Organisations and shareholders
An Association of Investment Trust Companies (AITC) case study

Page 1: Development of organisations and reasons to become a shareholder

Many businesses have humble beginnings; their founder had a business idea that worked. There are many 'rags to riches' stories of individuals who began with a market stall or corner shop and who are now multi-millionaires. The road to success can be long, requiring relentless hard work and some luck to overcome pitfalls along the way.

A business owner may start as a sole trader. They are responsible for accounting records, which are required for tax and VAT purposes. This type of business is not without risks as the owner has unlimited liability and may lose all his/her personal assets if the business should fail with debts outstanding. Funding may become a pressing problem as the business grows and the sole trader needs, say, to buy new equipment or to move to larger premises.

In this case a sole trader may then decide to become a private limited company, which has the right to raise additional money through a private share issue. As a company, there are legal requirements e.g. filing annual accounts at Companies House and completing an annual return. There is peace of mind knowing that with limited liability, the owner will not be personally liable for any debts incurred if the business runs into difficulties. Alternatively, a sole trader can borrow money to finance growth. This might mean that the sole trader has to offer a personal asset, such as his/her house, as security for the loan.

Growth may be through:

  • developing new products or services
  • buying latest technology to improve products or the services
  • moving to larger premises
  • opening operations overseas
  • acquiring another business.

A growing business needs capital, this might be raised through:

  • issue of new shares (known as a 'new issue')
  • retained profit
  • overdraft
  • bank loan
  • hire purchase
  • sale and leaseback.

A growing business might 'go public' and raise funds through a public issue of shares on the stockmarket, known as a new issue. It is a good way for businesses to raise funds and grow. Investors can then purchase these shares and become shareholders. Once issued, company shares are bought and sold on the stockmarket (known as the secondary market) at a price that may rise or fall depending on many different economic and business constraints affecting the way the business performs.

Many high street names are public limited companies, listed on the London Stock Exchange. Investors can purchase shares in them. Here are just a few examples:

  • Next
  • BT
  • HSBC
  • Vodafone
  • Marks & Spencer
  • British Airways.

Why become a shareholder? Of course to make money. Over the longer-term, investing in the stockmarket has proved financially more rewarding than saving through high interest savings accounts. However, the stockmarket can go down as well as up and investors may not get back their original investment. In extreme cases, investors may lose all of their investment. Many shareholders are also attracted to the idea of becoming a shareholder in a company. This means that they own a small part of the company (as section 5 illustrates). Because of this, public limited companies like Marks & Spencer and British Airways, have obligations to make money for their shareholders.

Share prices saw a huge downturn in value after the dot.com bubble burst. Shares in technology and dot.com companies had become overvalued and quickly went from boom to bust. This coincided with a general fall in share prices after the stockmarket peak of 2000. The terrorist attacks of September 11th 2001 exacerbated these falls, illustrating how much the stockmarket is driven by confidence. Because of the inevitable peaks and troughs, it is important to take a long-term view when investing in the stockmarket. Despite the potential for gains, investment may result in large losses, although over the long-term stock market highs and lows can often be evened out. The buying and selling of shares is done through the Stock Exchange.

Stockmarket falls, whilst painful for shareholders, can present opportunities for potential investors, who may be keen to buy the shares as their low price seems attractive. These investors will hope the company is undervalued and that its share price will recover, making them a profit, although there is no guarantee.

Association of Investment Trust Companies (AITC) | Organisations and shareholders

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