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RISING SPEND ON OVERHEADS WIPING OUT AIM COMPANY PROFITS

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But directors silent in annual reports on rising running costs

Research into the accounts of 134 AIM-listed companies by accountancy firm SKS Business Services reveals a surprising leap in spend on non-core operations that has more than wiped out their profits[i] over the past 5 years. Findings include:

  • Overhead costs have increased 21 per cent since 2008 (compared to inflation of 12%, a real increase of 9%), while profits have fallen from an average of £9.6 million to an average loss of £1.52 million.
  • In the most recent year for which accounts are available (year-ending 2012) AIM-listed companies spent 5 per cent more on non-core operations than in the previous year.
  • Despite the rise in General & Administrative expenses, only 3 of 134 AIM companies analysed provided any explanation to investors on why this is happening or what they are doing about it.

The in-depth study of 670 small-cap financial reports[ii] shows that costs relating to non-core operations such as finance, legal and rents have soared 21 per cent in the last five years from £4.53m in 2008 to £5.47m in 2012, while profits over this time have fallen from an average of £9.6 million to an average loss of £1.52 million last year.

RISING SPEND ON OVERHEADS WIPING OUT AIM COMPANY PROFITS 3Firms operating in alternative energy and chemicals spend the greatest portion of their revenue on General & Administrative (G&A) expenses, while food producers and construction companies have their non-core operational costs most in check.

SKS expected to find that high investment sectors, such as energy and chemicals, will have high G&A spend as they need the support infrastructure to develop their products, while traditional sectors will have developed efficiencies and have their non-core costs in check.  However, overall and across all sectors, the research shows that head office costs are going up disproportionately.

Of 134 of the Aim-listed companies, only three have management discussion and analysis (MD&A) reports – in other words barely 2% of AIM companies, a very surprisingly low amount.  In these three reports, G&A is only mentioned with regards to an increase in costs, rather than in terms of any plans to reduce it.

Sanjay Swarup, Director, SKS Business Services, said:Although AIM-listed companies are not required to produce MD&A reports, their absence and the increases in costs in this area suggests that overhead and administration costs are not being properly managed at many.

“Regardless of the general upward trend of costs caused by compliance and regulatory matters, the past few years presented the opportunity to cut costs through better use of technologies and generally negotiate better terms with suppliers. This has not been the case and, in particular, there is compelling evidence here of endemic over-spending at AIM companies on non-core operations such as financial and professional services.

“Declining profits should mean belt-tightening, but at smaller cap companies overhead costs have gone up 9% in real terms.  Many seem to be developing puppy fat, at the expense of profits, when costs could easily be cut from their support costs without reducing the quality of these services.”

SKS Business Services estimates that these companies could reduce their G&A costs by up to 20% per cent just by restructuring their finance function and through a smarter use of outsourcing.

Sanjay Swarup added:  “While many of the companies we have looked at are developing reputations for innovation in fields such as biotechnology, oil and gas exploration and technology, many don’t seem to have their eye on controlling their general running costs.”

Sanjay Swarup said:  “The absence of MD&A reports and the silence of most companies’ directors on this issue is also worrying.  The MD&A report is a great opportunity to provide information to current and potential shareholders.  Investors like to hear about profits – both new sources of revenue and also what management is doing to control costs to ensure increased revenue actually boosts profits.”

G&A vs. Revenue Analysis

G&A vs. Revenue Analysis

 [i] See chart at the end of this release for summary of SKS’s research into Aim company G&A costs

[ii] The financial reports for financial years-ending 2008-12 (the last full year for which all accounts are available) of 134 randomly selected AIM-listed companies were studied by SKS Business Services in September 2013.

 

Investing

An outlook on equities and bonds

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An outlook on equities and bonds 4

By Rupert Thompson, Chief Investment Officer at Kingswood

The equity market rally paused last week with global equities little changed in local currency terms. Even so, this still leaves markets up a hefty 10% so far this month with UK equities gaining as much as 14%.

The November rally started with the US election results but gathered momentum with the recent very encouraging vaccine news. This continued today with the AstraZeneca/Oxford vaccine proving to be up to 90% effective in preventing Covid infections. This is slightly below the 95% efficacy of the Pfizer and Moderna vaccines already reported but this one has the advantage of not needing to be stored at ultra-cold temperatures. One or more of these vaccines now looks very likely to start being rolled out within a few weeks.

Of course, these vaccines will do little to halt the current surge in infections. Cases may now be starting to moderate in the UK and some countries in Europe but the trend remains sharply upwards in the US. The damage lockdowns are doing to the recovery was highlighted today with the news that business confidence in the UK and Europe fell back into recessionary territory in November.

Markets, however, are likely to continue to look through this weakness to the prospect of a strong global recovery next year. While equities may have little additional upside near term, they should see further significant gains next year. Their current high valuations should be supported by the very low level of interest rates, leaving a rebound in earnings to drive markets higher.

Prospective returns over the coming year look markedly higher for equities than for bonds, where return prospects are very limited. As for the downside risks for equities, they appear much reduced with the recent vaccine news and central banks making it clear they are still intent on doing all they can to support growth.

