Which is better for Business Angels? A residential property investment or Seed EIS?

Many business angels have invested in residential property. As a result, they often compare the yield of the property with the dividend that a startup business might offer and then the relative capital growth potential of the two investments.

But, can a Seed investment compare – in terms of risk and return – with a property portfolio?

Until recently, the startup investment opportunity has fared badly compared to the residential property investment.

However, as this property price forecast report argues, residential property investors have already lost a lot of money in the past 5 years – 21% of the property value – or perhaps 100% of their original deposit?

Whereas, now, under the UK’s Seed EIS scheme, those investors can get at least half their money back from their tax return. In fact, if a UK investor has a capital gain and re-invests the same money he can get 78% tax back.

Note, this is not a tax deduction but a rebate. So, if you invest 100k in a UK seed company, then you’d get 78,000 off your tax bill – assuming you pay tax of course.

Bricks and mortar vs code

Property is typically thought of as ‘as safe as houses‘ or, you can lose everything but never your property and land!

Investors like to think also that property is ‘safer’ because they control it and not some faceless fund manager or overpaid CEO.

However, this usually misses key points.

Firstly, property only survives if you spend money maintaining it. Leave a building empty and uncared for for 3 or 4 years and the building will be wrecked. A house needs to be heated and kept in good condition – this is a cost that needs to be met always. Hence, it carries liabilities.

Secondly, the price of the property is effectively a financial derivative. That is, the value of the property is not someone will pay for it but the amount of money a bank will lend for someone to buy it. The value is determined by many things but significantly by the amount of credit available.

Lastly, changes is laws – both local planning laws and renting or tax laws – affect the value of properties or your ability to achieve a rent or sale.

Investment in seed startups is high risk for different reasons.

Firstly, you are really buying two things – code or knowledge – and team work. And both of these can collapse and leave you with nothing.

In otherwords, all seed investments are based on something that some one knows (including people he or she many know) and has written (words or code). Code and knowledge are copiable and can not be defended until one or other are turned into protected intellectual property (in the form of patents) or brand (such as Facebook which has copiable code but you can’t just create another Facebook). Or, it may turn out that the knowledge and code didn’t connect with the market afterall.

Secondly, the ability to draw value from the code or knowledge depends on a team. The team must be both motivated and able. In fact, the team have to want to be together and want to remain together too.

One of the key reasons that startups fail is not the idea, but because the team no longer trust each other enough to keep investing time and effort (and sometimes money) in the hope or belief that the business will succeed.

These two risks are the key risks for all business angels – that the knowledge or code doesn’t deliver and that the team fails to function at a high level.

However, there are three  things that you can do to reduce this startup risk

  1. Ensure that your Seed investment has customers on board before investing – even at the most basic level – this significantly reduces the risk of market rejection and demonstrates that the startup team understand the significance of making sales (you may or may not be surprised how many do not get this).
  2. Assess the team – both from the perspective of skills – but also by looking at both the character of the individuals and how those individuals fit together in a team. You can either do this by developing the experience of assessing people or you can get support and help by using something like the eTeamTool.
  3. Use the UK Seed investment scheme to get a rebate of upto 78% of your money invested to make a series of investments and so spread your risk.
Seen in this way, the best busienss angels will develop fabulous sector /product skills but also be greater leaders of teams. A business angel who grasps this and is able to deliver this skill is worth a great deal.
On the other hand, trader business angels, who are used to buying low and selling high whilst adding little to the process or development of the business (as per the property example) are of low value to the startup.
Hence, becoming a great and successful business angel is about tackling the real risks that face startups – and these are principly human or character risks and not just the ability to trade.

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