Investing in start-ups: How to set yourself up as a 'Dragon'

You don't need to have big piles of cash to invest like the Dragons just get involved in equity crowdfunding, says Ed Bowsher.

Investing in stocks can be very profitable. But for most of us, it's not an overnight path to riches. It takes a long time and patient compounding to build your wealth in the stock market.

That's partly because, by the time many companies are listed, they're at a certain level of maturity, with the most stratospheric growth already behind them.

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The people making the big bucks are the existing owners, the ones selling their stakes in the business to the public. But what if you could invest in the next Facebook (or the next Tesco even), right at the start of its life before it came anywhere near the stock market?Then, conceivably, you might get rich over a shorter timescale.

This is the promise behind equity crowdfunding, which gives private investors the chance to be small-scale venture capitalists, taking stakes in very young businesses just like in the TV programme Dragons' Den.

The basic idea is that you invest in a business that is looking to raise cash, in return for a stake. These companies tend to be early-stage and aren't listed on the stock market. Instead, they are raising money via an equity crowdfunding platform' such as Crowdcube or Seedrs.

On most platforms, you'll find several companies looking for investors, along with information on each. You can then make your investment via the platform.Each company sets a target for how much it wants to raise over a set period for example, £100,000 over two months.

If it hits the target before the deadline, the fundraising will usually be shut, although sometimes companies go into overfunding', and accept further investments over and above the original target. But if it fails to reach its target, the fundraising is closed and money returned to anyone who did offer to invest.

Note that this is very different to reward crowdfunding', which has been in the news a lot recently. This is where people give money to projects in return for a reward'. This might be anything from an acknowledgement in the final product, to something more valuable, but you're not buying a stake in the company itself.

For example, in 2012, virtual reality firm Oculus VR raised $2.4m from individuals via the Kickstarter website. All the donors received a reward, ranging from T-shirts to prototype kits' for the first Oculus virtual reality headset.

But when Facebook bought Oculus for $2bn this year, the 2012 contributors didn't see a penny. With equity crowdfunding, on the other hand, you'll get shares. So if the company succeeds, you should all being well make money too.

Of course, it's not a one-way bet, by any means. Most companies on these platforms are start-ups', so the level of risk is very high. Many will fail and investors will lose all their money. So you need to understand that going in no matter how promising a company sounds, there's a good chance you'll lose 100% of your investment. So do not invest money that you absolutely cannot afford to lose.

Even if a company survives, you may not strike it rich. Companies at this stage of development will almost certainly need to raise money in further fundraising rounds, possibly from venture capital funds.

Shares will be issued to these later investors too, so your original stake may become very diluted your 0.5% stake in the business might be diluted down to 0.003%, for example. That might not matter if the business became a huge success, but it would be an issue if it survived only asa modest success.

Another potential problem is liquidity. Remember, these companies aren't listed, so if you need to get at your money, you probably won't be able to sell your shares. Instead, you may have to wait for an exit point, which might be a sale to a private equity firm, or to a rival, or a stock-market listing. That's assuming the business ever reaches such an exit point.

One way to reduce the risk is to invest in a wide range of companies at least ten. You don't need to make all ten investments in one go you could do it over a year or so. Then there's at least a decent chance that one will be a big hit, while two or three more may do OK.

Siding with the Angels', a report by the British Business Angels Association, suggests that diversified investment in start-ups can make money. The report examined more than 1,000 young UK firms in the ten years to 2008. If you had invested in all of them, you would have earned an average annual return of 22%. But I should stress that a big chunk of this was driven by a few big winners.

You may find that you never invest in a big winner, and if that happens, then your returns could be very disappointing.

As a result of the risks involved, the Financial Conduct Authority introduced new regulation for the sector in April. It said that several different groups of people are able to invest in equity crowdfunding.

These include sophisticated' or high net worth investors, but also retail investors who confirm they will not invest more than 10% of their investable assets' inequity crowdfunding. This 10% rule is very sensible. It makes no sense to invest more than that in a high-risk area like this.

