New analysis from legal-tech firm FounderCatalyst reveals the number of start-up investments needed in order to receive the optimal return is approximately 25.
The research shows that this will lead to a 2.77 times return, or a 3.19 times return, when taking into account the 30% tax relief with HMRC’s Enterprise Investment Scheme (EIS) (returns would be even higher if using the Seed Enterprise Investment Scheme (SEIS)).
This optimal number of investments is higher than the actual average number of investments made by angel investors, which is 17, showing that many angel investors could optimise their portfolio by increasing its size over time.
The findings use data from a report by UK British Angels Association and British Business Bank: The UK Business Angel Market 2020 (p20 & 22). FounderCatalyst used a Monte Carlo simulation to drill into data covering 300 exits from 2018/19 and the rate of return on original investment.
The analysis shows it doesn’t pay to put all your eggs in one basket: the return from just two investments is 1.5 times the money invested, excluding any EIS tax relief.
But it also shows that an investor gets diminishing returns beyond 25 investments – though more investments still means greater returns overall. The data shows a peak return of around 2.77 times for a portfolio without the benefit of EIS or 3.19 times with the benefit of EIS.
According to the analysis, a ‘concentrated’ portfolio of 3 investments is likely to yield, on average, worse returns than a portfolio of 10 companies. So rather than investing £10,000 each in three companies, it would make sense to invest £3,000 in 10 different companies.
The findings suggest that, despite the Coronavirus pandemic, UK start-ups are an attractive asset class for investors, especially given the SEIS and EIS tax relief. And though increases to Capital Gains Tax and Inheritance Tax look likely, SEIS and EIS investments are exempt from both.
Sam Simpson, COO at FounderCatalyst and angel investor comments: “Angel Investing is increasingly seen as an attractive asset class especially at a time when tax reliefs are being squeezed and Capital Gains and Inheritance Tax are under review.
“Angel wisdom has always dictated that you ‘shouldn’t put all of your eggs in one basket’ but I’ve never been able to find an analysis of exactly how many eggs I should have to optimise my portfolio. This analysis shows a portfolio of 25 companies is the sweet spot.
“It would be remiss not to acknowledge that angel investing isn’t for everyone – it is a relatively illiquid asset class – and to take advantage of the SEIS and EIS schemes you need to hold the investment for at least 3 years. Before investing, you should also consider the potential impact of Coronavirus and Brexit on the business model of the investee company.”
Jenny Tooth, Chief Executive, from the UK British Angel Association, comments: “Diversification is important for any investor, especially in these difficult times when new investments should be made carefully. But it is reassuring that high performing portfolios can be achieved taking a relatively lean approach – delivering good returns for angel investors at a time when we need many more investors to see the benefits of backing entrepreneurs across the UK.”