Votes matter, or do they?

Let's get this straight from the get go. I am in favour of equality, democracy, tolerance and transparency in all areas of life and not least investment.  I spent the early years of my corporate finance career enfranchising non-voting shares in companies quoted on the London Stock Exchange.  I like the idea of the power of a crowd of private investors balancing the block voting power of institutions.  Like Xavier Rolet, CEO of the London Stock Exchange, I think that private investors need to return to the equity markets and use their voice more loudly when it comes to the companies in which they own a stake. 

The issue of non-voting shares has reawakened with the rise of crowdfunding. It has prompted me to do a bit of research into the issue as I had rather assumed that non-voters had disappeared into the mists of time.  How wrong I was.  Were you aware that companies as diverse as News Corporation, Schroders and Berkshire Hathaway as well as AIM companies such as Jelf Group all have non-voters?  Google has come under flak for having three classes of shares, A shares with one vote, B shares with 10 votes and C shares with NO votes.  You won't be surprised to learn, if you did not already know, that the B shares are mainly owned by Google's founders.  LinkedIn and Facebook have similar share structures and Twitter is the notable US tech giant outlyer that does not have a dual class structure. In effect Founder Shares are not just valuable for the economic interest they have, they are worth a fortune because they enable the holders to control a company long after the uninitiated would have assumed that they are operated and run in a similar way to all large quoted corporations.

Some stock exchanges, such as the Hong Kong Stock Exchange, ban dual share class structures, but whilst it is frowned upon by many stock markets in the West they have tended to take a more tolerant view.  They are right to do so.  There are occasions when it is appropriate for control to remain in the hands of a few.  The newspaper industry is a good example - where it makes sense in the context of editorial independence for the management to have consistency in terms of those who have voting power of the direction of the company and an accompanying inability of one interest group taking control of the publishing company and using its media outlets for its own ends. Companies operating in areas such as defence, where the national interest is at stake, should have controls in place which prevent anyone from taking charge, which was the reason the privatisations of the 1980s and 1990s so often left a golden share in the hands of the government. 

Keeping control in the hands of the founders has enabled the likes of Facebook to make strategic acquisitions which may have been challenged by "normal" institutional investors wanting to keep a management team stuck to its knitting. If you believe in following the entrepreneur and the founder is still in control, is it so wrong to allow them to retain the power to follow their vision?  A prime example of this is Warren Buffet, who has delivered amazing shareholder returns on great fundamentals, whilst maintaining a superlative investor relations programme.  Keeping the greatest vested interest in the hands of the founder can make sense. And if quarter-results driven institutional investors continue to force companies to bend and sway to the whims of the moment, we are only going to see a more fundamental re-emergence of super voting shares in new IPOs as founding management teams seek to negate the impact of this type of pressure.

Of course super voting shares, if in the wrong hands, can lead to terrible abuse of less enfranchised investors. We should not ignore the study by Wharton School and Harvard Business School whihc showed that while large ownership in the hands of management tended to improve returns, heavy voting control by "insiders" weakened it. 

It appears therefore that the issue of who holds the votes and how they use them depends as much on the person as the principle. 

Personally I think investors should not be frightened of non-voting shares in SMEs.  Let's face it - when larger investors such as VCs start investing, control of a company's direction is effectively dictated by the shareholders' agreement. The new money will nearly always dictate the terms, which will be designed to give it the controls that ensure it optimises its economic interest ahead of others.  So even if you do have a vote, you won't necessarily be able to influence control.  At least non voting shares bring this issue to a head up front. 

As a very small investor in a company you won't be able to influence matters unless you gang up with every other very small investor; or you happen to be in that very rare position that your vote really is the casting one in a dispute where the opponents are pitted against each other. 

Non voting shares are not worthless, but they should be worth less than voting shares, because there is an instrinsic value to a voting share, and therefore this should be priced into any fund raising involving two classes of shares.  Quite simply, non voting shares should cost less than voting shares where all other factors are equal.  And if the factors are unequal e.g. voting shares having a right to a great share of dividends or capital proceeds this too should be priced into non voting shares. 

Then we come to the issue of the economic interest of non-voting shares.  This is a tricky one when it comes to fast growing SMEs which have little desire to pay dividends. EVen if the management teams of growth companies have not intention of paying dividends they should ensure that non voting shareholders will get a share of proceeds at exit, which is proportionate to overall share of equity capital they hold, not just what they vote on. The market will soon tell us what the normal parameters should be in these areas. 

When the time comes for a company to start paying dividends, the onus will be on management teams to make sure that non-voting shareholders get a share of this income too even if it is a smaller proportion of the total than the voters get. 

