This week I want to look at shares, particularly shares in early stage unquoted companies.

Over the last decade quoted shares have failed to generate significant capital gains but investors have been rewarded with dividends and hence returns have been somewhat disappointing for most.

Smaller companies have offered the best opportunity for substantial capital gains but at significant risk.

How then can an investor mitigate that risk?   There is compelling evidence that early stage investee companies are more successful when guided by an experienced, successful entrepreneur turned investor (i.e. a business angel).

There are three different ways to invest in early stage companies: via a professional fund manager, as an individual or in a syndicate.

There are a number of professional fund managers who operate in the early stage market. A Venture Capital Trust is one of the most popular structures.  VCT’s are quoted entities but have to invest in early stage businesses.  The professionals can structure individual deals and chose which companies to invest in.

In theory professionals should do well but no real superstar fund managers have emerged in fact a quick glance down the table of returns shows many VCT in the red.

Many investors prefer to invest as an individual.  Often they will have a network of contacts who bring them deals or perhaps an angel network like us.  Individuals do deals in a particular sector that suits their expertise and using a structure to suit their own tax position and risk appetite.

There is little objective evidence on the success or failure of this approach.  Certainly there is probably a maximum number of deals that one individual could run with?

Investor Syndicates, which my business specialises in, operate on an informal basis where each member makes their own investment decisions but has the benefit of working with like-minded individuals.  A group often makes better decisions than an individual, certainly working as part of a syndicate an investor can spread their funds over a number of companies thus lowering risk.  Perhaps the biggest benefit is post investment monitoring and support.

Working as part of a group enables the post investment effort of to be spread and a pool of expertise and contacts to be called on when needed.  Syndicates are the norm in USA the most successful economy at early stage investing.

Nest week I want to look at the latest changes in tax relief: investors can get tax free capital gains or if a deal goes wrong, a tax subsidy up to 78% of their investment!

Please do have a look at the Opportunities section of our website to see investment opportunities and at the Portfolio section to see how our business angel backed investee companies are performing.

2012 has arrived, and I want to look back some 12 years to 31 December 1999:

• FTSE 100 was at an all-time high of 6,930 nearly 25% higher than today’s level of 5,626.
• Government bonds with a 10 year maturity were yielding 5.5% compared to 2% today
• UK residential house prices have more than doubled over this period.

Put these in the context of inflation (as measured by CPI) which averaged less than 1.5% per annum during the years 2000 to 2004, then around 2.5% per annum until 2008 and recently has increased to say 5% per annum: how have your investments performed?

If you use ISA’s (or some other scheme) to remove the liability to tax then the dividend income from FTSE 100 investments has more than offset the fall in capital value.  Similarly the relatively low inflation has probably resulted in your cash savings suffering only a modest decline in purchasing power.  Only government bonds will be showing a reasonable capital gain.

But what is the outlook now and who should be considering the implications for investment?

There is some debate over the number of households in the UK but let us say 25m? Excluding housing wealth, fewer than 10% of these households have liquid savings of £60,000 or more and these figures were before the impact of the financial crash.  Thus over 90% of people should probably pay off their mortgage or other debts and then stick with a simple cash savings account.

Those with say £100k or more; and those who are managing their own pension (maybe with the help of an advisor) need to have an investment strategy.  Any well thought through strategy should be a consideration of the risks and rewards of all types of investment: bonds, cash, shares (unquoted shares as well as quoted) and “alternative” (wine, antiques etc.) investments.

Don’t forget one other recent relevant change: capital gains tax rates.  For capital gains up to and including 23 June 2010 a flat rate of 18% was payable.  Now gains may be taxed at up to 28% (much closer to the rates paid on dividends and other income) but to offset this there are a number of substantial tax reliefs for investors in unquoted shares.

My crystal ball is no better than anybody else’s but the credit crunch in the UK and EU (our main trading partner) looks to be here for a few years and in that environment: credit is restricted, interest rates are low and wage inflation is low.

