This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on May 30 – June 5, 2016.

Angel investments are an alternative vehicle to consider when traditional assets are delivering less-than-satisfactory returns. But there are high risks associated with such investments. Industry players give some pointers on how to minimise these risks and what to look for when evaluating start-ups. 

Angel investments can be seen as an alternative asset class used to enhance returns, especially when traditional assets are not providing high enough returns in the challenging global economy, says active Malaysian angel investor Pete Yoong, who is co-founder of Singapore-based digital advertising company CtrlShift Holdings Pte Ltd. 

“The reason why venture capitalism boomed in the US is because of low interest rates, fixed deposits and uncertain returns from stocks and bonds. As an angel and entrepreneur … I get to help start-ups succeed with whatever experience and network I have built over the years. Financial returns from start-up investing can be significantly higher, but angel investors need to understand that it is very risky. The rate of success is probably lower than 5%, and the investment is non-liquid until there is an exit following a sale or initial public offering,” he says.

But like many alternative investments, there is a high risk of losing all of your capital, and this happens more often than not in angel investing. Nevertheless, there are ways for aspiring local angel investors to mitigate the risks. One is the Angel Tax Incentive, a tax exemption given to investors to help lower the risks that are usually associated with early-stage investments. Approved by the Ministry of Finance and introduced in April 2013 by Cradle Fund Sdn Bhd, the tax incentive encourages investments in early-stage technology start-ups in Malaysia to boost the growth of the start-up ecosystem.

To qualify for the incentive, angel investors need to apply to the Malaysian Business Angel Network (MBAN), the country’s official trade association and governing body for angel investors and angel clubs. It is responsible for encouraging and promoting angel investing among local investors. 

MBAN previously came under Cradle Fund Sdn Bhd, an agency under the Ministry of Finance, but its operations have now been privatised. The network has accredited more than 115 angel investors and aims to provide accreditation for at least 200 more by the end of this year. 

MBAN president Dr Sivapalan Vivekarajah says that under the incentive, business angels are allowed to invest in up to five companies a year, with a minimum investment of RM5,000 to a maximum of RM500,000 a year. All investments must be fully paid in cash and the angels must hold shares in the invested company for a period of two years prior to claiming the exemption.

“So, if you are earning RM300,000 a year and you invest RM200,000 a year, in three years’ time, you only need to pay tax on RM100,000. You don’t have to pay tax on the RM200,000 you invested. About 70% of our members earn between RM180,000 and RM600,000, while 30% earn more. So, if you are earning RM600,000 and you invest RM500,000, you literally pay no taxes,” he says. 

However, the tax incentive is limited to certain high technology sectors, including advanced electronics and IT, telecommunications, healthcare and transport. Sivapalan says this is to encourage growth in the “new economy” companies.

“What the Ministry [of Finance] is trying to do is to encourage investments in ‘new economy’ companies because Malaysia’s future has to be built on these kinds of companies. We need to go into new forms of technology, whether it is manufacturing, services, or anything to do with innovation, to move up the value chain,” he says. 

While Sivapalan thinks there are enough sectors for business angels to invest in to enjoy the tax incentive, MBAN is also making efforts to widen the scope. “We are in talks to expand the tax incentive to sectors such as financial technology and renewable energy. But what is more important is to make sure they are already investing in the existing sectors,” he says.

Other ways business angels can minimise their risks include forming or joining an angel club and investing in a group (also known as syndicated investments). This way, the risks are spread equally among members while allowing them to tap each other’s skills and expertise. 

“For example, if you are in a group of six business angels, one of you may have legal expertise, one may have finance and market expertise and another may have technological expertise. When you put this group of people together, it is like having a super duper board of directors without having to pay for them,” says Sivapalan, adding that there are about seven angel clubs in Malaysia, with Coffee Biz Angels being the largest. 

Diversifying into multiple companies is also a good way to reduce the risks of angel investing. Sivapalan says an angel investor should not put all of his money in one company and hope that it succeeds. “For example, if I invest RM10,000 each in 10 companies and five of them fail to yield a return, I lose RM50,000. However, if one of these companies exits successfully and makes me a return of 10 times, I make RM100,000 and this covers all of my losses.”

Khailee Ng, who invests in early-stage companies, concurs. “This is a high-risk game. You are not just buying shares or investing in property. You put money in a company and the company can die or be the next multibillion-dollar company. I have seen angel investors make up to three to six times their investment in a period of three to six months. Sometimes, they lose their money very quickly, which is why it is important to diversify your portfolio and invest in many companies, because you never know which will hit the jackpot.”