A Warning About Investment Managers Masquerading As Angels And VCs
At Unionise we mostly focus on startup employees. But we received an excellent story from an early stage founder about the perils of dodgy investors parading around as angel VCs that was too good not to share.
The founder wrote to us asking for some advice about whether she should accept the offer of investment from a fund that has SEIS status in the UK. This means it is able to invest in startups and the fund’s investors receive the SEIS tax benefits. The reason for the fund’s existence is so that people who want to invest in startups but don’t feel they have the ability to identify companies with potential can outsource this to a professional investment manager.
You could also argue that startups are getting a service; a simple way to raise all your angel investment. A one-stop-shop if you like.
But if we look at a few basic facets and data points, you quickly come to the conclusion that this particular SEIS investment fund is not benefitting either the investors or the startups.
Understanding the fees
If the SEIS fund is big or run casually like an angel network, then the economics are easier to understand. The investors might be willing to put in the groundwork, or enough investments are raised to pay for the overheads of running the fund or network. But for a small fund the dynamics are very different.
The fund in question has less than £5m under management. Its charging structure was similar to a hedge fund with a 3% annual charge and 30% of any gains. But very few hedge funds can demand these fees and it would be hard for investors to walk away with gains unless significant tax breaks permitted it. You should note that the point of tax breaks is not to subsidise investment fees.
With this 3/30 model, the fund will take £150k in annual revenues just from the 3% annual fee. This might be able to support a single person but not an investment team who will not only need salaries, but also have significant overheads. The 30% performance fee on big wins is a long-term bet which may take 7 years to appear, but this doesn’t pay the rent. So the SEIS fund manager has a problem.
The obvious conclusion is that either the investment manager is about to go bust, or (and more likely) there is another source of income. The founder who wrote to us also shared some documents from the fund and things became much more evident. Buried in the small print are a number of investee company fees – these are fees the startup pays.
From what we saw between 7.5% and 10% of the investment amount given to the startup is described as a ‘finder fee’ for the SEIS fund manager. With a £150k investment that’s £15k, so the startup actually only gets £135k.
Then there is an annual management fee due to be paid from the startup to the SEIS fund manager. This is anything between £2k and £3k.
Finally, the SEIS fund manager demands a seat on the board of directors, and an income, which for 2 days a month work will be approximately £12k a year.
So in year 1, the startup is paying £29k to the SEIS fund manager and then £14k from year 2 onwards, After just 3 years, the total amount paid would be £57k from the initial £150k and will continue.
Killing the business
The startup would have an investor that is sucking the equity out of the business and there may be board members that are impossible to shift. As soon as we were told this story, we told the founder to run for the hills. If she agrees to the investment, her business is as good as dead, and she will find it impossible to find other investors at her next rounds of funding. Even if she made it that far.
Although, the SEIS fund manager is making a steady stream of guaranteed income, this is actually counterproductive. If £3m of his fund is invested each year he can expect to get around £600k in fee income – enough to support a 3 or 4 person team – but zero chance of a sustainable startup that will be able to exit and deliver a proper return on his investment.
This story is also relevant for people thinking of joining an early-stage startup. Take a look at who has invested in the business. If they have no successful exits or you can see there is evidence of this type of charging structure in public documents, our advice is to stay clear.