How to invest in startups?

Who can invest in a startup?

While investing in startups was the preserve of private equity professionals until the end of the 1980s, it became highly democratized with the arrival of the Internet in homes. The reduction in the number of intermediaries and the associated costs make it an increasingly attractive investment for individuals wishing to boost their portfolio.

What is the shareholder's gain or remuneration?

Individuals investing in startups in exchange for shares can be paid in two ways: through dividends, which correspond to a portion of the cash paid to the owners of the business, and through the realization of capital gains during the resale of shares. The first possibility is rare in the case of young companies, which need to reinvest every euro of cash in order to finance their growth. The second option requires finding a buyer who agrees to acquire your shares at the desired price, which involves a valuation exercise that can be complex given the absence of market capitalization and recurring revenue.

The absence of dividends and the illiquidity of startup shares are the price to pay for hoping to outperform. The Fama-French three-factor model, which is an authority in the world of university finance, highlights a market anomaly in which the shares of small companies outperform, on average, the shares of large groups (the two other factors of outperformance being investment in value and portfolio diversification). The study by the two economists focuses on listed small caps, but can be extrapolated to startups, whose two- or triple-digit growth rates open up more attractive return prospects than those of companies that are already firmly established in their market.

Investing through crowdfunding

A first way to invest in startups is through crowdfunding platforms. Named Wiseed, Crowdcube or Sowefund, they have blossomed on the web in recent years and offer individuals the opportunity to invest in startups with an entry ticket accessible to all budgets.

Several financing methods should be distinguished: crowdfunding, which is a loan granted to the company in exchange for the payment of an interest rate, and crowdequity for which the investor receives shares in the company in exchange for his investment. The first is less risky than the second because, in the event of a company bankruptcy, creditors have priority over shareholders for the repayment of their debt. However, it should be noted that many startups, particularly in the IT field, have few tangible assets and can therefore have a liquidation value close to zero; causing a net loss for lenders and shareholders.

The performance of the second method of financing is more uncertain, as it depends not on the financial capacity of the firm to honor its debts, but on its total valuation. A company that survives financially can thus enrich its creditors while leaving its shareholders on the run, for lack of cash to pay dividends or significant progress justifying an increase in its valuation. Conversely, in the event that the profits of the startup take off, the shareholders will reap the benefits of their investment, while the creditors will only receive a fixed interest rate defined in advance when the loan is contracted.

Startup tax exemption: think of FCPI and FIP!

Mutual Funds for Investment in Innovation (FCPI) and Local Investment Funds (FIP) are two financial vehicles that allow you to invest in startups or SMEs, while benefiting from tax exemption: up to 25% of the amount invested can be deducted from your income taxes, taking into account payments made up to 12,000 euros for a single person and 24,000 euros for a married couple.

In concrete terms, after selecting the fund that interests him, the investor acquires shares from his broker or bank, which are blocked for a period determined by the fund managers (most often 8 years). FCPIs and FIPs are therefore medium-term investments, whose gains (or losses) are only realized after several years.

Venture capital funds (Venture capital)

Venture capital funds specialize in taking stakes in unlisted companies (private equity), which are most often startups. The objective of these funds is not to support these companies until their maturity phase, but to start them up and then sell them as soon as the business plan results in solid and fast-growing recipes.

Some venture capital funds are listed on the stock exchange (Oaktree, Saratoga Investment, etc.) and some are eligible for a PEA, such as the Dutch holding Prosus, which has participations in both listed companies (Tencent, Delivery Hero, Udemy, etc.) and unlisted startups; or the French fund Eurazeo, which has more than 31 billion assets under management.

Conclusion

Whether you choose to invest in crowdfunding, via an FCPI, a REIT or by acquiring shares in a venture capital fund, the important thing is to carefully analyze the startup (s) in which you are investing your money. In particular, it is essential to verify the solidity of the project, the integrity and track record of the management team and whether institutional investors are present in the company's capital. Once this verification work has been done, all that remains is to let time do its work to, perhaps, find yourself a shareholder in the next Google or Facebook!