It is very difficult to see any growth potential in government bonds.

Residential house prices look to be static at best? My guess is they will fall as there is no improvement in affordability for first time buyers.

In the next few blogs I want to take a look at the opportunities for other investments, especially shares, and how they are impacted by the new capital gains tax rules.

Please do have a look at the Opportunities section of our website to see investment opportunities and at the Portfolio section to see how our business angel backed investee companies are performing.

I’d like to think that we have hit bottom and that next year will see the start of the return of some confidence and the beginnings of a sustainable recovery.  According to the theory the best time to invest is at the point when all hope seems lost for that is when recovery is due to start.

The deal in Europe has failed to solve the immediate problems of the Euro and yet it seems to have done enough to show how a lasting deal might arise.

The financially challenged euro economies of southern Europe look to be sufficiently scared maybe to actually begin the process of cultural change: it might take decades but conditions look good for a start to be made.

I heard a senior German finance man, interviewed on the radio, talk about the possibility of further support for these troubled economies once a process of budgetary discipline had been established.  At that point, he felt that support would then be an investment in the future.

The UK is a net importer of EU goods and services.  We are a substantial net financial contributor to the EU so maybe worries over our isolation may have been a bit overdone?  Maybe the veto will turn out to have been a demonstration of our real power to influence the direction of the EU as other countries also start to question the detail of the “treaty”?

The battle to persuade the public sector unions to confront the financial realities of a world were economic power and wealth are shifting from the western economies to the developing world (except Africa), seems to be gaining momentum.  No deal has yet been announced but it has gone quiet?

There is a growing consensus that inflation has peaked and will now decline maybe even be back below 3% before the end of 2012.

If banks accept the new Basle III rules and if regulators (and politicians) stop them using soft credit as a competitive option then change will flow.  Prudent housing finance will prevent house prices running out of control and the difference between CPI and RPI will be negligible.  Banking bonuses will be paid in shares and will be only for real long term growth in shareholder value.

There is even some positive news in the unemployment figures; self-employment is up – even if many are reluctant to go down the entrepreneurial route.  If we continue to reform our precious welfare safety net to prevent it destroying the work ethic then this revitalised work ethic will help get youth unemployment down from its current dreadful levels.

Could it even be possible that the European Commission, in Brussels or on the train to Strasbourg, might start to focus on freeing up markets rather than producing more job destroying legislation – maybe that is a bit too optimistic!

Please do have a look at the Opportunities section of our website to see investment opportunities and at the Portfolio section to see how our business angel backed investee companies are performing.

The small business owner had committed himself to the business in full and had no “safe pension” at all.  He was working every day of the week to keep his business alive yet earning significantly less than the head teacher.

The head teacher displayed zero understanding of business and the nature of a competitive market.  How can an educated person expect to enjoy their safe pension for many more years and yet not expect to pay more? The comment I found really disturbing, and one which the union leaders use,   was “we are striking to get decent pensions for all” – a childlike refusal to confront the problem of “who pays?”.

Worse still the head teacher holds the leadership position in educating our children and creating their understanding and attitude towards business and competition.

I have always tried to keep this column politically neutral but I have to ask is it really credible to suggest we can borrow our way out of these economic problems?

The latest article by Samuel Brittan (an economic commentator who I really admire and respect) is still claiming that lack of demand is the core problem and that we need more government spending to create more demand and drive growth.

How can that be right?

We are already borrowing huge amounts of money to prevent a collapse in demand.  If you add together: government, household and company borrowing the UK has some £6trillion, (436% of GDP) of foreign debts.

Only the USA has more foreign debt: £9.5trillion but it is only 101% of their GDP.  The comparable figure for Germany is 176%; France 235%; Italy 163%; Ireland 1,093% and Spain 284%.

Our economy has become too focused on financial services and property. The only solution is change:  adapting our economy to the new realities of global markets. A long term process with short term declines in living standards.