Beyond the potential returns, a big plus point for equity crowdfunding is the tax regime. The majority of companies on the platforms qualify for the SEIS the Seed Enterprise Investment Scheme.

Under SEIS, you get 50% income tax relief. So if you invest £1,000 in an SEIS company, you'll reduce your tax bill by £500. If you then hold on to the investment for at least three years, you won't have to pay capital gains tax on any profits you may make.

The only catch is that you can't invest more than £100,000 into SEIS companies in any tax year. All the platforms flag up which investments are eligible for SEIS. If you invest in an SEIS-eligible company, you should receive form SEIS 3 from the company you invest in, which you then submit with your tax return to HMRC.

The main platforms

Below we'll look at the main equity crowdfunding platforms in the UK. Crowdcube and Seedrs are the largest, but there are other interesting players too.

Seedrshas raised £9m for start-up ventures since it launched in 2012. It's now raising money at a rate of £1m a month. Seedrs has even successfully raised money for its own business on the platform, raising £2.6m late last year in fact, I hold a small stake in the company as part of my own small equity crowdfunding portfolio (more on that below).

It is using this money to expand into continental Europe, so we should see more European start-ups looking for funds on the platform soon. I've been following Seedrs for two years now, and I've been impressed by chief executive Jeff Lynn's determination to build his business in a sustainable manner.

Seedrs makes its money by charging 7.5% if money is successfully raised, and it will charge a further 7.5% on any capital gains made if the entrepreneur's company is sold at some point. The minimum investment for those putting money in is £10.

Crowdcubelaunched in 2011 and has raised money for 120 businesses. Marketing director and co-founder Luke Lang told me that £9m has been raised on the platform so far this year. It's not just aimed at start-ups it's also raised money for more established businesses that are looking to grow.

Like Seedrs, Crowdcube has raised money for its own business on the platform £1.8m in Crowdcube's case. As with Seedrs, the minimum investment is £10.

SyndicateRoom takes a different approach. It enables private investors to follow a lead investor' who is an experienced angel investor'. All of the SyndicateRoom investors will invest on the same terms as the lead investor, and benefit from their due diligence.

SyndicateRoom has a higher minimum investment level of £1,000, meaning it's harder to build a diversified portfolio. The site argues that it's better to focus on a few well-researched investments rather than spread your moneyaround.

I'm not entirely convinced at this stage even the most promising firms often fail but it's an interesting approach. SyndicateRoom only launched last year yet has already raised £6m for entrepreneurs.

Other sites include CrowdBnk which originally offered both equity and reward crowdfunding to its users but now focuses just on equity; InvestingZone; and Angels Den.

Perhaps the main difference between the platforms lies in how investments are managed once the fundraising is complete. Seedrs operates a nominee structure. This means that Seedrs manages all the investments made via its platform. Crucially, Seedrs casts the votes for all the shares.

Seedrs argues that this is the best structure because it makes life easier for the entrepreneurs they don't have to deal with lots of different small shareholders. It also makes companies more attractive to venture capitalists in future fundraising rounds, for the same reason.

Crowdcube takes a different approach. Anyone investing more than £10,000 in a company receives A' shares with voting rights. Smaller investors only get B' shares with no voting rights.

Crowdcube says that investors want to get as much control as they can, and that some venture capitalists have been happy to invest money in companies with this structure. SyndicateRoom and CrowdBnk take similar approaches.

It's early days, but at least some of the businesses that have raised money on these platforms have grown fast after that initial financial injection. One example is Righteous, which makes salad dressings.

After raising £225,000 on Crowdcube, its dressings are now available in around 1,000 UK supermarkets, 1,000 UK independent retailers and 400 stores in North America. Over on Seedrs, I'm impressed by software company Satago. It provides data on how late or early business customers pay their bills. It raised £30,000 on Seedrs in 2012. More recently, it raised £600,000 from venture capital investors.

For my own part, I've made three modest equity crowdfunding investments so far. As I mentioned, I've invested in Seedrs itself. I've also backed a new West End musical production called The Pajama Game, which has opened to good reviews.