Both factors mean we have taken the decision to increase our equity exposure. While our portfolios already have significant allocations to equities and have benefited from the rally in recent months, we are now moving our allocations into line with the levels we would expect to hold over the long term.

Our new equity allocations will be focused on the ‘value’ areas of the market. The last few weeks have seen a significant rotation out of expensive high ‘growth’ sectors such as technology into cheaper and more cyclical areas such as financials, materials and industrials. Similarly, countries and regions, such as the UK which look particularly cheap, have fared well just recently.

We think this rotation has further to run and will be adding to our UK exposure. This does not mean we have suddenly become converts to Boris’s rose-tinted post-Brexit view of the UK’s economic prospects. Instead, this more favourable backdrop for cheap markets is likely to favour the UK.

We will also be adding to US equities. Again, this does not represent a change in our longstanding caution on the US market overall due to its high valuation. Rather, we will be investing in the cheaper areas of the US which have significant catch-up potential.

We are also making a change to our Asia ex Japan equity holdings. We will be focusing some of this exposure on China which we believe deserves a specific allocation due to the strong performance of late of that economy and the sheer size of the Chinese equity market.

On the fixed income side, we will be reducing our allocation to short maturity high quality UK corporate bonds, where return prospects look particularly limited. We are also taking the opportunity to add an allocation to inflation-linked bonds in our lower risk, fixed income heavy, portfolios. These have little protection against a rise in inflation unlike our higher risk portfolios, which are protected through their equity holdings.

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Investing

Optimising tax reclaim through tech: What wealth managers need to know in trying times

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Optimising tax reclaim through tech: What wealth managers need to know in trying times 5

By Christophe Lapaire, Head Advanced Tax Services, Swiss Stock Exchange

This has been a year of trials: first, a global pandemic and, now, many countries facing the very real possibility of a recession. For investors, private banks, and wealth managers, these tumultuous times have manifested largely in asset price volatility, ultra-low interest rates and uncertainty about when things may level out, as well as questions about what can be done to safeguard portfolio performance.

The answer here lies within identifying and creating efficiencies to maximise performance and minimise cost, and while there is a slew of options as to how to do this, they are often siloed or have a single USP. Tax optimisation, on the other hand, provides benefits to all, not just in increasing returns for investors, but also in creating economies of scale across stakeholders, creating millions – if not billions – in savings for banks.

Evolving tax reclaim

The tax reclaim process used to be a tedious one banks had to manage themselves, and required detailed, industry and country-specific knowledge to stay on top of constantly shifting requirements and regulations. And when we consider that many countries – such as the UK – allow for capital gains exemptions, tax optimisation may not seem like an integral part of the process. However, this isn’t the case for all countries, and can lead to severe after-tax implications on global portfolios.

Furthermore, even if you’re able to avoid double taxation, getting the money back is not always as simple as it sounds. This, combined with the fact that countries often have contradictory taxation rules or requirements, makes navigating the tax reclaim space a challenge even for those with the right expertise and experience.

Ultimately, providing tax optimisation to investors ends up being a heavy lift for private banks and wealth managers, who often don’t have the right solutions, are relying on outdated technology and manual processes. While this is generally fine for business, it is no longer fit for the purpose when it comes to tax optimisation. To date, knowledge and expertise have been the key to protecting and maintaining profitable investments and avoiding tax leakage. However, through tax optimisation services starting to emerge, portfolio managers can now manage and reinvest easily.

Today, technology has evolved the process so that banks are able to access and submit tax reclaim – and the relevant documentation – online, leaving the tech provider to coordinate next steps with custodians and tax authorities behind the scenes. In essence, taking the legwork out of the process while assuring consistency and completeness in execution.

Simplifying tax through tech

While tax optimisation may seem like an easy choice in theory, it is not always the go-to for every private bank or wealth manager. Without the right supports and setup, including innovative technologies and automation, tax reporting must be done manually, leading to labour intensive processes and huge time wastage. Changing these processes can be overwhelming for those used to a certain way of operating.

By making tax reclaim digital, banks will be more able to optimise returns and gain efficiencies while reducing redundancies and unnecessary complexities. Cloud based solutions or platforms can offer a safe and secure solution for banks, wealth managers, and investors to access and submit any information required, processing the data automatically for conformity and completeness.

It is critical that providers who intend to offer tax services are able to do so efficiently with the right software and data processing capabilities. Not only does this drive continuity in service and efficiencies in process, but it is the only sustainable way to handle such a complex landscape sustainably without wasting time or money.

End-to-end, technologically driven tax services offer a huge number of advantages to private banks and wealth managers, the most important of which is the ability to provide continuity through tumultuous times. As we move through the end of 2020 into 2021 this will only be increasingly important as banks, managers and investors look to provide new services to clients and strengthen existing relationships in a difficult market.

As investors seek to find returns amid the global economic downturn, the demand for innovative solutions will only increase. Technology like cloud-based software, AI, and data optimisation can all serve to improve not just the tax reclaim processes, but the overall client experience within capital markets.  Private banks and wealth managers are suitably equipped to provide these innovative solutions, but those who do not prepare themselves effectively and keep ahead of trends will run the risk of losing current and new clients to someone who can offer more for less.