Two things will help this change: lower interest rates plus honesty and leadership from all our politicians.

Please do have a look at the Opportunities section of our website to see investment opportunities and at the Portfolio section to see how our business angel backed investee companies are performing.

But what exactly are the issues?

Many economists say it is a result of the fixed exchange rates inherent in a monetary union, that does not also have a fiscal union i.e. a central tax and spend authority.  These same economists express relief that the UK is outside the euro and hence can devalue its currency to “help” fix the economic problems faced by the UK.

There is however a different explanation to the underlying problems in the Eurozone.  Governments are simply spending too much on: public sector wage costs; regulation and on providing a safety net (unemployment benefits; health benefits etc.).  To keep this apolitical,  by too much I mean more than their taxpayers are prepared to pay in tax.

The problem is exacerbated as economic power shifts to “low cost” countries with virtually no safely net and little regulation.  Europe becomes more uncompetitive and loses more jobs.

What we have seen in Ireland and will start to see in Greece and Italy is a reduction in government spending, some increases in taxation and probably an increase in the work ethic as pressure to respond to the low cost economies grows.  Change is being forced on these countries only because Germany refuses to cover their debts.

I think the jury is still out on the UK’s “advantage”: devaluation.

Devaluation may help exports in the very short term however it is usually followed by inflation, as the UK has seen over the last 50 years, but, without addressing the underlying problems.

UK productivity is poor by international standards and the UK education system has fallen steadily in international rankings over the last few decades. We all need to work more effectively for fewer rewards and at increased risk to get ourselves out of this mess.

As I have said before the private sector is well into this change process let us hope that the public sector can respond too.

Lest anybody doubt the problem: in 2010 the UK had a similar budget deficit to Greece and one that was twice as big as Italy.  Yet incredibly our government long term borrowing is about the lowest it has ever been.  If we falter ……….

A review of previous debt crises by McKinsey suggests that recovery will take 6 years at least and that the economy will fail to grow much in the next few years.

Economic problems cause pressure which increases the rate of change and hence Entrepreneurs and business angels can look forward, I am sure, to a period where there are some real opportunities for new businesses to be created and grown.

Please do have a look at the Opportunities section of our website to see investment opportunities and at the Portfolio section to see how our business angel backed investee companies are performing.

The move by George Papandreou the Greek prime minister looks quite shrewd to me, and is an interesting lesson in different negotiation styles.  Assuming he survives the vote of confidence then he has to tackle the democratic issue in Greece if the bailout is to work.  At the moment there is simply no majority support for the austerity measures and the EU bailout plan.  The risk of civil disobedience causing major problems in Greece and impeding the necessary reforms is too high: but a referendum will spike the guns of protesters.

I am sure a carefully worded referendum question, supported by intensive debate within the country, will appeal to enough people to win a “yes” vote.  There may even be further concessions from Germany to help ensure a yes vote?

The evidence of opinion polls from Greece is that although the Greeks do not like the austerity measures there is apparently a significant majority for staying with the euro.  There is no real support for a return of the Greek drachma.

What is the alternative?

Who else will lend Greece enough money to pay for an “un-reformed” public sector?  Would the country really risk complete economic failure and a probable decent into widespread civil unrest or worse?

Whatever happens this shows how a skilful politician can use negotiation tactics, rather than tanks, to try and get his way.

The markets have fallen on this news: an opportunity to make some money?

Please do have a look at the Opportunities section of our website to see investment opportunities and at the Portfolio section to see how our business angel backed investee companies are performing

It is still a hot media topic today and one that the politicians are starting to get excited about.  Despite various government schemes there is little to suggest that any new financing innovation has yet been identified that might revolutionise this area.

But, there is compelling evidence that private equity provided by a wealthy and successful individual, together with their advice and contacts remains the optimum method.

Most people have heard of James Watt but have you ever heard of James Roebuck?

