How To Invest In UK Private Companies – Forbes Advisor UK
While it has been a difficult time for UK investors given the volatility in financial markets in recent weeks, the picture remains relatively rosy for UK private companies, where investment is booming. In addition, recent government announcements should provide a boost to the sector.
Here’s a look at UK private companies and the ways private investors like you and me can gain access to them.
Remember, investing is speculative and your capital is at risk. You may lose all or part of your money.
What is a private company?
A private company does not offer or trade its shares to the public on a stock exchange such as the London Stock Exchange. Your shares may be held by private individuals, employees or institutional investors such as private equity firms.
Investment in UK private companies is booming, with a record £15bn in the first half of 2022, according to research specialist Beauhurst. This means an increase of almost 40% compared to 2021.
There has also been an increase in the amounts raised by private companies as companies mature and seek to secure larger sums of money. Beauhurst reports that 62 fundraising deals over £50m and a record 29 ‘gigadeals’ over £100m were closed in the first half of the year.
Government support
Another boost for investors in start-up companies came in last month’s financial report from Chancellor of the Exchequer Kwasi Kwarteng MP with an expansion of the Seed Enterprise Investment Scheme (SEIS) – see below.
Mr. Kwarteng then announced that further details on new ventures would be announced over the coming months. Changes are then expected to take place in the new tax year in April 2023.
Henry Whorwood, Head of Research and Advisory at Beauhurst, says: “It’s hard to imagine that the expansion of the scheme can be anything but good news for investors in UK startups and the companies themselves.”
Here’s a look at the range of options for investing in private companies, including the returns investors have reaped from some of the more successful private fundraisings.
SEIS and EIS funds
Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS) funds invest in companies that have been in business for a maximum of two to seven years.
These funds pool investors’ money to buy shares in about five to 10 start-up companies, giving investors shares in the underlying companies rather than the fund itself.
Gousto, the meal pack provider, used the EIS as a source of early-stage funding and helped it grow sufficiently to attract private equity firms (see below) to participate in later fundraising “rounds.” The company was valued at £1.2 billion in its 14th round of fundraising earlier this year.
Under the programs, investors receive tax relief provided they meet certain criteria, including income tax relief of between 30% (EIS) and 50% (SEIS) and capital gains tax relief provided the Shares have been held for at least three years.
Mr Kwarteng announced that the annual SEIS limit for investors will double to £200,000 from April 2023, allowing for greater income tax relief for investors. On the corporate side, the funding limit will be raised to £250,000, along with a relaxation of asset and trading history criteria to allow more companies to qualify for SEIS funding.
Mr. Whorwood says: “SEIS supports companies in their earliest stages, encourages companies to scale and accelerate their growth, and encourages investors – who can bring both skills and capital – to invest.”
No changes to the EIS were announced, but the government reiterated its support for the scheme, which may be similarly expanded in the future.
venture capital trusts
Venture Capital Trusts (VCTs) were established in 1995 to encourage investment in small businesses. They are growing in popularity, with the Association of Investment Companies (AIC) reporting a 65% increase in fundraising in the most recent fiscal year.
VCT funds typically invest in around 20-30 companies whose shares are publicly traded. Unlike EIS funds, investors receive shares in the VCT itself and not in the underlying companies.
Annabel Brodie-Smith, Communications Director at AIC, comments: “Because VCTs invest in high-risk companies, private investors receive generous tax breaks to offset the increased investment risk.
“Those tax benefits include a 30% upfront tax break if the shares are held for five years, no capital gains tax on growth, and they have tax-free dividends.”
Real estate information provider Zoopla was powered by Octopus Titan VCT in 2009. It then went public on the London Stock Exchange in 2014, breaking the record for the first VCT-backed UK start-up to reach a valuation of £1bn. Octopus Titan’s eventual exit cost 33 times its original investment.
Broadly speaking, Ms. Brodie-Smith points out that VCTs have averaged nearly 140% returns over the past decade, along with a return (annual return in the form of dividends) of 8%.
However, she warns: “Investors need to remember that VCTs invest in younger companies and that return is far from guaranteed. VCTs are down 5% in the eight months to the end of August.”
Although no changes were announced in last week’s mini-budget, given the government’s support for VCTs, further tax breaks could be included in future budgets.
Richard Stone, Chief Executive of AIC, says: “This is a strong vote of confidence in VCTs and we welcome the Government’s intention to continue the program beyond 2025.”
private equity funds
Private equity encompasses a range of investments, from smaller companies to large corporations. Although private equity firms can acquire shares in public companies, the majority of investments are made in private companies.
Private equity firms pool money from individual investors and institutional investors (e.g. company pension funds) to invest in a portfolio of around five to ten companies. They strive to add value to the business through growth and/or acquisitions.
Companies will typically try to sell their holdings after five to ten years in order to realize their profit. This can be done through an initial public offering (IPO) or a sale to another company or private equity firm.
Examples of private equity-backed companies include supermarket Morrisons, recently bought by US private equity firm Clayton, Dubilier & Rice, and breakdown company The AA, owned by TowerBrook and Warburg Pincus.
Direct investments in private equity funds are usually reserved for experienced, wealthy investors due to the high minimum investment amounts and regulatory restrictions.
One option is to invest indirectly through an exchange-traded fund (ETF), which tracks an index of publicly traded private equity companies. The iShares Listed Private Equity UCITS ETF tracks the S&P Listed Private Equity Index and has delivered a five-year total return of 42%, according to information provider Trustnet.
Alternatively, investors could buy shares in one of the listed private equity investment trusts. These provide a return through the payment of dividends and an increase (or decrease) in the company’s share price.
For example, 3i Group invests in middle-market private equity and infrastructure companies and has delivered an average annualized total return of 22%, according to information provider Morningstar.
crowdfunding
Crowdfunding is one of the largest sources of funding for start-ups in the UK, allowing a large number of private investors to get involved in fundraising with relatively small amounts of money.
Crowdfunding platforms provide a curated selection of start-up companies seeking investment and coordinate fundraising. Investors get a small stake in the company with the option to sell their stake if the company is acquired, refinanced, or taken public.
This method of raising capital accounted for almost 20% of transactions by number in the first half of 2022, according to Beauhurst, behind private equity and investments by high net worth individuals. Crowdfunding platforms Seedrs and Crowdcube were responsible for the vast majority of deals, facilitating 137 and 101 rounds respectively.
Scottish brewery BrewDog is one of the most notable crowdfunding success stories, with the earliest investors being rewarded with returns of over 2,700%.
Another example is challenger bank Monzo, which, according to Crowdcube, took just 96 seconds to raise £1million in its first crowdfunding round in 2016. Subsequent rounds of funding have brought initial investors a 15x return.
employee participation programs
Companies may offer employee stock ownership programs to motivate employees by allowing them to participate (positively or otherwise) in the company’s performance. These share programs may include the gift of shares or the right to purchase shares in the future at a set price.
Mr Kwarteng announced that the annual limit on company stock option plans (CSOPs) will be doubled to £60,000 per employee from the next tax year, along with the easing of certain restrictions.
CSOPs allow companies to grant stock options to employees with tax benefits. Subject to meeting the eligibility criteria, options may be exercised with no income tax or social security contribution for the employee on the difference between the market price and the exercise price.
However, employees typically have to pay capital gains tax on any gain if they sell the shares.
Employees who receive shares in private rather than public companies may find it more difficult to sell their shares. Private companies may offer buyback programs, or alternatively, employees may sell stock in an IPO or sale of the company.