SEIS: an Asset Class? or why you should consider early stage investing

At the recent budget, the British Government announced changes to SEIS.

Seed Enterprise Investment Scheme (SEIS)?– From April 2023, companies will be able to raise up to ￡250,000 of SEIS investment, a two-thirds increase. To enable more companies to use SEIS, the gross asset limit will be increased to ￡350,000 and the age limit from 2 to 3 years. To support these increases, the annual investor limit will be doubled to ￡200,000

This is a welcome change as it becomes increasingly difficult for start-ups to raise smaller early stage round (below ￡250k). Early stage investing is significantly more risky than other types of investments but also offers higher returns. But how risky and how profitable is SEIS investing?

There is little research done to the risk/return profile of angel investing in general and SEIS investing in particular. Data is difficult to get with dilution, valuation upon investment and valuation upon exit not readily reported. Even if we know the size of an exit, it is generally reported as a multiple not as an IRR (Internal Rate of Return). To circumvent the lack of Data we use Monte Carlo techniques to model assumptions to create better insights.

Below are a few links to research done on angel investing.

As far as I now there is no research done for SEIS investments.

I redid my earlier SEIS Monte Carlo stimulation but this time I used the Argo Excel module from Booz Allen Hamilton, Inc.

In layman terms my assumptions are:

• 70% of the investments will fail, 20% will give a 1 to 5X return and 10% will give a Good to Stellar return
• I used the Beauhurst report Exits in the UK Acquisitions and IPOs 2011–2021 to model Good to Stellar Returns
• If the SEIS investment fails the return is -27.5%. ?Income tax relief of 50% upon investment and 45% loss relief upon failure for the remaining 50%.
• I assumed 84 months to Exit.
• Large exits dilute more than smaller exits.
• The model had 10,000 runs

Below are the statistical assumptions and distribution types used in the Monte Carlo Stimulation.

The expected IRR is +/-14% which is higher than other Asset classes but also significantly riskier with a standard deviation +/- 85%. SEIS investment is also significantly less liquid than other Asset classes. You can't sell your SEIS shares in the same way you can sell listed shares.

For illustrative purposes, below you can find risk/return profiles for different asset classes over the period 2000-2019.

Below you find the distribution of IRR returns. As expected +/- 70% of the returns are negative. The majority of the positive exits create an IRR of 30 to 60% with a long tail of larger IRR's.

When analysing the results. You can see that Exit Price Large Exit, Exit Month and Failure Rate have the biggest impact upon IRR. Valuation and Chance of Small Exit have a medium impact, while dilution and Exit Price of Small Exit have a lesser impact.

Angel investing is traditionally associated with large exits as these dominate the news and social media but there is certainly a case to be made to invest into companies that focus on quick liquidity events (Dividend or Exit) versus large but risky exits.

Creating a diversified portfolio is the golden rule for investing in general but even more important for SEIS investing. Stock picking is possible but I suspect that randomness is still the biggest drive of return. Having said even small improvements in increasing the chance of a large, early exit have a big impact on the IRR.

I can recommend every SEIS investor to join a syndicate to help diversify the portfolio and help with the stock picking. (shameless Apollo plug)

Conclusions

• SEIS investing is extremely risky but can generate high returns.
• Create a diversified portfolio of SEIS investments. Aim for at least 20 investments but more is better. Do not only focus on the large Exits but also on less risky companies or quick liquidity generating companies (Exit or Dividend).
• SEIS is an interesting Asset Class but make sure you understand the risks and lack of liquidity ( you also need to self-certify as High Net Worth Individual or Sophisticated Investor).