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Why high net worths should flock to angel investing

As the coronavirus impact continues, Bank of England policymakers report the UK may be headed for negative interest rates for the first time in the bank’s 326-year history.

With interest rates already at 0.1%, central bank officials announced an additional £150bn (€169bn) stimulus package, in an attempt to boost consumer spending during the second wave of the pandemic.

Despite news of a vaccine, the BoE has taken the total stimulus to £895bn, as double-dip recession forecasts emerge.

In the event of negative interest rates becoming a reality, banks would have the incentive to lend more by making loans cheaper, but account holders would likely be asked to pay to hold money in a savings account.

While plans for negative interest rates are pending, government bonds are already selling at a negative yield of -0.003%, with investors hoping for the safe haven of government-issued bonds paying out to get their money back in three years.

Between negative returns on savings accounts, lower yield on bond holdings, a volatile stock market and a projected dip in property prices, investors don’t have many options to diversify their portfolio in a negative rate interest environment.

However, for investors who are comfortable with risk, early-stage investing may be the answer, writes Oliver Woolley, founder and chief executive of Envestors.

Angel investors support early-stage companies through financial backing, typically in exchange for equity in the company.

An additional benefit for angel investors is the generous tax reliefs offered under the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS).

How would HNWIs be impacted by negative interest rates?

With stimulus packages to be extended over the course of 2021, BoE policymaker Gertjan Vlieghe noted that banks have already been contacted regarding their preparedness for what could be an earth-shattering move.

If the economy continues to shrink in the coming months, the BoE might cut interest rates below zero to encourage greater lending activity.

“If interest rates are cut so far that they fall below zero […] negative rates should encourage borrowing and discourage deposits and savings.” explained Azad Zangana, senior european economist & strategist at Schroders.

High net worth undividuals (HNWIs) would accrue losses from lower yields on bonds and annuities. In addition to that, they would be the first savers to be impacted, through both business and personal accounts.

As banks are charged to keep money with the central bank, they would start passing on negative rates to individual savers. While companies would be incentivised to take out loans, they would pay fees on deposits.

Charges are likely to be imposed on any savings over a certain amount, starting with the accounts of high net worth individuals.

Why is angel investing attractive?

An angel investor (also known as a private investor, seed investor or angel funder) supports early-stage enterprises by providing funding and getting actively involved in the business.

Typically, the amount invested is between £5,000 and £50,000 per investment.

Early-stage investments are high risk as the number of early-stage businesses that grow through to an exit is low.

Previous research from Nesta suggested that 56% of investments in early-stage companies went bust. This is why experienced angels aim to build a diverse portfolio of 20+ investments.

Although deemed as precarious, early stage investments come with the advantage that investors can buy company shares – in a business that has identified an addressable market, yet to be exploited – at a much lower price.

While angels usually have to wait a number of years before recovering their initial investment, returns can be considerable.

Due to the high risk nature of angel investing, HNWIs are usually looking for a 2.5x return of investment (RoI).

Angels are often highly experienced in business and provide more than financial support. They can support companies with know-how, introductions and strategic direction.

When first starting out, an investor should look for a well put together business plan with a defined exit strategy.

Many angels choose to join an angel network when starting out, where investors can pool investment capital and invest alongside like-minded, experienced investors.

Tax relief provided through EIS and SEIS

In order to encourage investment in start-up companies which play a vital role in the economy, the UK government has launched several tax relief programmes, including the Enterprise Investment Scheme (EIS).

This scheme, which makes investing in early stage enterprises tax-efficient, has encouraged £22bn in investment in 31,365 companies.

By investing in an EIS eligible company, angels receive income tax relief of 30% of the amount subscribed for eligible shares.

Investors can put in up to £1m per tax year in EIS qualifying companies for the tax relief; this cap rises to £2m if investing in knowledge-intensive EIS companies.

In order to qualify, companies have to be trading for less than seven years and can raise a maximum of £12m.

Through EIS, angels receive a capital gains tax (CGT) exemption, carry back and loss relief which can be offset against CGT or income tax.

Looking at a practical example:

If an angel invested £10,000 and the company failed, their actual loss would only be £7,000, due to the 30% income tax relief. However, a top rate income taxpayer paying tax at 45% will be able to claim loss relief on their tax liability at the 45% level.

In this example, they’re eligible for further relief of £3,150, making their actual loss £3,850.

The success of EIS led to the introduction of the Seed Enterprise Investment Scheme (SEIS), promoting investments in riskier, earlier stage companies. About 80% of UK angel investors seek relief through EIS or its sister scheme, SEIS.

SEIS allows HNWIs to invest up to £100,000 and receive 50% tax relief on their investment.

In order for companies to be eligible for SEIS, they have to have been trading for less than two years and cannot have more than £150,000 in previous investment.

Leading investment sectors

Reports from the British Business Bank and the UK Business Angels Association reveal that many investors are still seeing positive returns during the pandemic.

While angels are battling economic uncertainty, around three quarters are optimistic about the market bouncing back within the next 12 months.

Healthcare, digital health and medtech, biotech, life sciences and pharmaceuticals are the leading sectors in terms of investor engagement during the covid-19 crisis.

Software as a service and fintech have fared well throughout the pandemic and are still attracting a large number of investors.

Getting started with angel investing is now easier than ever, with an array of angel networks that can provide advice and support. Industry-association, the UKBAA, offers an Angel Investment Accelerator which is designed for those new to early-stage investing.

In order to choose the right angel network, HNWIs should look for the most active networks; research body Beauhurst recently published a list of the most active networks in the UK.

Active networks will present a greater array of screened opportunities as well as connecting new investors to more experienced ones.

The best networks cover a variety of regions, sectors and investment sizes, and they’re forthcoming with examples of previous investments, so first-time angels can make the right choice on how to grow their portfolio.

So, with negative interest rates as possibility it may require a rethink of current investment strategies for many HNWs.

The changed environment may also open up a new and exciting investment class.

This article was written for Expert Investor by Oliver Woolley, chief executive and founder of Envestors. 

Part of the Bonhill Group.