The great liquidity squeeze (Source: Getty)
Asset Match’s Stuart Lucas explains why investors must put pressure on firms when it comes to exit plans.
Investors in private businesses – whether they are angels, high net worth individuals, institutions or even sophisticated retail investors – are always, ultimately, looking towards the potential payout that an exit (traditionally an IPO or trade sale) can deliver. But the reality is that many private firms bypass the exit goalposts, leaving investors locked in. A three to five year timeframe is often given by businesses for a suggested exit route, but in a disproportionate number of cases this can quite quickly extend to 10 years or more.
And another trend is making this issue even more pressing: while there have always been limited opportunities for any investor to gain the liquidity they seek in private shares, the volume of private investors has grown significantly in recent years, driven by the rise of crowdfunding platforms and a new-found excitement about private and innovative British businesses. For many companies, smaller sophisticated investors now sit alongside angels and institutions. However, the terms and share classes are often different, and investors need to be aware of this. Several platforms are doing a good job of creating egalitarian models. Syndicate Room, for instance, enables the crowd to invest on the same terms as business angels (with the caveat that the minimum retail investment is £1,000), provided that a lead angel investor is investing at least 25 per cent of the overall amount.
Yet sophisticated or not, in most cases, private investors have neither the reach nor the volume of shares to trade through brokers, and can remain locked in for years on end. This means that private businesses need to manage the expectations of their investors in the same way as if they were a much larger public company.
Knowing that investors will be looking more closely at the exit options (or that they should be), private firms must be clear about the path they will tread from the outset, and investors need to be aware of the reality of exit challenges. For instance, although trade sales are the cleanest and most cost-effective way of providing a total exit for shareholders, there will always be debate about the timing, and whether more value could have been extracted ahead of a sale.
When it comes down to it, only a tiny fraction of companies ever go public. Cost can be a prohibitive factor – it can cost between £100,000 and £150,000 a year for a company to manage its Aim listing, for example – but most privately-owned British companies are actually too small in terms of earnings or assets to make a listing worthwhile.
It’s also worth being aware that one unintended consequence of increased regulation in banking has been the removal of liquidity from all major markets. Aim, the London Stock Exchange’s growth market, has suffered badly. The number of companies listed has declined consistently since the crisis. And buying and selling activity is now heavily concentrated in the largest companies – in August 2015, over 30 per cent of turnover on Aim was in the top two shares out of the more than 1,050 firms quoted there. Moreover, in August, more than 200 companies traded, on average, less than £1,000 of value by day.
Many hoped that the buy-side, the investing institutions, would take up the slack and provide liquidity, but so far they have shown no desire to act as market-makers, and are unlikely to do so.
THE RISE OF ONLINE SHARE AUCTIONS
Following closely on the heels of the alternative finance sector is the burgeoning online secondary marketplace. Online platforms regulated by the FCA, like Asset Match, connect buyers and sellers and negate the need to liaise with the business or employ a broker, opening up an asset class of unlisted shares that was previously pretty inaccessible to individual investors.
They provide shareholders with more control over when to sell their shares and, crucially, create a transparent mechanism that lets them know the value of their assets. It also gives an alternative selling option to institutional shareholders.
As far as I’m concerned, private businesses have a moral responsibility (it’s not currently a legal requirement) to provide a detailed exit plan. But unfortunately, most are vague about it. After holding shares for five or more years, shareholders should be asking the boards of the companies they have invested in to investigate the provision of a liquidity facility – perhaps through periodic online auctions.
As the numbers of private investors grows, more businesses will need to demonstrate far more due diligence on exits if they want to ensure future investment. Crowd investors can learn a lot from the locked-in experiences of angels and high net worth individuals.
City A.M. has partnered with Crowdnetic for the launch of its suite of UK crowd finance data. It features real-time information on private, UK-based companies publicly raising capital online through securities-based crowdfunding portals.