Investing in unlisted companies: When will you realise a return on your investment?
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Many investment strategies involve investing in early-stage start-ups because of the potential for eye-watering returns.
However, in the short term, investments in start-ups or small Australian businesses through equity crowdfunding are relatively illiquid, meaning they are not easily converted into cash. This is because companies (and their related parties) who raise capital under the crowd-sourced funding regime must not be listed on a financial market in Australia or overseas.
So, how can investors realise the return on investment in regards to equity crowdfunding?
There are multiple ways for investors to potentially recover their investment (and then some) post capital raise. These are usually called 'exit events' or ‘liquidity events'. Potential liquidity events for investors can include:
Initial Public Offering (IPO)
Low volume market
Here's an overview of each liquidity event.
Potential liquidity event #1: IPO
An IPO is the first exit event that springs to mind for investors when considering how they may make a capital gain, or return on investment. Under an IPO process, the company raises equity capital by offering shares to the public (this process closely resembles crowdfunding but is completed on a larger scale with greater regulatory requirements). Following this, the company lists on a publicly traded exchange, such as the Australian Securities Exchange (ASX).
Being listed on a publicly traded exchange, such as ASX, enables investors to sell (or buy more) shares of the company they invested in earlier. As an IPO is further down the road of a company’s lifecycle, it enables investors from earlier, illiquid rounds of funding to realise returns on their investment.
Potential liquidity event #2: Trade Sales
A trade sale is when another company decides to buy out some, or all of, the business. Potential buyers can range from those with strategic interests – to align long term business plans, to those with financial interests – seen as an investment from players in the private equity and venture capital space. For example, a larger business in the same industry that is interested in expanding it's product line and operations, or a venture capital who has the capital and connections to expedite the growth and scalability of the start-up.
Investors will be paid for selling their stake in the business, representing an exit event to receive a return on their investment. An advantage of a trade sale for investors is that the purchasing company usually pays a higher price for the business, which generally increases in as the percentage of company that was purchased – this is called a control premium.
Although, please remember, the impacts of merger and acquisition activity on shareholders can vary depending on the shareholder rights outlined in a company’s constitution (so always make sure you review the constitution before investing).
Potential liquidity event #3: Share Buyback
A share buyback occurs when the company decides to buy back equity (shares from its investors). Early-stage companies might want to engage in a share buyback to offset dilution from previous equity raises if funds are no longer required, better manage their share register, and provide investors an exit.
In this event, investors would have the option for their shares to be ‘bought back’ by the company at a pre-determined price.
Potential liquidity event #4: Dividend
Companies can provide investors a return by way of a dividend. A dividend is a distribution of profits amongst shareholders.
Given the profile of companies who are raising funds in the crowdfunding space are often early-stage with a growth focus, dividends are unlikely. This is because cash flows generated from early-stage businesses are typically reinvested into the company to fund future growth and expansion plans to deliver greater returns for shareholders.
However, it is possible that once the company increases sales and moves to the next growth cycle, they may take a different approach on offering dividends.
Potential liquidity event #5: Low volume market
A low volume financial market is similar to the share market, just on a much smaller scale. A low volume market allows no more than 100 completed transactions to occur at a total aggregate maximum value of $1.5m for a 12-month period. Without floating onto a publicly traded market, investors can experience a liquidity event by selling their shares.
To establish a low volume financial market, an application must be submitted to ASIC for approval. Companies in the equity crowdfunding space may consider offering a low volume market following their raise to offer investors an opportunity to exit or increase their stake in their company.
Neutrog Limited, who raised $3m from 784 investors plans to establish a low volume market that will enable investors to trade Neutrog shares. If approved, this platform will be available to investors 12 months from the date of the shares issued.
The above five potential liquidity events are most common when it comes to investing in unlisted companies and are worth familiarising yourself with.
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To learn about raising capital via equity crowdfunding with OnMarket, click here.
*Please remember crowd-sourced funding is risky. Your investment is unlikely to be liquid, meaning you are unlikely to be able to sell your shares quickly or at all if you decide it is not for you. You should be able to bear the risk without undue hardship.
*Please note OnMarket is not a financial advisor and all contents of this article is general financial knowledge. You will need to conduct your own research and due diligence before making investment decisions.