On the surface there are two broad types of investor:
- Institutions, like small company funds or pension funds, and
- Private individual investors.
Stereotypically, institutions are perceived as being long-term shareholders. It is said that they have deep pockets, are inclined to take a relatively large stake in the right company and, providing you keep them on side, are on hand to provide further rounds of investment as and when it is needed.
Private (or retail) investors, on the other hand, are often deemed to be short-term shareholders. They usually invest smaller stakes (both pre- and post-float), and it is said they trade their shares more often.
Like all stereotypes, there are many cases where the description doesn’t fit.
The premier choice in investors
Nevertheless, it is easy to see why institutional support is more highly prized by leaders of businesses. Yet things are not as straightforward as they seem. The choice of institutional backers is wider if you are choosing the main London stock market, because more institutions invest in this market. But if you are considering AIM as your stock market of choice, there is an additional pot of money available, as a result of the beneficial tax rules, from the venture capital trusts.
To Peter Ashworth, head of smaller companies research at broker Charles Stanley, the range of institutions now prepared to back small Aim firms is ‘broader than you would think, as companies like Majestic Wines have proven to be really good investments’. Even pension fund money is currently being invested in this market as a result of this perceived quality.
According to Ashworth, there are two institutional groups you need to pitch your business to, both before and after your flotation. ‘You have the core audience, which is the venture capital trust (VCT) unit,’ he begins. ‘They represent the largest group. Then there are the smaller company funds that are not driven by tax but just look for good opportunities and companies.’
Tax-driven institutional investors such as VCTs will invest only when you are raising funds for your business because they have to invest in ‘new’ shares to qualify for the tax benefit. They will usually hold the shares in your company for three years in order to reap the full benefits. Other institutions, not driven by tax, and seeking out quality investment opportunities, may also invest both before and after you’ve floated the company. These are likely to sell up and move on if things fail to go as planned.
There are 20 VCTs currently focused on AIM, and the portfolios of many others contain AIM shares, and currently the funds are there for those who can prove their worth.
More than just a deep pocket
The benefits of professional investment are extremely far-reaching, according to Robert Mitchell, joint manager of ISIS Asset Management’s AIM VCTs.
‘As institutional investors we try to meet [with investee companies] on a regular basis and give them the benefit of our experience. If things are going well, we are also happy to use our contacts to assist them in other ways, bringing in key skills the board may otherwise be lacking, for example.’
Many VCTs will assist in finding suitable acquisitions and can often prove to be the catalyst for lucrative business deals due to their market knowledge.
Importantly, VCTs will often start from an assumption that they may need to meet further cash calls over the course of the relationship and will expect to hold their stake for between three and five years, providing you with a degree of long-term stability.
Finally, big backers can enable small young companies with good products to bridge the credibility gap. Says Dru Edmonstone, director of institutional sales at broker Seymour Pierce, ‘institutional support makes you look good from a business point of view.’ As any entrepreneur will confide, dealings with large organisations are only possible if the large company believes you are credible. ‘If you have to go to the banks, or when the time comes to bid for contracts, having [an institution] in your corner can make a huge difference,’ says Edmonstone.
Never forget the institutional motive
All of the above benefits come at a cost and the most important point to remember is that, as with all investors, institutional backers are there to make money. This means two things. Firstly, they will be looking for an exit somewhere along the line – so it’s important to discuss this from the outset – and secondly, they are unlikely to welcome under-performance.
‘We’re happy to help with non-executives and the like, but if things go wrong we will use our vote to change the management,’ admits the straight-talking Mitchell. ‘We will always support our companies, but if [an investment] proves to be a complete dog, there’s no point throwing good money after bad’.
Though less matter-of-fact, Alastair Conn, managing director of Northern Venture Managers, makes a similar point. ‘If we’re unhappy we would most likely take issue with the company directly, but we might also team up with other institutional backers, as if you own 15-20 per cent of the company between you, the directors have to listen.’
Some private investors are very professional
There is more to the category of private investor than meets the eye. John Craven, director of Bridgewell Corporate Finance, comments that ‘a lot of the larger private investors can be very professional and there can be quite a lot of blurring.’
High net worth individuals will be familiar to many unquoted firms and even for a public company will frequently provide funding in similar sized chunks to institutions. Like institutions, many have much more to offer than just their cash – a breadth of experience and contacts, for instance. They often take significant stakes either just before or during flotation.
But they may look to take a more proactive role in the running of the
company. Many ask for a place on the board, frequently as non-executive chairman, and are therefore in a position to shake up under-performing management teams and offer their views on corporate strategy.
Pure private investors
Private investors on the other hand will act in a very different way. The main variance is that they will typically hold just a small chunk of shares, probably as part of a portfolio of similar-sized investments.
Although their holdings will be too small to influence the running of the company, their importance can not be overstated. As KBC Peel Hunt corporate financier Adam Hart suggests, ‘it would be a very silly company that ignored its private investors. Institutions tend to hand over larger stakes to other institutions with little effect. It’s the smaller trades of private investors that move the share price.’
Hart’s comments highlight the importance of a diverse shareholder base and the issue of ‘liquidity’.
