the company do well. The flip side, as with any form of investment, is that investors stand to lose some or all of their capital should the company struggle or completely fail. Prior to the advent of crowdfunding, only HNWs, VCs, and angels could invest in startups but this new way of funding has democratised the early-stage investment space.
What are the different types of early-stage business investment?
At very early-stage, founders typically secure funding from a combination of the following sources:
- Bootstrapping - a method of funding a startup where the founder uses their own resources and operating revenue from the business to fund its growth, rather than seeking external funding from investors or loans from banks.
- Family & friends - startups can choose to raise money from their personal networks. This often takes the form of numerous small sums invested by friends, family and close contacts and does not require those providing capital to be sophisticated investors.
- Loans - startups in the UK can apply for a government-backed Start Up Loan of between £500 to £25,000 to start or grow their business which is unsecured, unlike personal business loans which need to be secured against property of a director’s guarantee.
- Crowdfunding - a process by which startups can raise money from a large number of people, often through an online platform. This could include rewards-based crowdfunding where backers receive a product or service in exchange for their contribution or equity crowdfunding where backers receive shares in the company.
- Angel investment - Angel investors are high net worth individuals who invest their own money in startups in exchange for equity. They often invest in early-stage companies and can provide not only capital, but also mentorship and expertise. Angels generally have a high risk appetite and as they invest very early they will expect their terms to reflect this.
What are the benefits of investing in start-ups?
Investing in startups can offer various benefits for investors, which are outlined below:
- High Growth Potential: startups often have significant growth potential. If successful, they can experience rapid expansion and increase in value, providing investors with substantial returns on their investment.
- Early Entry Advantage: early investors may benefit from lower valuations and a larger ownership stake than those that invest once companies are more established.
- Diversification: the performance of startups does not always correlate with traditional financial markets, which can help spread risk and enhance the overall stability of an investment portfolio..
- Innovation and Impact: Investing in startups can be a way to support innovation, groundbreaking ideas and disruptive technologies.
- Active Involvement: many startup investments come with the opportunity to actively engage with the founders and management team, providing advice, mentorship, and networking opportunities.
- Tax Benefits: in the UK, there are two venture capital schemes which offer tax relief to individuals to encourage them to invest in small, high risk companies, EIS (Enterprise Investment Scheme) and SEIS (Seed Enterprise Investment Scheme).
- Building Connections: Investing in startups often involves networking with other investors, entrepreneurs, and industry experts, which can lead to valuable connections and potential future opportunities.
- Access to New Markets: Investing in startups can grant exposure to emerging markets and industries, opening up new investment opportunities and potential revenue streams.
What are the risks of investing into startups?
Despite the benefits listed above, investing in startups comes with inherent risks. A significant portion of startups may fail, leading to a loss of invested capital, so it’s crucial for investors to conduct thorough due diligence, have a clear investment strategy, and be prepared to diversify their investments to mitigate risks.
Investing in startups is typically considered a high-risk, high-reward activity and investors should carefully assess their risk tolerance and long-term investment goals before committing funds to early-stage ventures. Seeking advice from experienced investors can provide valuable insights and guidance in navigating the startup investment landscape.
How to find business opportunities to invest in
Finding opportunities to invest in small businesses requires a proactive approach and a combination of networking, thorough research, and participation in relevant events. Building a network of entrepreneurs, business owners and other angel investors is hugely beneficial. Once you are underway with your investment journey, angel investor groups can be a great pathway, with members pooling resources, sharing deal flow, and conducting due diligence collectively, all of which can help you access a broader range of investment opportunities.
Attending industry events, networking meetups and pitch events allows you to meet not only other investors but also founders, providing the opportunity to learn about a range of early-stage businesses and their potential. Connectd hosts regular startup pitch showcases giving investors access to the most innovative startups on our platform.
Connectd’s unique smart match technology also provides the data and insights needed to assess the suitability of businesses when considering investment. Providing real time data insights on key metrics such as ARR and CAC, and identifying the startups that match your specific investment criteria, the platform can support you on your angel investment journey.
Remember, investing in startups and small businesses involves risks, so it's crucial to conduct thorough due diligence and seek advice from financial professionals if needed. Understanding the business model, market potential, and the team behind the startup is essential before making any investment decisions. Always invest funds that you can afford to lose and be prepared for the possibility of a long-term investment horizon before seeing any returns.
Evaluating Small Business Investment Opportunities
Evaluating Small Business Investment Opportunities
Evaluating small business investment opportunities requires a comprehensive and methodical approach to assess the potential risks and rewards. Here are some steps to guide you through the evaluation process:
- Understand the Business: Start by thoroughly understanding the nature of the business, its products or services, target market, competition, and industry trends. A clear understanding of the business model is crucial before proceeding further.
- Financial Analysis: Review the company's financial statements, including balance sheets, income statements, and cash flow statements. Pay attention to key financial ratios, such as profitability, liquidity, and debt levels.
- Market Potential: Assess the market size and growth potential of the business. Is there a demand for the product or service? Is the market saturated, or are there opportunities for growth
- Competitor analysis: identifying the competition will allow you to understand the company's position in the market. Evaluate the strengths and weaknesses of competitors and how the business can differentiate itself.
- Founding Team: Evaluate the expertise and experience of the founding team - a strong and capable team can significantly impact the success of the business.
- Risk Assessment: Identify and evaluate potential risks associated with the business, such as market risks, operational risks, regulatory risks, and financial risks.
- Growth Strategy: Understand the company's growth plans and strategies for the future. Does the business have a clear plan for expansion, and is it feasible?
- Return on Investment (ROI): Estimate the potential return on investment. Calculate the projected ROI based on financial projections and consider the time frame for achieving returns.
- Due Diligence: Conduct thorough due diligence on all aspects of the business. This may include legal, financial, and operational due diligence.
- Exit Strategy: Consider the exit options for the investment. How and when will you be able to realize the returns? Having a clear exit strategy is important in evaluating the overall investment.
- Personal Fit: Assess how the investment opportunity aligns with your personal investment goals, risk tolerance, and overall portfolio diversification strategy.
Want to know more? Become an investor with Connectd
Connectd has supported hundreds of successful investments into innovative early-satge startups. With our data driven approach, smart match technology and unique deal flow tools, investors have all the information and insights they need to assess relevant investment opportunities through our match with metrics function.
Our platform brings together the three sides of the early-stage ecosystem - investors, founders and board advisors - allowing our members to keep their fingers on the pulse,share knowledge and create valuable connections. Our exclusive investor community provides an open forum for investors to share deal flow, discuss the latest news and find opportunities while our regular pitch events give investors direct access to the most exciting businesses on our platform.
Investors can join the Connectd platform at no cost - learn more and sign up here.
