The previous three instalments of our "How to ..." series focused on investing in companies listed on the stock exchange. There are also good investment opportunities to be had in unlisted companies. But because it is less regulated, the unlisted share market also attracts crooks. We tell you what to look for in an unlisted company - and how to avoid getting burned.
Investments in companies not listed on the stock exchange range from shares in reputable but unlisted public companies to dodgy deals dreamed up by con-artists. The more you know about this less-regulated market, the more informed your investment decisions will be.
A public company is one that offers shares for sale to the public, and unlisted shares are shares in public companies that are not listed on a stock exchange. A private company, on the other hand, is one whose shares are not traded on the open market.
The Securities Services Act (SSA) regulates the trading of unlisted shares to a limited extent. According to the SSA, the Registrar of the Financial Services Board (FSB) can impose conditions on the trading of unlisted shares or on specific types of unlisted shares.
However, the provisions of the SSA that allow for action against insider trading, market manipulation and the publication of misleading statements apply only to listed companies, not unlisted ones.
Unlisted companies include those with an established track record that can give you some comfort in their ability to deliver ongoing good results, new companies that are just starting out or have a short history but look promising and may be worth the risk, and "companies" that are simply a front for a scam.
One way to check on the legitimacy of a company is to find out if it is registered. All companies, listed or not, are regulated by the Companies Act and must register with the Registrar of Companies.
You can check if a company is registered by going to www.cipro.co.za- click on "products and services" and then click on "enterprise search". You will need to know either the company's registered name or its registration number. But bear in mind that even if a company is registered, it may still serve as a front for dubious activities.
In terms of the Companies Act, every company - listed and unlisted - has to:
- Issue a prospectus;
- Register as a public company if it wants to sell shares to the public to raise capital. (Public companies can either sell you shares or debentures, which are loans made by you as an investor to the company. The sale of both debentures and shares fall under the Companies Act.);
- Submit annual financial statements to the Registrar of Companies;
- Have annual general meetings to which all shareholders are invited and where they have the right to vote on the composition of the board of directors and decisions concerning company activities; and
- Appoint a company secretary.
The Companies Act also outlines what information you should find in a company prospectus, including a general history and financial details of the company for up to the past five years. Be wary of start-up companies with a history of less than three years or no history at all. Such companies should at least have detailed information about their business plan.
When you look at the company's financial statements (as discussed last week) remember that a big order book does not automatically mean big profits. Order books can easily be trumped up to give you the illusion of a profitable operation. Check the cash flow statement for a more realistic idea of the company's financial situation.
The prospectus should include the following:
- A statement telling you why the company needs to raise money through a share offer and what this money will be used for;
- Details of any loans, including debentures;
- Details of all fixed assets, such as immovable property;
- Details of all contracts that will have an effect on the finances of the company;
- An indication of any direct or indirect interests each director has in promoting the company and in any property the capital raised in the share offer will be used to buy;
- Details such as the number of shares offered, the class of shares, and the issue price;
- The minimum amount the company intends to raise through the share offer;
- A statement telling you how a shortfall of money will be financed if the share offer does not raise sufficient capital.
If it can be proved that the directors knowingly provided false information in the prospectus, and you suffered a loss through buying shares based on that information, the directors may be obliged to compensate you. They could also be fined and/or face imprisonment for up to two years.
Anyone advising you about or selling you an investment in an unlisted company must be registered as a financial services provider under the Financial Advisory and Intermediary Services (FAIS) Act. To check if a financial adviser is registered with the FSB, go to www.fsb.co.za and click on the FAIS link.
Your adviser should also tell you what products he or she is authorised to sell, because there are different levels of FAIS accreditation. To sell shares to you, your adviser needs a category-one licence.
Trading
Unlisted shares are not traded in a regulated market like the JSE. Trade in these shares is said to take place "over the counter" (OTC).
When you buy OTC shares in public companies, you can either do so through a stockbroker, just as you would if you were investing in listed shares ("How to invest in shares", Personal Finance, April 4), or you can buy them directly from the company you are investing in.
If you buy direct from the company, you can save on stockbroker fees. But because unlisted shares are not traded through an exchange, you may have difficulty selling your shares when you decide to disinvest because you will first have to find a buyer. Many unlisted shares are illiquid or thinly traded, which means they rarely change hands.
Many prominent unlisted companies, such as Clover, Pioneer Foods and Venfin, have links on their websites that tell you which stockbrokers to contact to buy their shares. Others allow you to buy shares directly from the company secretary.
Some company websites also have information such as the bid and ask share prices and the closing share price for the previous day.
Prices of unlisted shares are not published in the media, so you will have to rely on your broker or the company itself to tell you what your shares are worth. However, even your broker (also known as a trader) may not be aware of all the dealing in a particular share.
Do your homework before investing
- Establish what the company's business is and how it makes its money;
- Be wary if you are offered returns on your investment that sound too good to be true;
- Carefully review the financial statements, management's background and the company's business model before you make an investment decision;
- Check that the directors of the company are reputable - find out what their backgrounds are;
- Study the products and services being offered by the company and make sure you are not buying an empty shell. Ideally, you should visit the company premises yourself - don't invest in something you can only see on paper;
- Find out who the company auditors are - check that they are independent and discuss the company's prospects with them;
- Be wary of promises that the company is soon to be listed on the stock exchange and that you will make a big profit if you "buy now". Contact the stock exchange yourself and find out if the company's application for a listing has been received.
Warning signs of a scam
Many investment scams take the form of share offers in unlisted companies. There are some warning signals that should immediately raise your suspicions.
One is that con-artists rely on hard-sell tactics. These often take the form of lavish promises, including guarantees on your capital and high returns. You may be told that the offer is limited to a certain period or that only a limited number of people can participate in it - this is to get you to part with your money as quickly as possible, before giving the decision considered thought.
A good rule is to ask for copies of the investment proposal, or prospectus and financial statements so that you can study them at home and seek advice from an independent financial adviser or lawyer. If a salesman refuses to part with documentation or insists that you sign on the spot, without taking the documents home first, you should start running as fast as you can.