I am sure it is true that many people who are buying non voting shares in crowd funded companies do understand that they are having a bit of a punt on a new company.  They are probably buying the shares because it is a bit of fun, they want to help a person or brand they like, or they like the reward on offer.  That is fine, but founders and management teams need to understand that just because they have invested for these reasons it does not mean they should be disenfranchised from the returns that in normal circumstances they would expect.  Non voting shareholders deserve a powerful investor communications programmeand they should also be able to command the opportunity in the future, for dividends, for a proportionate share of exit proceeds and for the opportunity to enfranchise one day. Companies that respect that the investors should be rewarded for the risk capital they have provided will win in the long term. 

In the short term, one way to reward non-voters could be to restrict the rewards offered as part of a campaign to non voting shares only.  This would have the advantage that it would send a clearer message to investors that non voting shares are different, and should be considered as such.

It appears that the trend for dual class share structures may well grow in the future as more and more tech and wannabe gazelles raise money from different markets - from crowd funding to VCs to the New York Stock Exchange and other quoted markets. We will have to learn to live once again with them as "normal" or at least not unexpected.  The trend will be reinforced as companies come to the public markets with younger founders still in control and intending to stay that way for decades.  They will become entrenched if management teams discover it is the way to stop institutional investors pushing them around.

Beware though, if they do become the norm, the market will become more expert at valuing them and using other means to influence management behaviour than voting on ordinary and extraordinary resolutions.  Expect the unexpected; activist non-voting shareholder groups may, for example, start to exert their influence via social media. It would not surprise me to see management teams who do not treat their non-voting shareholders "right" facing a Twitter storm launched by the angry non voting investors which encourages the public boycott the products the company is selling, killing profitability and destroying value for the voting shareholders.  

Ouch!!

 

Modwenna Rees-Mogg

 

Visibility: Clear

As I sat enjoying myself, courtesy of Lloyds Bank, at the UKBAA Angel Awards last week, I was struck by the immense developments the UK's angel market has made over the last decade or so.  Around 300 of the industry's finest - ranging from angels to entrepreneurs and advisors, the room truly represented how large, diverse and interesting we have become.  

10 years ago the angel industry into which I launched AngelNews was a very different place.  Largely siloed and pretty incohesive, the order of the day was akin to mediaeval Italy - angel networks were like little city states, most of which had more in common than they cared to admit, but which were fundamentally only interested in their own small worlds.  Research into the market was hard, very hard, so it was difficult to get a helicopter view of the market. Without the facts or even a clear idea of the themes, it was nigh on impossible for anyone to move forwards.  Too often is was a case of one step forward and two steps back.  Angels rarely came out of the woodwork.  Networks were chock full of passive angels.  I remember attending one network meeting and talking to a couple of "angels" only to discover that they had no intention of investing, "but this is a good place for us to meet up for a coffee because we are old friends and live at opposite ends of the region."  

Fast forward to today: the work of Jenny Tooth and her long term stalwart supporters at the UKBAA (not least the amazing Stephen Pegge of Lloyds Bank), who have, behind the scenes, supported the market's development with not only money, but wisdom, has created a very different world.  Combined with the fact that angel investing has become "cool", the massive awareness raising exercise that is Dragon's Den, like it or loathe it, has helped to make the market much more visible.  And of course much larger and more valuable.  

Entrepreneurship is not only creating more and more investment opportunities, but is now creating the next generation of talented angels who in turn are backing the next entrepreneurs.  Investing as well as giving back within the world of business is one of the reasons why our economy is speeding along the right track.

I think it is fair to say that the angel market is now contributing so much to the development of other financial services markets.  Would the equity crowdfunding market have emerged so quickly and so strongly if it had not been able to grow out of the angel market?  It is a child of angels of which we should be justly proud.  And our cousins in Venture Capital have grown and learnt too from angels.  The latest generation of Venture Capital fund managers nearly all have their roots in the angel market.  The nine nominations for the Angel-VC deal of the year are testament to the new bonds that exist between the two markets, just as the eight nominees for Best Crowdfunding-Angel Deal of the Year symbolised that we can invest with our children as well as our cousins in harmony. 

The Awards themselves showed how diverse the angel market has become.  Michael Blakey's continuing 15 year commitment to the angel market means he was a deserving winner of Angel of the Year, but the other nominees could all have been deserving of the prize.  

I am not normally a public champion of the "women" issue, but it was satisfying to see that there were six nominations for Best Women-Led Investment of the Year.  A decade ago probably fewer than 1 in 10 angels were female.  Now we have not only women-led investments, but we also have a handful of women-led angel networks - and that is not because the network is administered by a woman, but because there are enough women investors to make such networks sustainable.  I hope the growth in diversity in the angel market will mean that in future we can have "young" angel networks and angel networks with ethnically diverse make up - Sharia Angels anyone?  I hope we will see further growth in impact investing. Next year I am confident that the nominations for Social Impact Investment of the year will be chosen from a pool of dozens of nominees, as this particular and very special type of investment becomes mainstream.  The Green Angel Syndicate is symbolic of the sector specialist angel market. 

