Investing in high quality unquoted companies
We look at some of the benefits and risks of investing in unquoted companies.
In this month’s piece I’m going to look at some of the benefits and risks of investing in unquoted companies and some collective investment vehicles that can give you access to these businesses.
Some companies choose not to list on recognised exchanges and become members of the FTSE indexes or the S&P 500, preferring to remain private while others see it as an opportunity to expand faster, spread the risk of ownership and access potentially deeper pools of liquidity.
The benefits of investing in unquoted pre Initial Public Offering (IPO) companies
As a company moves from private to public a ‘private to public arbitrage’ can occur. Put simply, private companies tend to trade at a discount to similar public companies. Therefore, being an investor at the pre-IPO stage has the potential to produce some significant rewards. However, as with all types of investing the potential for big rewards comes with big risks.
One of those risks, ‘IPO failure,’ is illustrated by the recent IPO of Aston Martin and the flop in its share price, shown in the graph below.
Source: Digital Look.
Reasons for a company to remain private
- Founders retain a greater share of the profits
- Founders maintain control over strategy
- With the rise of private equity there is more capital available to unquoted companies
- The founder has more control over who can invest in the company, potentially leading to a better alignment of values
- The size of the company may be such that it wouldn’t have enough clout to compete during its early growth phase
- The company management is not answerable to large numbers of stockholders
- Going public can be costly and have a big impact on a small company
- Potentially less public scrutiny
There are arguments that by not going public it becomes harder to attract top talent and limits liquidity, making it difficult to sell a stake. Acquisitions can be a huge drag on cash or involve raising debt finance unlike using stock as currency in a public company to acquire a business. However, unquoted doesn’t necessarily mean high risk – Mars, JCB, Cargill and PricewaterhouseCoopers are some of the largest companies and manage to compete globally.
I make this point as some private companies may choose indefinitely to remain private, which is not a bad option and in this situation you, and the founder’s interests, remain aligned.
The benefits of a company undertaking an Initial Public Offering (IPO)
- Perceived status, potentially making it easier for companies to do business with others
- Perceived status may also make it easier to raise additional financing from the debt markets or undertake a rights issue
- Companies can use their shares as currency, which could potentially lead to faster growth via acquisition
- Raised profile
What are the benefits to investors of owning private companies within a listed structure?
- You get access to unquoted companies that you otherwise would not be able to invest in
- A collective structure provides diversification
- Professional management – investing in experts that have significant knowledge of the market
- Professional management that has strong cultivated networks that allow them to access private company opportunities
- While there may not be liquidity in the underlying company the listed structure does provide liquidity
- A professional manager should be able to avoid owning ‘pump and dump’ stocks (these are artificially inflated companies that lack legitimate customers and revenues)
- Fund managers and advisors are able to better value the business they are following and ultimately end up investing in
What are the risks of investing in unquoted companies in a listed structure like an Investment Trust?
- While the listed investment structure will be bound by a regulatory structure, the underlying companies are not until they are listed, and only then will they be exposed to the listing rules
- Being exposed to pump and dump stocks prices quoted on the underlying companies may not reflect recent trading in the company concerned
- Collective investment structures such as investment trusts trade at a premium or discount to the underlying portfolio’s net asset value (NAV), which can complicate matters
There are a number of collective investment vehicles that give investors some exposure to unquoted companies as outlined in the table below. The unquoted elements of these vehicles have the potential to IPO at some point in the future, although some will remain private.
|Investment||Approximate current unquoted exposure|
|Woodford Patient Capital Trust||69.44%|
|Merian (name change from Old Mutual) UK Mid Cap||5.2%|
|Merian (name change from Old Mutual) UK Smaller Companies||4%|
|Woodford Equity Income||8.2%|
|Merian Chrysalis Investment Company (Launch period ends 31st October)||Up to 100%|
Source: Respective fund fact sheets.
A potential opportunity provided you are comfortable with the risks
The managers of the Merian funds listed above are pursuing a new venture drawing on their years of experience and success investing in unquoted companies, launching the Merian Chrysalis Investment Company Investment Trust. More information can be found here.
For transparency purpose; The TC Share Centre Multi Manager fund managers have met with the Chrysalis fund manager and are giving some consideration to making a purchase in the investment trust. No firm decision has been made either way at the time of writing. (17th October 2018).
All information given including prices, yields and our opinion is correct at the time of publication. Our opinions on investments can change at any time and for our latest view please go to www.share.com. To understand how our Investment research team arrive at their views please read our Investment Research Policy.