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Equity Sharing – How do you choose the right plan for you?

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Equity Sharing – How do you choose the right plan for you? 6

By Ifty Nasir, co-founder and CEO of Vestd, the share scheme platform

In a survey of 500 SMEs, nearly half told us that the pandemic had made them re-evaluate how they operate. That’s not surprising as they’ve been faced with some unique challenges this year. Government support during the early stages of the pandemic, is now being extended till March 2021 but many businesses continue to struggle.

Making good people redundant improves cashflow in the short term but will have a long-term damaging impact on the business. At the same time, motivating employees, who are working remotely and worried for their jobs, is not easy.  It’s therefore not surprising that equity sharing, in the form of ‘share’ and ‘option’ schemes has become even more popular, with one in four SMEs now sharing equity with their employees and wider team

However, sharing equity can be a complex area and is easy to get it wrong. When it goes wrong there is a danger that you create tax issues (for you and your employees), de-motivate your team and even create future funding issues for the company. It is therefore really important that you choose the right scheme to set-up, but make sure you manage it too.

Below is a brief summary of the main schemes used by Start-ups and SMEs in the UK today. There are similar schemes and considerations globally.

  1. EMI Option Schemes – This is the most tax efficient scheme. Recipients pay just 10% Capital Gains Tax (CGT) on any value growth. The employer can also offset both the cost of the scheme and the value growth achieved by employees against its Corporation Tax  liability. You can also set conditions to control the release of equity, such as time served or performance. The recipient can’t simply walk away with shares, having delivered no value (which is one of the top concerns of many of the businesses and founders we talk to).  EMI Option Schemes are used by 41% of SMEs (who share equity) and, for good reason, are the most popular. Read our full guide to EMI for more information.
  2. Ordinary Shares  – This is the issuance of  full ordinary shares in the business, often without conditionality and with immediate effect. They are most often issued against cash investment. Once an employee (or any other recipient) has ordinary shares, you have no control over what happens to the shares thereafter. The individual can simply walk away with the shares, so we don’t normally recommend them for contribution that’s yet to be delivered. They’re also not tax efficient, as the recipient will have to pay tax at their marginal Income Tax (IT) rate, on any value the shares have at that point. These are used by 31% of SMEs.
  3. Growth Schemes  – These are a good option when the founders have built value into their company. The recipient only shares in the capital growth of the business from the date that the shares are issued.  You can give growth shares to anyone (not just employees) and you can attach additional conditions. These shares limit the risk of the recipient having to pay income tax on receipt of the equity, as they do not hold any value when they are issued but do pay CGT on the value growth at sale. Growth schemes are used by 31% of SMEs. Read the full details on Growth Shares here.
  4. Share Incentive Plan – SIP –  This is a tax efficient plan for all employees that gives companies the flexibility to tailor the plan to meet their needs.  Share Incentive Plans are used by 23% of SMEs.
  5. Unapproved Options – These are not very tax efficient as the recipient will pay IT on any value inherent in the share, above the exercise price, when they exercise the option. That said, they do provide more flexibility than the other options and are the easiest to set up as you don’t need HMRC approval. Unapproved Options are used by 22% of SMEs.

Is it worth the hassle? Earlier this year (i.e. during the first lockdown ) we carried out a piece of research with  business leaders,  exploring their attitude towards sharing equity with employees and wider team.  We spoke to over 500 owners of SMEs and identified six main business benefits to doing so:

  • Recruitment. You can combine salary with equity, to create compensation packages that match, or improve on, offers made by other more established companies with deeper pockets.
  • Retain the best talent. Share schemes are proven to increase employee retention and can help you reduce if not avoid hiring costs.
  • Increase productivity and performance. Studies have shown that employees who are also shareholders are more committed to their work and contribution because they feel directly vested in the growth in value of ‘their’ company.
  • Improve employee engagement and happiness. The more all employees feel included in the mission, direction, and success of the business, the more they’re motivated to contribute to the company.
  • Relieve cashflow pressure. Equity can be used to reduce the need for finance. Instead of paying people top rates and large bonuses, you can incentivise them via shares or options…giving them a share of the future they are helping to create.

Recruitment and retention are clearly the key drivers. It’s not too surprising to see why. Companies succeed or fail largely due to the quality of the people they manage to attract and retain. However, for smaller and start-up employers, attracting the right people can be difficult.  Good people are typically attracted to the idea of working for a house-hold name brand, they look for job security and are enticed by comprehensive employee benefit packages and high salaries that are unaffordable by most smaller companies. Employee share schemes are an effective way for smaller companies to compete in the job market against larger companies, with that potential for a massive/significant upside.

However, at this challenging time, it’s not all about money, keeping people focussed and motivated during the pandemic is at the top of most employers’ worry list.  If you choose the right scheme, equity sharing encourages employees to align their motivations to that of the long-term success of the business, over the immediate or short-term gains. And, right now, that is perhaps worth more than anything.

If you’d like to get into the detail then check out our guide to employee share schemes.

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