Liquidity events or exits as they are known in common parlance will become more common not only as the increasing volumes of angel investments mature, but because angels and their advisers are getting better at achieving this goal. Activity will be supplemented as more and more corporates see the value of buying quality angel businesses.  Further liquidity will be achieved as Asset Match* increasingly comes to the attention of angels as a route to liquidate part or all of their angel holdings. Why will they use Asset Match to generate cash from their investment? Partly it will be to use for personal reasons, but more importantly it will be so they can invest in more angel deals.  Once this recyling of investment becomes the norm, we can expect to see the angel market grow exponentially and we will see the sub segmentation of the angel market into "experts". Some angels will become prolific start-up investors recycling their money with increasing speed; others will elect to become "second stage" angels, buying up second hand shares in more established companies, perhaps investing new monies in the company alongside the new trade.  

Syndication is an interesting theme.  Taking a more co-ordinated approach to investing will help busy people (including those in full time jobs) to join their more active angel peers as passive investors.  Platform technologies enable strong angel groups, such as Envestors and Ruffena, to co-ordinate angel activity in volume, but without losing the personal engagement with the entrepreneurs that is the point of angel investing.

The way ahead is now clear.  Angels no longer just play a role in the economy as the default source of entrepreneurial money. I expect that by next year the UKBAA will be able to announce many more awards.  One might be Bank Debt/Angel Deal of the Year, another might be "Most insightful piece of research" and a third could be "Most Exciting New Entrant to the Market". And maybe it will even be able to command several nominations for International/UK Angel Deal of the Year?

In the meantime, congratulations to Jenny Tooth, Noelle Baquiche and the Board of the UKBAA, not only for putting on a great party, but for their devotion and commitment to supporting the angel market.  Without them we would all be weaker and more divided. With them in charge, the future is not just clear, it is rosy. 

Modwenna Rees-Mogg

 

 

 

 

EIS and the little red box

Just a short time to go until George Osborne's first Budget of the new Conservative Government - expected on 8 July. Investors and companies are waiting eagerly to hear if there are any changes to be made to the draft legislation published in March.  One of the more obscure quirks in the Government's proposed changes to the EIS legislation, is to restrict EIS relief where an investor already has a previous investment in an EIS company.  Where that's the case, the new investment will only attract EIS relief if the earlier investment was:

• an investment by a founder in the shares issued to establish the company and the same person still holds the shares, or
• part of an issue of shares which the company has included on a form EIS1, SEIS1 or SITR1.

This could have the effect of disadvantaging investors who've made a small early investment in a promising company without the benefit of EIS or SEIS, and who now want to follow their investment.

Whatever the outcome, Robertson Hare can help you untangle the new rules.  

www.robertsonhare.tax

Tel: 0203 141 9108

 

Kathryn Robertson

 

 

 

The Smart Cities of the future just became the present

Since the boom of the motor car cities have increasingly become clogged, especially in city centres. As well as clogged streets, parking has been a perennial problem.  Traditionally the local government solution has been to pile multi-story monstrosities into the centres of our towns and cities to cope with the problem. Now, however, technology is providing a more elegant solution. 

An ingenious Smart Parking system is being trialled at Milton Keynes train station. Instead of the usual bullfight for car bays, it allows the driver to find a bay before even setting off. This breakthrough is courtesy to a tech revolution known as ‘The Internet of Things’, which sees everyday objects being connected to the internet. Smart Parking is just one offspring from this field of tech. The system works by monitoring the vacant spaces in the car park using sensors in each bay. The sensors then relay their data to the local council, which in turn displays which spaces are free on their website. Citizens of Milton Keynes can then view a map of where they can and cannot park.

Not only does this system make for a better parking experience, but it is also a more efficient way to use the spaces available. What’s more, with the data collected by the council means they can adjust their parking rules to suit demand. Without the Smart Parking system Milton Keynes was looking at adding twelve thousand new spaces in town, despite having an average of seven thousand vacant at any time. The new system will allow the city to use its spaces more efficiently, thus saving the council needing multi-story car parks clogging up the city centre.

Another example of the Internet of Things revolutionising our lives is the use of drones to monitor oil rigs. Sending children up chimneys may seem like a barbaric practice that couldn’t exist today; however oil rigs send employees up their rigs to monitor corrosion; tragically this has led to 16 deaths last year alone. The good news is that a company called Sky-Futures can send a drone to do the work of monitoring corrosion on the rigs remotely. As well as removing human risk, oil companies no longer have to shut down the rig while it is being watched by a drone, thereby saving huge amounts of money.

