Five things you need to know about investing in unlisted companies
Most investors want to be able to sell their holdings easily if necessary and therefore buy shares traded through the London Stock Exchange; those looking for higher potential gains (and willing to stomach higher risk) may turn to smaller companies listed on the Alternative Investment Market (AIM).
But what if you want to invest in companies whose shares are not available on the open market?
1. Why invest in unlisted companies?
Small companies with ambitions for high, rapid growth need financial input to take the business to the next level. Funding for such high-risk enterprises is not necessarily easy to come by, and that's where private equity comes in.
It consists of investors and funds that invest directly into unquoted firms, and is seen as being for wealthier, more sophisticated investors because of its risky nature and the difficulty of getting money out.
But the right investment can yield spectacular returns.
2. What are the routes in?
It depends what you want. There are various forms of collective investment that focus on different parts of the private equity market, including private equity investment trusts and tax-efficient venture capital trusts (VCTs). But you can't pick and choose your own investments.
If you're looking to put cash into a particular unquoted company, you may be able to use the share-matching facility offered by the likes of JP Jenkins or the regular share auctions run by Sharemark. But you can only trade the relatively few member companies on offer, and they tend to be larger private companies.
You may also be able to buy shares in an initial public offering (IPO or new issue) – the first sale of shares in a company. A stockbroker should be able to keep you posted about forthcoming IPOs.
3. How do I invest in very small firms?
For start-ups and very young companies, you could consider becoming a business angel. These are private investors or syndicates of investors who plough not only funds but also in many cases their own expertise, contacts and management support into the chosen enterprise, often taking a seat on the board.
There are around 18,000 angel investors across the UK, investing around £800 million annually, according to the British Business Angels Association (BBAA).
Shares in companies that qualify for the enterprise investment scheme (EIS) – for example, by having assets of less than £15 million and less than 250 employees – can be bought as single-company EISs, in which case they qualify for generous tax breaks.
EIS funds are also available as a way of spreading risk across several such businesses. In addition, new 'seed' EISs launched on 6 April that channel funds into tiny firms less than two years old and with less than 25 employees.
4. How much money will I need to invest?
Again, it depends which route you want to take. Business angels, for instance, may invest anything between £10,000 and £750,000 in a business, though most put in less than £100,000.
The bottom line is that these are risky, uncertain investments and it's not easy to get your money out at short notice (you could also lose EIS and VCT tax reliefs if you did so within the qualifying period – three years for EISs and five years for VCTs).
In general they are only suitable for highnet- worth investors with other sources of wealth.
However, it is occasionally possible to invest small amounts via share-matching schemes or IPOs. The recent IPO by Scottish brewery BrewDog attracted almost 6,000 investors and raised £2.2 million to build a new brewery.
The minimum spend was £95 for four shares, with investors spending an average of £372; they will be able to trade their shares in 2013.
5. Where can I find out more?
Execution-only broker www.clubfinance.co.uk has a lot of information about current VCT and EIS issues. The BBAA website, www.bbaa.org.uk, is a good place to start if you fancy becoming an angel. Venture capital in general is well explained on the British Venture Capital Association website, www.bvca.co.uk.
For trading unlisted shares, have a look at www.jpjenkins.ltd.uk, which offers shares in such worthy ventures as Dyson Group and Sheffield United Football Club.
This article was written for our sister publication Money Observer
Venture Capital Trusts were introduced in 1995 to encourage private investments in the small-company sector by offering tax relief in return for a minimum investment commitment of five years. A VCT is a company, run by a fund manager, which invests in other companies with assets of no more than £7m that are unlisted (not quoted on a recognised stock exchange) but may be listed on the Alternative Investment Market (AIM) or plus with the aim of growing the companies and selling them or launching them on the stock market. Investors in new VCTs are offered desirable tax advantages and VCTs themselves are listed on the London Stock Exchange, with strict limits laid down by HM Revenue and Customs on what they can invest in and how much they can invest.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
An Initial Public Offering is the US equivalent of flotation, and is the first sale of equity in a private company in the form of shares (know as stocks in the US) to the public in order to raise capital to finance growth.
Describes the relationship between a client and a stockbroker or independent financial adviser whereby the broker or adviser acts solely on the client’s instructions and doesn’t offer any advice on which shares to invest in or financial products to buy and simply “executes” the wishes of the client, regardless if they are judged to be sound or wrong. Other types of broking service offered are advisory (whereby the client/investor makes the final decisions, but the broker offers advice) and discretionary (whereby the broker manages the portfolio entirely and makes all the decisions on behalf of the client).
Enterprise Investment Scheme
A scheme set up to encourage investment into small, unquoted trading companies and give investors tax breaks to compensate for taking risk. Because the companies in the scheme are not listed on a stock exchange they often carry a high risk, so the tax relief is intended to offer some compensation. An EIS company cannot be a subsidiary, must trade wholly in the UK, can’t employ more than 50 people and certain activities (including forestry, farming and hotels) preclude companies from offering EIS relief.
Alternative Investment Market
AIM is the London Stock Exchange’s international market for smaller companies. Since its launch in 1995, 2,200 companies have raised almost £24 billion listing on AIM. The market has a more flexible regulatory system than the main market and can offer tax advantages to investors but its constituents are a riskier investment than bigger companies listed on the main market.