I've put money into a start-up incubator called WebStart Bristol, which has then invested into ten start-ups itself. It's far too early to know whether my investments will be successful. But I'm enjoying the experience, and I plan to make further investments to build a diversified portfolio.

Below, I look at five of the most interesting-looking potential investments out there looking for funds right now.

The five best places for your money now

Odyssey Airlines is much larger than the average crowdfunding venture. It aims to become a transatlantic airline flying from London City Airport. British Airways already operates a service between London City and New York, but the eastbound flight has to stop off at Shannon Airport in Ireland to refuel.

The short runway at London City means that BA's planes can't leave London City with a full tank. But by using a different plane the Bombardier CS100 Odyssey will be able to fly non-stop to New York.

Each flight will have the capacity for 40 business class customers; there won't be any economy passengers. Odyssey has already raised more than £5m from other sources, including well-known venture capitalist Jon Moulton.

Business description: AirlineInvestment target: £1mEquity stake for new investors: 5%Platform: CrowdcubeCampaign expires: 13 June

Minicabit: mobile apps' for booking taxis are all the rage at the moment. The best-known app is called Uber. This enables you to hail a minicab on the street via your phone.

You may have read about London black cab drivers protesting against Uber which they see as a threat to their businesses recently. Uber is way too big to raise funds on a crowdfunding platform, but UK rival, Minicabit, is currently looking for investors on Seedrs.

Minicabit is really an aggregation service where you can compare prices charged by different minicab operators. Unlike Uber, it doesn't actually provide the driver in fact, Uber's taxis might be listed on Minicabit in the future.

The clever thing about Minicabit is that it aggregates providers at both ends of your journey. So if you want a taxi from Birmingham to Leamington Spa, Minicabit will probably find you cab firms based in Leamington Spa as well as in Birmingham.You may get a cheaper fare this way.

Minicabit CEO, Amer Hasan, told me that around 400 minicab firms are currently signed up with his service, and some have invested in Minicabit via Seedrs. I think that's a good sign. Another minicab app called ubiCabs will soon start raising money on CrowdBnk, but it appears to be a smaller player than Minicabit.

Business description: Online minicab appInvestment target:£150,000Equity stake for new investors: 5%Platform:SeedrsCampaign expires: 14 June

GoCarShare enables people to share journeys in private cars. It raised £50,000 in a first round' last year on Seedrs and is looking for a further £75,000. GoCarShare has so far facilitated 26,000 journeys, so it's still early days, but the company has secured a licensing deal with Telefonica/O2.

Initially this partnership only serves Telefonica staff, but GoCarShare hopes the partnership will broaden from here. Passengers normally pay the driver 9p a mile less for long journeys and GoCarShare takes a 15% commission.

Business description: Online car sharing serviceInvestment target: £75,000Equity stake for new investors: 7.32%Platform: SeedrsCampaign expires: 10 June

Canary Systems offers a home monitoring system so that family members can make sure an elderly relative is OK. This is normally done using four wireless sensors in the home. Crucially, the elderly person doesn't have to wear any alarm or device to make this work such devices often go unworn.

Using the system, families can check their relative is behaving as normal going to bed and using the bathroom at normal times, for example. They can also see if a care worker has visited.

Business description: Home monitoring for elderlyInvestment target: £250,000Equity stake for new investors: 14.29%Platform: SyndicateRoomCampaign expires: Not announced

NearDesk is a clever concept that I've never come across before. The idea is that many people don't want to do a long commute to an office every day, but they don't want to work from home either there may not be space or there may betoo many distractions.

Thanks to NearDesk, you can hire a desk that is near your home and is part of a normal office environment. You pay an hourly fee for the desk and you can also hold meetings in the same office if you wish. This is the company's third fundraising on Seedrs.

What's particularly interesting is that Harry Platt, former chief executive of Workspace, has joined the company as chairman and has invested £50,000 via Seedrs I'm impressed that someone with a background in commercial office property thinks that NearDesk might be a winner.

Business description: Renting deskspace by the hourInvestment target: £600,000Equity stake for new investors: 14.88%Platform: SeedrsCampaign expires: 8 July