This article first appeared in Money Observer.
This should change. Allowing ISAs to hold unquoted shares would mean investors could buy into companies at an earlier stage. This would create more flexibility for building diversified portfolios.The range of assets you can hold in an ISA has grown steadily over the last few years. Yet there remains an obvious gap. At present, investors can’t use ISA funds to buy shares in unquoted companies.
There’s another huge benefit. Hundreds of billions of pounds are held in Stocks and Shares ISAs. This would open up that pool of capital to some of the UK’s most high-impact businesses.
The logical next step
In 2013, ISAs were permitted to hold shares of AIM-listed companies. This has proven very popular with investors, and has developed into an important source of finance for smaller companies.
Unquoted equity is the logical next step. Indeed, investors can already invest in unquoted companies via peer-to-peer (P2P) lending platforms. And thanks to the Innovative Finance ISA, they can do so with ISA funds. But there’s a catch. As things stand you can only invest ISA funds in the debt of unquoted companies. Not the equity.
This limits returns to the interest received. Investors don’t share in the upside if the company does well, and so are denied the chance to make potential returns of five or ten times their money, which are perfectly possible with early stage companies.
This is despite the fact that investing in the debt of unquoted companies can sometimes involve a very similar level of risk to investing in the equity. The current regime lets ISA investors take equity-type risks without offering equity-type returns.
A boost for Britain’s smaller companies
Allowing ISAs to hold unquoted shares would also unlock more investment capital for Britain’s entrepreneurs.
More than £300 billion is held in Stocks and Shares ISAs. Investors often hold assets in their ISA indefinitely, withdrawing money as a last resort, so this is some of the most patient capital around. While smaller company investing is not for everyone, and is likely to be high risk, it would only take a small proportion of ISA investors to make a big difference.
Giving small, unquoted businesses a chance to access this capital makes sound economic sense. It would channel more capital to those businesses at the heart of economic growth and job creation.
The Octopus High Growth Small Business Report, published earlier this year, finds that 22% of economic growth is created by less than 1% of all UK companies. This same group of small companies creates one-in-five new jobs.
Some of these businesses are listed on AIM. But many are not. Letting ISAs hold unquoted shares would provide an additional source of financing to help small companies scale up, especially those companies too big to receive venture capital trust or Enterprise Investment Scheme funding but too small to list or attract institutional investment in the UK.
At present, such companies often turn to overseas funders, typically from the US. Or they end up selling the whole company to a big US corporate, which takes the intellectual property as its own. In other cases, businesses slow down their growth and even lay off staff until they can secure more funding.
Letting ISAs hold unquoted shares would help create an investment environment more akin to what has been achieved in the US. This would help more businesses succeed and would keep more productivity within the UK.
How to do it
Adapting the existing ISA legislation would instantly open up a very large pool of capital for entrepreneurs at a time when other sources of funding may be disrupted, for example following Brexit.
Investors would be free to find promising businesses themselves and use their ISA funds to back them. In such cases they may well have an information advantage, for example if they personally know an entrepreneur is talented and diligent.
Or they may find opportunities via a specialist early stage investment manager.
Either way, investors would have a broader range of opportunities, while more small companies would get access to a major pool of capital. It’s time for the UK to unlock these benefits.
For journalists in their professional capacity only. The value of an investment, and any income from it, can fall as well as rise. Investors may not get back the full amount they invest. Personal opinions may change and should not be seen as advice or a recommendation. We do not offer investment or tax advice. We recommend investors seek professional advice before deciding to invest. Issued by Octopus Investments Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 33 Holborn, London, EC1N 2HT. Registered in England and Wales No. 03942880. Issued: October 2018.