New research suggests that 'business angels' stand to make a substantial profit from investing in start-ups, with an average internal rate of return of 22 per cent over four years.

A group of British investors that put personal money directly into young unquoted companies has reported a substantial profit.

The British Business Angels Association (BBAA) has claimed an average internal rate of return (IRR) of 22 per cent over four years.

The results were revealed through a joint research report with the National Endowment for Science, Technology and the Arts (Nesta).

The report reviewed 1,080 investments.

More than half were directed at early-stage pre-revenue start-ups, the riskiest time of a company’s life.

This was reflected in the investment returns.

Despite the fact that 56 per cent of investments in the study made a loss, 44 per cent led to positive returns, with nine per cent generating more than 10-times the capital invested.

The BBAA report also specified a number of strategic choices and practices that may lead to better investment outcomes, such as investing in one’s area of expertise, performing at least 20 hours of due diligence before investing and staying connected with the business, preferably at a board level.

‘Angel investing can be a strong viable complement to traditional forms of investment, which are not making anywhere close to 22 per cent returns,’ said Jonathan Kestenbaum, chief executive of Nesta.

‘As the UK grapples with finding new sources of finance to build the sectors that will drive our economic recovery, Business Angels will form a critical new asset class.’

The study found that the Enterprise Investment Scheme (EIS) and other tax incentives contributed substantially to activity from members of the Business Angels group.

Approximately 82 per cent of members used the EIS at least once.

The members stated that about 24 per cent of their investments would not have been made without the tax incentives.

Nesta and the BBAA have called for the treasury to increase the Enterprise Investment Scheme tax relief from the current level of 20 per cent to 30 per cent for the much higher risk start-ups.

‘This research has proven that Business Angels is now the key source of investment in early-stage high-risk companies,’ said Anthony Clarke, chairman of the BBAA.

‘BBAA estimates that angels are currently investing £1bn per annum in the UK and it is important that further individuals should be encouraged to consider this asset class, supported by targeted financial incentives.

‘Angels brings not only its own finance, but business-building skills.

‘The UK needs to significantly increase the pool of business angels to invest in the successful innovators of tomorrow.’

The report said that each individual UK ‘business angel’ invested an average of £42,000 and that each investor made around six investments.

Investors typically reviewed 20 opportunities each and acquired eight per cent of a company.

Most start-ups tended to prefer co-investments, according to the report.

The research indicated that an average of five investors co-invested in any one round.