Risks Associated with Investment into Start Up & Growth Companies
Investing in start-up and growth companies involves a high degree of risk. Investors should be prepared to lose some or all of the money that they invest. Prospective investors should carefully consider all of the information in the offering documents before making an investment into a company and carry out their own due diligence as necessary.
The following risks do not necessarily comprise all the risks associated with investments into start-up and growth companies and there may be additional risks currently unknown or which may be specific to certain companies that may also have an adverse effect on that companies business.
Target returns are for illustrative purposes only and no forecast (guaranteed or otherwise) is implied or should be inferred. Investment value may fall as well as rise and Investors may not get back the full amount subscribed. The majority of start-up businesses fail or do not grow as planned and therefore investing in these businesses can involve significant risk. Investors may lose all, or part of their investment. Investors should only invest an amount they are willing to lose. If a business an Investor invest in fails, none of the money invested will be repaid by the business. Start-ups or early stage companies will very rarely pay dividends to their shareholders (if at all), as such investing in these types of company does not give a regular return on an investment. Even if a company is very successful, Investors may not see any return on their investment until such time as a sale of all of the shares in the relevant company.
Investment Portfolio Diversification
Diversification is an essential part of investing. By building a diversified portfolio Investors spread risk and increase the chance of an overall return on investments. Investors should invest only a limited proportion of available investment capital into start-up and growth stage companies. These should be balanced with safer, more liquid investments with a more predictable and secure return.
Lack of liquidity
Investments in unquoted companies are likely to be more difficult to sell than shareholdings in AIM-quoted companies or companies on the main London Stock Exchange. Investors should be aware that there is no market for such shares and they are not readily realisable. Even in the event that a buyer can be found by the Investor on the secondary market, the Investor may have to accept a significant discount on their shares in order to realise their investment early. Investors should consider an investment to be a medium to long term investment. Investments may also be subject to dilution as a result of the grant of options (or similar rights to acquire shares) to employees of, service providers to or certain other parties connected with, the investee company.
In the majority of cases Investors in small stage companies will only acquire a minority interest in the company they invest in. Buying a minority interest entails certain risks and individual investors will have little or no control over the company and its business.
Limited Operating Histories
Start-up and growth companies are unlikely to have established any revenues or operations that will provide financial stability in the long term. There can be no assurance that companies will realise their plans on the projected timetable in order to reach sustainable or profitable operations. It is likely that companies will require additional capital funding. There can be no assurance that such capital shall be available at reasonable cost, or that it would not materially dilute the investment of existing shareholders if it is obtained.
Investing in smaller, unquoted companies is, by its nature, high risk. Information regarding the value or the risks that these companies face may not always be available. In addition, there is no guarantee that the valuation of shares will fully reflect their underlying net asset value, or that the shares can be sold at that valuation.
The performance of a company will depend upon the skill and expertise of the Directors and senior management (and any Investment Consultants, Advisers, Fund Managers etc engaged). The departure of any of these could have a significant effect on the performance of a company.
It is possible a new competitor could overtake and dominate the market or area that a company operates. The market or area that a company operates in may have a low barrier to entry. Even where it may be considered that a high barrier to entry exists at the time of investment this may not remain the case in the future.
Investment into companies that operate in the fast moving technology world may be superseded by a new technology their ideas or underlying modus operandum become uncommercial. This would render their product or service of little utility even before it has been able to turn a profit.
Any start or growth company may require additional financing in the future. Dilution occurs when a company issues more shares. Dilution affects every existing shareholder who does not buy any of the new shares being issued. As a result, an existing shareholder’s proportionate shareholding of the company is reduced or diluted and an Investors proportionate share of the economic and voting rights in the company will be reduced accordingly. In addition, new shares may also have certain preferential rights to dividends, sale proceeds and other matters, and the exercise of these rights may work to an Investors disadvantage.
If a company takes on debt this could significantly increase risk to the company and an equity investor. The potential debt of a company is likely to be secured against the assets held by the company.
Availability of tax reliefs
Investors should be aware that the availability of reliefs to UK investors under the Enterprise Investment Scheme; Seed Enterprise Investment Scheme; Venture Capital Trusts and Social Investment Tax Relief are dependent on investors’ own personal circumstances, as well as those of the company/investment in question, and are subject to change. There can be no guarantee that any particular tax relief will be available at any relevant time or that the company/investment in question will continue to be a qualifying investment.
Although advance assurance will usually be sought from HMRC, there is no guarantee that the formal EIS claims will be agreed or that such agreement will not be subsequently withdrawn. If a company fails to obtain EIS Qualifying Company status, or if it is subsequently withdrawn, EIS income tax relief and capital gains tax deferral relief and any other EIS tax benefit would not be available to Investors or could be withdrawn.
Investors should seek their own independent professional advice on their particular tax situation and the application of such tax reliefs prior to making any investment.