EARLY-STAGE investors who lost their shareholding in FanDuel when the firm was taken over by Paddy Power Betfair have warned that their experience could prejudice the environment for seed investing and deter businesses from realising their ambitions to scale up.

FanDuel was sold to the Irish bookmaker this week in a deal that valued the Edinburgh-founded fantasy sports business at $465 million.

FanDuel’s preference shareholders received a 39 per cent stake in the new business - FanDuel Group - as part of the deal, but common stockholders received nothing because the valuation was not high enough to include them.

While many early investors believe they were locked out of the deal by the company being undervalued, they were unable to protest because majority shareholders Kohlberg Kravis Roberts and Shamrock Capital Advisors exercised their drag-along rights to push the deal through.

According to one angel investor, this should prompt bodies such as the Scottish Government’s development agency Scottish Enterprise, which helps Scottish start-ups secure financial backing and which itself had a 2% stake in FanDuel, to ensure greater protections are put in place for early-stage investors.

“This has prejudiced the seed environment in Scotland and will put people off seed investment, particularly for early-stage investors,” the angel, who lost between 15,000 and 20,000 FanDuel shares in the deal, said.

“What are Scottish Enterprise doing to protect the seed environment? What lessons have they learned from FanDuel in terms of protecting that environment?

“The broad investment community needs to understand this better - they need to understand the perils of preference shares and managing that downside risk. Who is advising those people to be investors?”

Despite this, Derek Shaw of the Scottish Enterprise-owned Scottish Investment Bank said that it is up to individual investors to assess “both downside and upside risks when making their investment decisions”.

“Angel investors are an invaluable source of investment capital for start-up, early-stage and growing businesses and many have achieved significant returns on such investments, even in situations where further investment has been required by companies from later-stage investors,” Mr Shaw said.

“Angel investors recognise the significant potential of our highly innovative company base in Scotland, but likewise accept the high-risk, high-reward characteristics of making investments in this space.”

Bill Nixon of Maven Capital Partners, a Glasgow-based firm that regularly leads investment rounds in early-stage businesses, agreed.

Noting that Maven would only invest in a business whose management team “has a track record of having done it before”, Mr Nixon said angel investors should not be surprised if on some occasions their investment is lost.

“The key point is that with growth investments the returns can be very high but the risk is proportionate to that - you can lose all your money,” he said.

“If investors invest wisely across a portfolio there are reliefs that cover the downside risk.”

Specifically, seed investors receive generous tax breaks via the UK Government’s Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS), which have been designed to promote job creation and economic growth by encouraging investment in start-ups.

However, as the schemes also stipulate that angels must only buy ordinary shares Ian Ritchie, who invested around £70,000 in FanDuel’s first fund-raising round, said that early investors become particularly vulnerable when businesses attract the attention of large-scale funders who invest on preferential terms.

He added that a knock-on effect is that too few companies are able to achieve what FanDuel did, which in turn hampers the economic growth and job creation that seed investment is supposed to foster.

“Angel investors in Scotland have a tendency to sell companies too young and too cheap,” he said. “These are companies that could be substantial but they don’t get the chance.”