Last week we tackled the thorny issue of whether company management really do look out for shareholders interests. We saw that in large unwieldy companies, shareholders (Principals) tend to cede control to management (Agents). And when let off the leash, management have a fantastic talent for enriching themselves at the expense of shareholders.
But the PA problem isn’t unique to big companies. In fact it is rampant among small caps too.
Every year, thousands of investors are ripped off by unscrupulous start-ups – hustlers whose only intention from the start is to milk money from their shareholders.
And I’m not just talking about scam artists and boiler rooms. Many of these start-ups have respectable reputations – you might even be considering investing in one yourself.
Today I’d like to talk about a widespread problem among startups. And three ways you can spot these troublemakers from the off.
Tread very carefully among the small caps
Many small cap shares are tightly held among management and founders. And that is usually a good signal that they have the best interests of shareholders in mind when they go about their business.
But there are plenty of dangerous start-ups out there that don’t – companies set up by serial entrepreneurs whose sole intention is to take fresh capital from investors, and re-deploy it to insiders through fees and other special arrangements.
Having worked for a bona fide City firm, I was blissfully unaware of these kind of activities for many years. It wasn’t until I left the City and set up my own business that I fully appreciated how cynical some business founders are.
But during the dotcom boom it was absolutely rampant. I saw at first hand the shady practices and people involved in many small company set-ups. And I’m sure the very same thing is happening today.
Here’s some advice for avoiding the nasties…
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Three nasty warning signals to look out for
If you’re going to set up a business with a view to skimming people’s cash, you’re going to have to sell the idea to the punters. That means setting up a business in a fashionable area of the investment market.
Back in the late nineties, that meant the technology markets. At the moment, you’ll be looking at resources and energy for instance. The hustlers will always set out to take money from the greedy – and that means faddish stocks – to take out anyone chasing a runaway market.
Secondly download the original company prospectus and subsequent company accounts – see if any party seems to be skimming off unreasonable fees.
The third thing to look out for are the ‘promoters’. By this I mean the people who are really behind the business – and that probably won’t be the ‘front-man’. Look at the share register – see who the key stockholders are. Note who the company accountants and advisers are.
Check out whether these guys are what I call ‘serial entrepreneurs.’ That is do they get involved in loads of start-ups and small companies every year? Have they got links with loads of failing, or failed businesses?
Anyone can be a private investigator
I know that this due diligence sounds like a lot of investigative work. But with the advent of the internet, it’s a lot easier to do your ‘due diligence’ on these guys than in the past. Put their names into a search engine and see if they come up on discussion threads for other stocks. Believe me, if these guys have been involved with failed businesses, there’ll be disgruntled investors out there talking about it.
You can also get details of company directorships of any person at Companies House. If one of your directors has about 50 other posts in faddish and dodgy sounding companies, it should start alarm bells ringing.
Look up the company adviser. Is it a blue chip City name? Somebody with a decent reputation? If not, check out their pedigree – have they been involved with success stories, or failures?
Lastly, if you get the opportunity, go to the company AGM (if you’re not a shareholder, you can buy a single share to get your invitation) and meet the guys involved. See if they are just ‘City suits’, or whether they look like the genuine article, someone with a passion for the business.
So it is well worth doing a little digging on the internet. A couple of keystrokes could end up saving you a hell of a lot of money!
By the way, here’s a hint. If you need a hand finding great small cap candidates, get Tom Bulford’s help. He’s been round the block a few times and will give you some great leads. You can read about his Red Hot Penny Shares letter here.
Red Hot Penny Shares is a regulated product issued by MoneyWeek Ltd. Forecasts are not a reliable indicator of future results. Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Penny shares can be volatile, relatively illiquid and hard to trade. There can be a large bid/offer spread so if you need to sell soon after you’ve bought, you might get less back than you paid. This can make them riskier than other investments. Please seek advice if necessary. 0207 633 3780
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