Angel funding has enabled Sky Futures to develop the technology, build working drones at a cost of £35k each and train pilots to control them. With working drones now available the oil and gas sector is adopting the solution worldwide. Furthermore, Sky Futures is developing new drone technology that can sense gas leaks and avoid the drones crashing when conditions are difficult.  

There is no doubt that internet-enabled devices are revolutionising our world. Sky Futures is one of the early examples of successful angel investment into this new tech sector.  It is highly likely that the Internet of Things will be the place where angels will find many more new and exciting investment opportunities in the future. 

Joseph Shaw

 

 

European Venture Capital Funds (EuVECA Funds)

Retail Investors

The EuVECA Regulation restricts financial promotion to retail investors subscribing a minimum amount of €100,000 but there is no such restriction in the agreed text for the ELTIF regulation. 

Consideration should be given to eliminating the EuVECA restriction or reducing it to a level consistent with the average investment in an SME raising capital in the UK under the Enterprise Investment Scheme or in a Venture Capital Trust which will be around £15,000- £25,000 per investor. To put this in context, the EIS and VCT schemes now raise a short £2 billion every year for investment in SMEs, are classified as mainstream investments for retail investors by the FCA and make a very significant contribution every year to the creation of growth and jobs in the UK.

It would be marvellous if Lord Hill were able to marry the inspiration and drive behind his Green Paper with the export to other Member States of the UK's successful model for SME investing by retail investors. I am sure the industry would provide a lot of support for this endeavour both at EIS fund manager and adviser level as well as through its leading representative body, the Enterprise Investment Scheme Association (EISA) the board of which is led by Lord Flight as Chairman and Sarah Wadham as the EISA's Director General.

Part4A authorisations

SEIS and EIS venture capital funds should be qualifying funds under the EuVECA Regulation provided they are only marketed to professional investors or high net worth investors pursuant to Article 6 of the EuVECA Regulation. Article 16 of the EuVECA Regulation should then apply so that the UK cannot require the manager of such a SEIS and EIS fund to require a Part 4A permission, but, for the reasons stated below, a Part 4A permission would still seem to be required under Article 37A of the RAO as a matter of UK national law.

Paragraph 2.3 of the EuVECA manager registration form http://www.fca.org.uk/firms/markets/international-markets/aifmd/eusef-euveca

requires an applicant who is not currently authorised by the FCA to answer questions 2.4 to 2.10 of the registration form before moving on to complete the rest of the application form, the implication being that it is possible to become a EuVECA manager without the need for any Part 4A permission from the FCA. If this is right then there would seem to be a glitch in the amendment of the RAO which has not yet caught up with the urgency with which the FCA is seemingly keen to join the fray in building an EU capital markets union by the provision of EuVECA registration forms.

The glitch is as follows:

FUND 1.3.7G(3) says that a small AIFM which has applied for registration as a EuVECA manager will not be carrying on a regulated activity in this capacity, but if this is so then on what basis is Article 37 RAO disapplied?

Article 37 of the Regulated Activities Order requires a person to be separately authorised if they will be 'managing investments belonging to another person in circumstances involving the exercise of discretion'. This is qualified by Article 39, which refers to Article 72AA.

Article 72AA provides that the activities of a person with a Part 4A permission to carry on the activity of managing an AIF under Article 51ZC are excluded from the need to obtain a Part 4A permission for any other activities. This means that if the person is a small authorised UK AIFM he only needs a Part 4 A permission to carry on activities under Article 51ZC and a permission to carry on other activities described under other Articles of the RAO (including under Article 37) is not required because of the Article 72AA exclusion.

But what is the position of a small registered UK AIFM? Article 51ZC is qualified by Article 51ZF which provides that there is excluded from Article 51ZC the activity of managing an AIF if the person carrying on the activity is listed in Schedule 8. Schedule 8 lists a small registered UK AIFM in respect of the AIFs by virtue of which it is entitled to be registered as a small registered UK AIFM. This means that a small registered UK AIFM does not need a Part 4A permission to carry on the activity of managing an AIF under Article 51ZC. 

But because the small registered UK AIFM will not have a Part 4A permission to carry on the activity of managing an AIF under Article 51ZC this also means that the benefit of Article 72AA will not apply. This means that a small registered UK AIFM will still need a Part 4A permission under Article 37 if it will be 'managing investments belonging to another person in circumstances involving the exercise of discretion'.

O' what a complicated web we weave!

 

Contact:

Roger Blears

Senior Partner

RW Blears LLP

125 Old Broad Street, London EC2N 1AR

e: [email protected]

w: www.blears.com

tel: 020 3192 5691