Investment

What is venture capital / angel investing / startup investing?

Deliveroo, Uber, Netflix. These were all companies being run out of bedrooms at one point. They’ve had millions invested into them, and today they stand as some of the most important companies in modern society.

Startups are a crazy beast. In this article, I’m going to dig into what startup investing is all about. We’ve been startup investing for some years now so and wanted to share what we have learnt – as this is an asset class around which there is a surprising amount of mystique.

I’ll also be sharing the Islamic angle on startup investing and whether this is all sharia-compliant.

What is a startup?

In short, a startup is high-potential, scaleable company. They usually operate in markets that are ready to be disrupted. The classic example would be Uber and the taxi industry.

A startup is NOT simply a new business. A new business selling oranges on the high street is not a big, high-potential, scaleable company.

Why is startup investing so big these days?

In a world where people find it hard to make good returns, startup investing offers the high-risk high-reward potential that many people crave.

That is why venture capital funds have been doing well in fundraising recently.

An early stage venture capital fund is a fund that invests in startups (£200k-£2m typically), usually once the company is a year or two old. Angel investors are individuals who invest earlier, typically between 0-4 years of a company’s age. All of these investors are looking for high growth companies with the potential to scale up to at least £100m companies. Due to these motives, startups that take such capital (fund capital in particular) are incentivised to grow quickly and get to that scale – as their investors ultimately want to cash out.

We recently caught up with Husayn Kassai, co-founder of Onfido. They’ve had the likes of Google and Microsoft invest in them. Running some quick numbers, it is very likely early investors in Onfido have made 500x returns. In real terms, that’s me or you putting in a cheeky 5 or 10 grand a few years ago and it now being worth £2,500,000 or £5,000,000.

There isn’t really an asset class that can get close to those returns. On top of that you can also get some great tax breaks on startup investing in the UK. This can mean that you can get 30-50% of your investment back as a tax break.

Is it risky?

Fairly. That’s why the returns are so massively high if you do manage to hit on a successful one.

It’s certainly not something to be putting all your life savings into. The way we’ve approached it is to allocate the spare capital in our portfolio to startup investing (maximum around 20% of our overall portfolio). If we lose it, it’s not the end of the world. But if it works, it could propel our wealth significantly.

The way to properly invest in startups is to mitigate this risk by being very disciplined and investing a set amount every month (or every few months) so that you build up a basket of 10-20 startups over 2-3 years. The old adage “don’t put your eggs in one basket” applies particularly strongly to startup investing where you will almost certainly have a few companies fail in your portfolio.

How do you find startups to invest in?

Because startups are private companies, you can’t just easily pick off the best ones by just going on a stock exchange. But there’s a few ways to invest in startups.

Firstly though, what you should understand about the startup world is that the hottest startups are invested in off-market through private networks and the first you will hear of them is an announcement on Techcrunch or the Financial Times. It’s only if you’re connected to these networks that you know who the hot startups are, when they are raising investment, and if you are lucky you’ll get to invest in them.

Nonetheless, here are some ways you can begin startup investing:

  1. Go to a public platform designed for small startup investors. Seedrs is a good example of this. The pros here are that it’s super easy to invest and you can invest small amounts and Seedrs have a decent infrastructure. However, the con here is you have to slightly question the quality of the deal flow coming through and why they couldn’t raise investment privately. There’s sometimes a genuine answer to this though – for instance, maybe they wanted to do a public fundraise as part of a brand awareness strategy. You will also have to log in and spend some time each month doing your own analysis and due diligence – a time-consuming activity. The other big downside is that there is no sharia-compliance screen that you can rely on. No one checks what the company’s documents say about debt, negotiates the relevant protections in or considers whether the company’s long-term strategy is to stay in sharia-compliant products. This lack of sharia-compliance also means you can’t just automatically invest in an EIS fund that invests in lots of startups – as you have no guarantee they will be sharia-compliant.
  2. Start embedding yourself deep into the startup space and founder networks so that you get to learn about these companies first-hand. If you’re willing to spend a bit of time and you’re genuinely interested in the startup world, then this is the way to go. You’ll know first-hand when a company is raising money and you may be allowed to invest. This is a serious option if you are high net worth and you can bring a decent cheque size to the table and you are willing to spend years building out that network. You will start off seeing the worst deals, but slowly (if you’re good at building networks and adding value) you will start seeing the stronger deals.
  3. Become part of a syndicate. These are groups of people who invest together. We’ve been running our own angel list for a while now. Alhamdulillah, because we’re very entrenched in the founder networks (we are a startup ourselves and have background in venture capital legal work), we get access to very strong deal flow. Because we all invest together, we can invest a decent amount into a startup too. We’ve weaved our way into some very hot deals, including deals where we’ve invested with the Twitter co-founder, Serena Williams, Bill Gates, and others. We invest ourselves into each deal – so our interests are completely aligned. If you want to be part of our angel list (minimum £5k commitment per deal but you get to choose which deals you want to invest in), then sign up to the IFG Angels list.

Is startup investing sharia-compliant?

Yes. In fact, it’s completely Islamic at its core. You’re combining capital with human endeavour for a share in the return.

There are a few things to watch out for though:

  1. Is the business of the startup sharia-compliant? You’ll need to think not just about the core business and what they do, but also about how they actually make money. So for example, a startup that sells some clever software that automates when a housebuilder should order their bricks, that sounds absolutely fine from a sharia-compliance perspective. But if you dig a bit deeper and you find that the way they’re monetising this software is not by selling the software itself, but by providing interest-bearing financing for the housebuilders to buy these bricks, then that is problematic.
  2. You should also check that the company hasn’t taken on any interest-bearing financing. It would be unusual for a startup to do this, but not unheard of. You can find this out by asking the question of the founder. You should also talk to the founders on their vision for when the company gets bigger and their appetite for debt.
  3. There are also debt-like shares/instruments that enter the fray, particularly at later rounds which you should be alert to.

Why do we care specifically about startup investing?

Beyond the actual potential financial gains we care deeply about impact.

Our view is that if we want the next tech billionaire to stem from the Muslim community, we need to be backing exceptional Muslim founders. Only when we create that ecosystem can that happen. Through the IFG Angel List that’s what we hope to bring about.

We don’t just invest in Muslim founders though. We invest in anything exceptional (as long as it is sharia-compliant) and impactful. We think that as if our angel list can access these high-quality deals with relatively small entry sizes, we’ll not only be propelling the wealth of the Muslim and BME community, we will also be bring our wealth to bear on some of the knottiest problems that are facting mankind (such as climate change) and so helping the lives of all.

Where can I learn more about startup investing?

We’re actually in the midst of shooting a groundbreaking startup course designed for potential angel investors who want to learn more.

We know that startup investing is a weird and wonderful world.

We’ve got a bunch of really quality people together to deliver a course on the A-Z of angel investing. We’ve got the likes of the founders of Muzmatch, Quit Genius, Onfido, Scoodle and others. We’ve also got renowned VC fund managers like Hussein Kanji (early investor in Deliveroo) and others on board too.

We’re going all out on this course to deliver something that’s truly groundbreaking and useful to take someone from not knowing anything about angel investing.

Whilst the course is still being shot, we’re offering a 10% early bird discount for people who register their interest. Just fill in the box below to secure your 10% early bird discount and get notified as soon as it’s ready to purchase. Offer ends 11pm on 28 February 2020.

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