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

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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.

What about investment trusts?

Investing in shares of an individual company involves more risk than in the shares of a variety of companies. This is where collective investment vehicles such as investment trusts, unit trusts and open-ended investment companies (OEICs) come in. These invest in the shares of other companies on behalf of investors. They pool investors' money and have a professional fund manager to invest in a wider range of companies than most people could practically do themselves. This way, people with small amounts of money can gain exposure to the long-term potential of the stockmarket, at low cost, through a diversified and professionally run portfolio of shares. This spreads the risk of stockmarket investment. Investors can invest from £25 per month or a £250 lump sum.

Investment trusts, unit trusts and OEICs do have their differences. Investment trusts are closed-ended, public limited companies quoted on the stock exchange. They are companies that invest in other companies on behalf of investors.

Most plcs produce either goods or services for sale to customers. Investment trusts are plcs but unlike most other plcs their sole aim is to make money for shareholders by investing in shares of other companies. Investment trusts are closed-ended funds: at launch, they issue a fixed number of shares to raise the initial pool of investment capital. The value of which will increase or decrease according to how well it is invested by their managers. Unit trusts and OEICs on the other hand are open-ended. This means that, unlike investment trusts, they expand or contract in size as people buy or sell their investment. Unit trusts are not companies and OEICs, although they are companies, are not listed on the stock exchange. This structure is one of the main differences between investment trusts, unit trusts and OEICs, but each have their own advantages and disadvantages as a result of their structures.

Some investment trusts and other financial institutions buy shares in under-performing companies to try to improve their performance and the ultimate return on their investment. Investment trusts will monitor the performance of those companies and as shareholders may influence the decisions made there.

Shareholders and their role in an organisation

A shareholder is a part owner of the business to which the shares relate. S/he may be an individual or a large financial institution. Many pension fund managers use clients' money to buy shares as a long-term investment, hoping for a higher return from this investment than might be achieved from other types of assets.

Stockbrokers will buy and sell shares according to the wishes of their clients, to maintain their clients' investments and watch them grow. Investment trust shares can also be purchased directly through the product provider, through saving schemes or Individual Savings Accounts (ISAs), which are a low cost way of investing in the stockmarket.

Directors of plcs, including investment trusts, continually try to improve their companies' performance. It is in their interest that shareholders invest in their business. A popular and good performing business in the market place might help its share price rise as demand for its shares increases.

Investment trusts can provide a sound investment option for shareholders as they invest across a variety of sectors and risk profiles, spreading risk over a number of investments.

An investment trust company will use its shareholders' money to buy shares across several different sectors of the market place. The investment trust will consider carefully its aims and objectives and which companies have the best potential to meet them. They will invest accordingly.

A shareholder owns a share of the organisation in which s/he has invested. This means the shareholder can have a say in the running of that company, e.g. they may vote on key issues. The shareholder with more than half the value of the business is known as the majority shareholder. S/he or it - many shareholders are companies or institutions like pension funds - will be very influential in the decisions the organisation takes. If the majority shareholder believes a proposal to be detrimental to the businesses, it may not be carried through.

Investment trusts are themselves shareholders but on a much larger scale than individual investors. This ultimately gives them more power in the company. Where the investment trust has a large shareholding in a company, it has the power to influence the decisions about the company's future.

One respected fund manager, who manages investment trusts and other investment vehicles, was reported to have led a successful shareholder revolt to prevent the appointment of the nominated Chairman of the proposed merged entity of the TV giants Carlton and Granada.

The UK government encourages large institutions that invest substantially in companies to use their power as shareholders to influence decisions in the best interests of the company and their investment. Shareholders are able to vote at the Annual General Meeting for the removal or election of different members of the Board of Directors.

The issue of chief executives' pay often hits the headlines. In many companies, shareholders are urging key personnel be paid in line with their performance and not be given big payouts.

Shareholders as stakeholders

A large plc will have a number of different stakeholders of which shareholders are only one, customers perhaps being the most significant. An investment trust company has stakeholders, just like any other PLC, but investment trusts' only customers are its shareholders. This is because investment trusts are companies whose only purpose is to invest in the shares of other companies. They do not produce goods or provide services, but as with any other quoted business, investment trusts have a number of other stakeholders who have an interest in their business.

The stakeholders of a public limited company:

Here are some examples of the type of stakeholder s that plc's may have:

Conclusion

A stockmarket flotation can help a business to secure funds to help it meet its aims and objectives and to grow. Shareholders can influence decisions made. Ultimately shareholders invest in the stockmarket in the hope of making more money than they would elsewhere. They accept a greater potential risk in the hope of a greater potential return. Shareholders can be either private individuals or large corporations. Choosing to invest in an investment trust can help to spread the risk across a wider range of companies and both private investors and large institutions invest in investment trusts as a way of diversifying risk.

AITC

The Association of Investment Trust Companies operates on behalf of investment trusts by:

  • raising awareness and promoting benefits of investment trusts to consumers
  • providing education, information and training on investment trusts to financial advisors
  • supplying statistical information to the marketplace
  • lobbying policy makers on behalf of the investment trust sector
  • working with member companies to help them realise the potential of the investment trust structure.

At the end of 2004, the investment trust industry managed assets of approximately £60 billion.

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