James Watt needed a financial backer to develop his first steam engine and James Roebuck a wealthy businessman took two-thirds of Watt’s original patent (9th January 1769) in return for discharging some of Watt’s debts.  Unfortunately despite Watt’s success the financial crisis of 1772 (caused by a credit boom in the previous two years: sounds familiar?) led to the bankruptcy of Roebuck.

James Watt still needed further finance and then went into business with Matthew Boulton (who took over Roebuck’s share of the patent) and they had a long and very prosperous association.  Interestingly enough there is no evidence of any written shareholders agreement between the two men: not an approach we would recommend.

This type of financing needs to be kept well away from any clearing bank or any government scheme!

Please do have a look at the Opportunities section of our website to see investment opportunities and at the Portfolio section to see how our business angel backed investee companies are performing.

This new process followed political pressure and figures from the Federation of Small Businesses (FSB).  The FSB’s research showed that 16% of small businesses were looking to borrow money and of those nearly 40% were being turned down.

The appeals system allows a small business to appeal to a more senior bank employee to reconsider its application. The appeals process only applies to businesses with a turnover of less than £25m.

Last week the Financial Times reported that about one-third of the 800 appeals that have been ruled upon since the process was set up in April have ended up with the original refusal to lend by the bank being overturned.

However, the success rate rises to 40 per cent for those at the volume end of the market – making requests for overdraft facilities, credit cards and smaller loans.

Even among businesses rejected for loans in excess of £1m, the appeals process is overturning about a fifth of the decisions, according to Russell Griggs head of the process, who chaired the CBI’s small business council before taking up his current role.

Why so little media coverage of this?

Please do have a look at the Opportunities section of our website to see investment opportunities and at the Portfolio section to see how our investee companies are performing

One of the key features of capitalism is its ability to bring in change.  Old ways of working, old organisational structures and old products fail as new ones start to dominate via the mechanism of the market.

Typically customers’ spending preferences decide which new ideas will be successful.  This “creative destruction” is a very brutal process as failure has to precede renewal.  If there were no “safety nets” change could result in substantial long-term hardship for people.

The evidence is building that excessive “safety nets” have prevented our form of capitalism from confronting the changes necessary in a world economy being driven by China, India et al.  Some of these changes will be unpleasant until we learn to adapt and accept them.  But, the longer we delay the more painful the changes are likely to be.

Greece for example has resisted change for too long and is now having to play a very painful catch-up game.  Others in the Euro area appear rather resistant to change while some, like Ireland, are now responding rapidly.

The private sector in the UK has long been exposed to change and appears to be flexible enough to adapt.  There are promising signs of change in some parts of the public sector as well but there are still some resistors  there most obviously in education and health.

These resistors need to look at the lessons from history to see their fate.

There are two measures to consider:

First the budget deficit (Deficit): how much governments are spending in any one year compared to the amount raised in taxes.  The Deficit is measured as a percentage of Gross Domestic Product (GDP) and countries in the European Union have a theoretical limit of 3% for their Deficits.

Secondly the total amount of debt the country owes; again this is expressed as a percentage of GDP.  There is no real maximum limit here it depends on who will lend the money and at what cost.

Looking at the Deficits first, remarkably in 1999 the UK had a small budget surplus, Greece was in balance and Germany had a very small Deficit.  Compare that to the position at the end of 2010 when the UK and Greece had Deficits in excess of 10%, while Germany had a Deficit of 3%. (Ireland had a Deficit of 32% in 2010!).

The UK and Greece both reduced their Deficits during 2010 while Germany’s remained the same.

The total debt picture mirrors this. In 1999 the UK had debts of 44% of GDP; Germany owed 61% and Greece owed 94%.  In 2010 the UK debt had risen to 80%, Greece to 143% and Germany to 82%. One major plus point for the UK is that its debt is relatively long term compared to most other countries: maybe something to thank the bankers for?

David Cameron has said he believes that the UK has a debt crisis and not a cyclical drop in growth hence the current absolute focus on deficit reduction for the next few years.