To be able to buy and sell the shares in your company, it is quite simply essential to have a strong private shareholder base. Those private investors who trade more frequently in the market can wield a greater influence on your share price. This is important because if these active private investors believe that you have a ‘good story’ their purchases can enable a share price to keep moving in the right direction. In turn, this means, a small company can issue its own
paper (that is, more shares) for acquisitions and other corporate deals that enhance the growth of the business without diluting your own stake too much.
Moreover, if trading in your shares is sparse, just a couple of small sales can wreak havoc with your overall valuation.
In addition, says Seymour Pierce’s Edmonstone, retail investors ‘can also be very useful for further equity calls if you’re looking for an extra couple of hundred thousand’. It could be difficult to raise such a small amount from an institution.
However, overloading your shareholder base with private individuals has one major disadvantage, namely that you may miss out on being able to raise significant sums of cash after flotation in an institutional placing. A placing is by far the cheapest and quickest administrative way to raise cash and generally speaking this can only be carried out with institutions. To raise money from private investors involves a company producing a much more expensive document to meet investor protection rules. Additionally, speaking to a few institutions incurs less expenditure than distributing information very widely to private investors.
So what is the ideal mix?
Edmonstone, for one, advocates that an 80:20, or 70:30 split in favour of institutions is the ideal shareholder base to possess. Others point out that even the strongest growth companies may struggle to attract such levels of institutional support. After all, as one broker puts it, some companies ‘don’t have a hope in hell of attracting institutions.’
Brewin Dolphin corporate finance director Vikram Lall is in no doubt. ‘There is no ideal mix between institutions and private investors,’ he challenges. ‘I’m sure that on the FTSE 100 more than 80 per cent is institutional, but this ratio lessens as the companies get smaller’.
Getting investor sex appeal
The amount of money you need and the type of financial adviser or broker you employ will determine the investor profile of your company, at least in the early stages. If you need smaller sums, you will probably utilise a specialist corporate finance boutique or smaller private client broker, which will most probably raise funds from individuals.
If your company is well developed and needs a large injection of cash, a broker with substantial institutional contacts is most appropriate. Unsurprisingly, both sets of investors tend to consider similar issues before ploughing money into a business.
More often than not, a strong management team comes at the top of the investor wish-list. As ISIS’ Robert Mitchell opines ‘small companies can succeed or fail on the head of the management’. It is essential to persuade would-be backers of your ability to deliver on your business plan.
Most professional investors also warm to companies with a proven track record, so if you are lacking experience yourself, put together an experienced non-executive board to add weight to your case.
Almost as important as a strong management team is evidence that there is a sustainable market for your offerings. ‘The first thing we really look at is what the need for the product or service is, then we look at what the market size for it is,’ confides Sally Leeson, Investment manager at venture capital group Quester. ‘After that we look at the business plan as a whole.’
Finally, John Wakefield, director at broker Rowan Dartington argues that it is vital that firms looking to list on AIM, ‘play the tax angle’. Wakefield believes that smaller companies are ripe for VCT investment, so you need to make sure that your business will qualify for the relief (not all do).
Case Study – ‘Institutions provide support, but in time we’ll need liquidity’
Confectionery business Glisten floated on AIM in June 2002 and experienced little difficulty in raising £4.8 million via an institutional placing at the time of its arrival.
With an experienced management team at the helm – chief executive Paul Simmonds previously held senior management positions at Associated British Foods and Glanbia Foods – a proven trading history and strong links with several major supermarket chains, it is unsurprising that Glisten attracted such a high level of institutional support.
Yet despite amassing an impressive register of backers – the likes of Artemis, Rathbones and Unicorn to name but three – Simmonds admits that over time ‘institutional holdings will migrate over to private investors and this will be good for liquidity’.
Glisten’s plan is thus to broaden its shareholder base over the medium-term. However, Simmonds also ventures that ‘it is quite a challenge to make private investors feel wanted’, particularly if you have so many institutions on your books.
Because of this he believes that growing businesses should ‘take every chance to keep [private investors] up to date and informed’ and identifies investor fairs as ‘a very useful way of meeting people and colouring in the story’. Simmonds also notes that occasional private client roadshows, and newsletters are a good way of keeping private investors up to speed.
Case Study – ‘We will need institutional help for the company to grow’
Children’s intellectual property firm Maverick Entertainment floated on AIM in May 2001, raising a net £2 million prior to launch with the aid of specialist private client broker Seymour Pierce Ellis. However, it continues to experience a dearth of institutional support.
‘We have a large private shareholder base basically because when the founding directors went to float the company they appointed a broker – in Seymour Pierce Ellis – with a large private shareholder base,’ recently appointed finance director Sookra Raveendran explains. ‘But if you go for a larger fundraising, say £5-10 million, you have to get institutions on board to raise the money.’
To Raveendran, the benefits of having a diverse retail investor base have been mixed. ‘The fact that we have no single large shareholder has been a benefit in this climate as it puts less pressure on management,’ he concedes. ‘However, it can also be a negative, particularly if you are trying to do something that requires shareholder approval…your task is just that much greater.’
As for the future, Raveendran admits that ‘we will need institutional help for the company to grow’. He therefore endorses a need to meet with prospective backers at least every six months, after each set of results.
‘There are institutions who’ve expressed an interest in backing us as and when the time comes,’ he concludes.
