Why invest in businesses?
Beyond the potential profits that may come from investing in a portfolio of businesses, investors can enjoy a few additional benefits of buying into businesses they believe in.
First, it’s a chance to be a part of the next big thing – to be like the dragons on Dragon’s Den and pick exciting businesses, follow their progress as they grow and get credit and recognition for having been one of the first people to spot them.
Second, you get to contribute to the culture of innovation by supporting entrepreneurs when they need it most and giving them a chance to get great new businesses off the ground.
Third, it’s a way to get involved with innovation in an area you’re interested in or are passionate about, and share in the success of the business.
And, it is the opportunity to support your friends and family on their exciting new business endeavour.
What are you investing in?
Investing in businesses (equity crowdfunding) is about picking early-stage and growth-focused businesses that you think have the potential to grow. You invest money in them in exchange for a portion of their equity, meaning that you buy shares in their business. If a business that you’ve invested in succeeds, the shares that you own will become worth more than what you paid for them, and you may be able to sell them at a profit or receive dividend payments in the future. However, if the business fails – as many businesses do – you will lose some or all of your investment.
What are the main risks of investing in businesses?
There are three broad types of risks when investing in early-stage and growth-focused businesses. The first is that the business will simply fail – or even that it will tick along without ever really succeeding – and you won’t get any of your money back.
The second is that even if the business succeeds, your investment is likely to be illiquid. Even a successful investment will be locked in for a long time – often several years – while the business grows. This means that you are unlikely to be able to sell the shares, and you will likely not receive dividends, in the early years of your investment no matter how successful it later turns out to be.
Finally, there is the risk of dilution. If the business raises more capital later on (which most successful startups need to do), the percentage of equity that you hold in it will decrease relative to what you originally had. Dilution in itself is not always a bad thing, and this blog postexplains why it is often to be welcomed, but it is something of which you should be aware.
Read our Risk Warning for additional information about the risks associated with investing in early-stage and growth-focused businesses.
The importance of diversification
The key to investing in early-stage and growth-focused businesses successfully – and mitigating the risks described above – is diversification. Most businesses fail, but the few that do succeed can do so to such a degree that they more than make up for losses. This means that in order to achieve strong returns, you need to have invested in a few of the big winners. Your chances of doing so are much greater if you build a diversified portfolio by investing small amounts in many businesses rather than large amounts in just a few. And when we say many, we mean many. We believe that an effective portfolio should include at least 50 early-stage and growth-focused businesses and potentially 100 or more (there is even data out there to suggest that investing in as many as 800 companies may greatly increase your performance).
One of the main reasons we developed Seedrs was to make it easy to create a diversified portfolio of investments you choose. By setting the investment minimum very low, we make it possible to invest in many businesses – no matter how much money you are prepared to invest.
The main way you can make money from your investments is by selling your shares in the businesses for more than you paid for them. There is no active secondary market for shares in private businesses, meaning that you won’t be able to sell them immediately. However, if the company grows to the point where it floats on a stock exchange, is bought by another company or conducts a share buyback, you are likely to be able to sell your shares – often at a significant profit – at that stage.
Alternatively, some businesses may begin paying dividends. This can occur if the business has achieved profitability but does not expect to continue growing significantly; it can also happen in cases such as theatre productions or films, where the company has a limited duration and distributes any profits at the end.